How to Finance a Startup
By Emad Rahim, DM, PMP
Entrepreneurial financing might be one of the most difficult and intimidating aspects of business ownership. While entrepreneurs are filled with innovative ideas and passion, they’re often starving for the capital to jumpstart and grow their business.
Within the early and growth stages of your startup, debt and equity financing are the two types of financing that you can seek out. Early stage costs include the development of your business idea, writing a business plan, developing and testing a prototype, capital investments, product development and establishing operations. Then, there are significant marketing costs associated with introducing the product to the market. You’ll be responsible for building channels of distribution to make the product available to the consumer, and advertising and promotion to inform target customers about the product and get them to try it.
At this stage, your profits are often negative due to high startup costs, low sales volume and the inability to take advantage of economies of scale. So it’s critical to have sufficient working capital to keep your business running.
Where Do You Start?
The size of your startup, its asset structure, organization type, growth orientation and your own characteristics as a business owner are all relevant to how you choose to get financing. Some financing options don’t require you to have a written business plan, presentation detailed information or collateral either.
Regardless of the size of your company, startup businesses share common struggles. You’re not likely to generate significant revenue, yet you’re faced with the challenge of establishing your business within the market. At this point, startup companies must depend on their innovation to catch consumer interest. Also, higher risks exist during the early and growth stages, and income rarely equals or exceeds the company’s debt. As a result, you can expect lower profits.
During the early stage of the business, it’s common for entrepreneurs to rely on personal income, funds from friends and family, banks and finance companies. Government grants are also an option, however they’re difficult to obtain, and applications can take long to process. CNN Money author Ann field lists a comprehensive summary of Early Stage financing options and their pros and cons.
Are Investors the Way to Go?
Raising money from investors by selling shares or ownership in your company in exchange for cash can be a motivating venture – or it can be a foray into financing of the most frustrating kind. But if you don’t have the money, and can’t afford to take on debt, it may be your only, albeit less riskier, option. What can be great about taking on seasoned investors, however, is that they can contribute more knowledge of what it takes to create a successful business.
Venture capitalists, angel investors and other investment organizations tend to give businesses more money than any other avenue, and, of course, there’s no requirement to pay back loans. But the up to 80% returns, ownership and decision-making that you might be turning over could be a business newbie’s nightmare. Finding the right investors also requires a long process of due diligence and relationship building.
You’ll want to take note of the differences between angel investors and venture capitalists to shorten your financing search, however. Angel investors invest in companies both in the startup and growth stages of companies while they opportunity to capitalize on returns before your company becomes larger. Venture capitalists, however, rarely participate in early stage financing for two reasons. They target large deals only and consider early stage investments as too risky. Financing from venture capital firms and angel investors aren’t how most businesses get their money, however.
Whatever the combination of options you choose, make sure that you’re willing to manage the consequences of your financing plan. Money issues can be the bane of your business – whether you have too little to successfully operate or grow it, or too much from the wrong people or institution. Research your options carefully and tread strategically toward the best combination of options for you and your business.
Emad Rahim, D.M., PMP, is a PMI Certified Project Management Professional®. Dr. Rahim has more than 10 years of experience in business development, nonprofit administration, management consulting and project management.
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