Starting a business can be incredibly exciting, especially if it’s a passion project. For many new business owners, building their own company from the ground up is a dream come true.
By HANNAH HICKLEN
Despite how rewarding it can be to start a new company, it’s an incredibly risky, stressful, and nerve-wracking process, especially because it can be very pricey. Startup expenses can quickly add up. New business owners should expect to spend money on:
— Insurance, licenses, and permit fees
— Equipment and supplies
— Website development
— Branding and marketing collateral
— Technological expenses, such as information systems and software
— Initial market research
In addition to startup expenses, businesses continue to spend money on payroll, workspace, office supplies, taxes, and inventory. As a result, it has been estimated that the average cost to start a business is around $30,000.
That’s a lot of money.
Although that number fluctuates depending on the industry, and there are ways to cut costs, funding a business yourself is still a major financial risk. For many new entrepreneurs, shouldering that expense simply isn’t an option. Instead, they need to find external funding from:
1. Family and Friends
2. Bank loan
3. Government grant
4. Line of Credit
5. Credit card
6. Venture Capital Investors
7. Angel Investors
Before selecting a source of capital, new business owners should consider the stage their company is in, their goals, the market they’re in, and how much money they need to get off the ground.
1. Family & Friends
Before turning to professional investors, some startup entrepreneurs turn to friends and family to get quick access to cash, but asking your close network for early-stage investments has its pros and cons.
For one, you can avoid going into debt, which can be a massive advantage if the business doesn’t reach the level of success that you expect.
Additionally, friends and family can be less stressful than receiving a loan from a bank or an investor. On top of that, your close network of family and friends are likely to believe in you and want to give you a helping hand. As trustworthy partners, they’ll be honest and let you know if the idea has merit.
However, going into business with friends and family can create a lot of tension and division. If things go smoothly, they might want to be more involved in the decision-making process and have differing opinions. If things don’t go well, you could lose their money, risking your personal relationship as well.
If you’re considering asking your close network to invest in your business idea, be sure to set clear boundaries and warn them of the risk ahead of time in order to preserve your personal relationship.
2. Bank Loan
Rather than financing the project yourself, you can still tackle your new endeavor by taking out a loan. Although you will take on debt and will have to pay interest on what is borrowed, a loan can augment cash reserves so you can continue to grow your business.
Loans usually have low-interest rates and are tax-deductible, which can make them an appealing option. Additionally, you’ll be able to avoid bringing in investors, so you can maintain control of the company and won’t have to share your profits with lenders.
However, going into debt shouldn’t be taken lightly. Most commercial lenders require you put up collateral, such as your stock portfolio or house.
On top of that, there are barriers to entry. Lenders require that you have a good credit rating so they feel confident that you’ll be able to repay them.
For new businesses that have difficulty accessing capital and getting a loan, they can turn to the Small Business Administration (SBA), a federal agency that helps small businesses get the funding and resources they need.
Although the SBA isn’t the lender, they guarantee a portion of each loan. The SBA can guarantee 85% of loans worth less than $150,000, and 75% of loans more than $150,000.
This reduces a lender’s risk, so small businesses like yours are more likely to be approved. It can also lower your interest payments, which can truly benefit you. In 2018, the average SBA loan amounted to $425,500.
3. Government Grant
Not to be confused with a small business loan, grants are a sum of money that the federal, state or local government gives to small businesses to use for very specific functions. Their most notable difference, however, is that grants don’t have to be repaid.
Of course, there’s a caveat; to receive a grant, businesses need to meet very specific criteria in order to qualify. Still, there are many options out there.
While small businesses continue to struggle due to the COVID-19 pandemic, forcing many to close, the SBA and several large corporations are offering grants in the hopes of saving businesses and stimulating the economy.
To see what your startup qualifies for, you can visit government sites like Grants.gov, or search for corporate small business loans from companies like FedEx, Invoice2go, or the National Association for the Self-Employed.
4. Line of Credit
A business line of credit is a short-term loan that extend the cash that’s available in a business’ checking count. It works similarly to a credit card, except businesses get access to cash and they can withdraw funds up to a specific amount.
This means that they can withdraw funds as they need it, instead of receiving a lump sum like they would through a loan. This means that businesses don’t have to pay interest on borrowed money that they don’t need. It also means that businesses have fast access to capital when they need it most.
Then, the business pays monthly interest payments on the advance until it’s payed back. However, the principal is paid off at the borrower’s convenience.
The main drawbacks include:
— Smaller borrowing limits
— New businesses can have a hard time qualifying
— Higher credit risk
However, line of credit loans is often a great option for companies looking to borrow money because they often carry a low APR and are very flexible. They also can help small businesses build up their credit history and build relationships with lenders.
5. Business Credit Card
Business credit cards can be used for just about anything related to your business and they’re easy to use. Generally, it’s easier to qualify for a credit card than a loan and it doesn’t take a lot of time to receive funds.
Assuming you pay on time, you’ll be able to build up your company’s credit and earn rewards. However, a credit card can also jeopardize your personal credit if you’re not careful.
