As an entrepreneur, one of the biggest challenges you may face is securing enough funding to start or grow your business. While personal savings and income can be an initial funding source, external funding becomes necessary when additional capital is required. In this module, we will explore different types of funding options available to entrepreneurs and provide insights into their pros and cons.
Understanding funding
The simplest way to fund your new business is through personal income or savings. This approach, known as “bootstrapping,” allows you to rely on the cash generated from your initial sales to further develop your business while retaining full equity. Bootstrapping is particularly suitable for businesses with low startup costs.
However, if you lack personal savings or if your early sales are unlikely to generate sufficient profits to support your business, you will need to seek external funding.
Taking on debt
Taking on debt is a common option for acquiring funding. Debt can come in various forms, including bank loans, credit cards, and asset financing, where you borrow money based on company assets. In each case, the borrowed money must be repaid regularly over a predetermined period, and interest is charged.
Grants and equity financing
In addition to debt, you may also be eligible for grants, which are non-repayable funds provided by organizations or government agencies to support specific business activities. Grants can be a valuable source of funding but usually have specific eligibility criteria.
Another funding option is equity financing, where investors provide funds in exchange for a share of your business. This means giving up partial ownership and control of your business but can provide access to capital and expertise from experienced investors.
Business credit cards
A business credit card is a form of debt, but it can help you manage your cash flow. Before settling on a credit-card provider, make sure you compare a range of different cards aimed specifically at new businesses, if you’re just getting started.
Look for cards that offer management tools, such as separation of business and personal expenses and the option of obtaining extra cards on the account of employees to use for you.
A low-rate card is the best choice for paying back large expenses over time. However, you often need a good credit rating to be accepted for low-rate cards and the lender may not offer cashback or other rewards that may appeal.
Meeting obligations
Before entering into any financing agreement, it is crucial to thoroughly read and understand all the terms and conditions outlined in the agreement. These terms will establish strict guidelines regarding payment schedules, amounts, and whether the interest rate is fixed or variable.
In addition, the agreement may include penalties for missed payments and potentially for early repayment of the full loan amount, commonly referred to as “balloon payments.”
It is highly recommended to consult with an accountant or financial advisor before taking on any form of debt. They can provide valuable insights and help you assess how you will meet your financial obligations. It’s important to be fully aware of the potential risks involved, especially if you provide collateral, such as your house, as security for the debt. Defaulting on the debt could result in the loss of your collateral.
On the other hand, equity financing offers an alternative to debt. By seeking investors who provide funds in exchange for a share of your business, you can avoid taking on debt. However, it’s important to consider that equity financing typically involves giving up some control over your business to the investors. This loss of control is the “cost” associated with equity financing.
By carefully evaluating the terms and conditions of financing agreements and seeking professional advice, you can make informed decisions that align with your financial goals and minimize potential risks.
In the following sections, we will delve deeper into each funding option, exploring their pros, cons, and considerations to help you make informed decisions about financing your business.
Types of funding summary...
1. Bootstrapping
Funding your business using personal savings or income without external help.
Pros...
- No debt means no repayments and thus no liabilities if business income stops for any reason.
- Good for B2B enterprises, for example, if you offer skill based services.
- Suits most digital businesses and those where staff can work remotely.
Cons...
- Requires creativity and tenacity to build a business with limited funds.
- You'll need negotiation skills for specific payment terms with suppliers.
- Not suitable for businesses needing significant upfront capital, such as immediately paying staff or buying premises.
2. Debt
This involves borrowing money from bank loans, credit cards or finance secured against your personal or business assets.
Pros...
- You retain equity and keep control of the business operations.
- Short-term borrowing can help with cash flow issues in fast growth periods of the business.
- All profits are yours, as you won’t have to share with any investors or shareholders.
Cons...
- To access debt, you need a detailed business plan and cash flow projections for at least 12 months.
- You need skills to negotiate specific payment terms with suppliers.
- Interest rates are often higher if the lender sees you as higher risk.
3. Equity
This is where investors provide funds in return for equity in your business, a share of profits and also control in decision making.
Pros...
- Removes the burden of debt and eases financial worries.
- You benefit from the expertise of experienced business minds.
- Investors can help build your business through their networks.
Cons...
- Finding the right investor is a time consuming process and you’ll need to pitch them - which can actually be quite a fun process!
- Investors share profits and may want a return in the short term.
- You may lose some control over the runnings of your business.
4. Crowdfunding
Individuals will provide small amounts of money in return for early access to your products or services – or even in return for small shares of the business.
Pros...
- A great opportunity to test the concept of your business with little to no costs.
- You can reach people worldwide for support.
- You can retain 100% equity in your business by opting for rewards instead of shares to repay supporters.
- If you’re good at marketing and brand messaging you can start generating turnover before your products have been manufactured, before you’ve hired staff and before you’ve spent a penny on equipment.
- There are platforms out there that cater specifically for crowdfunding campaigns, however you can also host the campaign yourself.
Cons...
- Advertising cost management is vital if you opt to crowdfund as you need to ensure you retain enough profit to cover your start-up costs too.
- You need to calculate exactly how much you need to raise for the campaign and ensure you hit it. If you ask for too much, you may miss it. Ask for too little and you may not maximise your potential.
- Takes expert planning abilities and amazing customer communication skills.
Expert Entrepreneur Advice
- Prepare accurate cash flow projections when applying for funding to ensure meeting repayment obligations.
- Maintain sufficient cash in your bank account to cover monthly payments and avoid additional fees.
- Agree on strategic dates with the lender regarding fund transfers.
- Schedule repayment dates to align with cash inflows into the business account.