It can also be an expensive option; interest rates vary between 8%–24%, which is why it’s important to carefully consider your business needs to determine what the best option is for you.
For example, businesses that have a lot of travel expenses could benefit from Capital One Spark Miles for Business because they can earn 2 miles per dollar on all purchases. But that might not be as valuable for a local floral shop that doesn’t need to travel.
Instead, Capital One’s Spark Cash for Business option might be better. It helps small business owners whose expenses don’t fall in traditional bonus categories get a high, flat rewards rate on every purchase.
When you’re conducting your research, be sure to check out websites like NerdWallet, that can help you compare different small business credit cards to fit your needs.
6. Venture Capital
It’s very challenging to receive funding through a venture capital investor. In fact, a recent Clutch survey found that only 1% of business owners received funding from VC investors in the first three months of business.
Part of the reason why is that, generally speaking, businesses usually have to be up and running to receive funding from VC investors. However, it can be a helpful option to help early-stage companies grow.
The most notable benefits of bringing on an investor is that, unlike loans, companies won’t have to pay the money back if the company fails. Rather, the investor takes on risk as well. In return, they’re required to share future earnings.
In addition to giving you the money they need to bring in new employees, cover expenses, or purchase new equipment, VCs can connect new business owners with industry leaders who can provide guidance.
While bringing investors into the business can either be a great opportunity, it could also be a big misstep for your business.
While investors often bring in industry knowledge and new ideas, founders may lose some control of the company. When there are additional stakeholders in your business, they often want to have a say in the decision-making process.
On top of that, companies that aren’t prepared to scale often spend too much on hires and expenses that won’t contribute to the business’ success in the long run. Investing too much in resources that don’t bring a lot of value to the business are often the reason why startups fail.
7. Angel Investor
Similar to VC investments, angel investors can help business grow considerably. However, there are a few key differences that can help business owners determine who they should work with.
Angel investors invest their own money, rather than a fund, so they’re usually likely to offer less money. In fact, the SBA estimated that the average angel investment is about $330,000, while the average VC deal is about $11.7 million.
However, angel investors don’t have the same protocols as VCs and are more likely to invest in businesses that are just starting out and take on riskier projects.
VCs, on the other hand, are focused on turning a profit, so they take on more proven companies with a likelihood of higher return, such as tech companies.
For companies looking for external funding, this means that they need to identify the type of investor that aligns with their business goals.
For example, an angel investor with background in real estate is more likely to reinvest in real estate companies.
Before you go looking for an angel investor to fund your business, be sure to do your research and find an accredited investor to get the support you need.
To increase your chances of receiving funding from either an angel or VC investor, be sure to get your financial statements in order by either bringing in an accounting firm or investing in accounting software.
Various crowdfunding platforms allow startups to harness the power of the internet to raise money and is increasingly popular. Not only do they help entrepreneurs raise money for their projects, but they also can use the platform to market their business to people online.
However, there is no guarantee that businesses will be able to raise enough money through a crowdfunding platform to finance their business. Rather, they have to compete against other startup ideas to get the most traction.
In order to make the process worthwhile, startups need to create an effective strategy that will bring attention to their idea.
The first step in this process is determining what type of crowdfunding platform will help them bring in investors: equity-based or rewards-based.
Rewards-based crowdfunding platforms, such as Kickstarter and Indiegogo, require companies to provide investors with incentives or rewards to attract people. This could be anything from a thank you card to access to the product.
It’s, therefore, very important that companies figure out what their audience wants. Some companies create tiers so bigger donors receive better rewards. This also incentivizes them to donate a bit more.
In comparison, companies on equity-based crowdfunding sites offer a piece of the company in return for capital. The main benefits here are that, usually, investors are more accomplished and can help drum up larger sums of money.
Similar to the issues associated with traditional investors, companies have to determine if they’re willing to give away some of their future profits.
For founders interested in equity-based crowdfunding should check out:
After setting funding goals and identifying what strategy works for them, startups can post their campaign online, complete with marketing materials, videos, social media links, and incentives to attract investors.
Find the Funding Option that Will Suit Your Business Goals
As new business owners look to get their company off the ground, the bill for website development projects, marketing, and other startup costs can get pretty high.
In order to get the project started on the right foot, founders often have to turn to external sources to secure funding.
There are pros and cons to every financing option, and so business owners looking to expand need to carefully consider what their goals are and what they’re willing to risk to make their business successful.
In early startup stages, some people turn to their personal network to ask for financial help. However, going into business with friends and family can put unnecessary strain on their relationship.
Instead, others will go to bank for a loan, take out a business credit card, or use their line of credit, taking on debt in order to make their dreams come true.
While there are other less-risky options, like grants and bringing on investors, those can be hard to come by and have their own drawbacks.
Still, the reward of having a successful business is enough that startup owners find a way to access funding and help their companies grow.
Hannah Hicklen is a Content Writer & Editor that supports content and research efforts for Clutch— an Inc 1000 company that provides B2B research, ratings, and reviews.