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If you want to be an entrepreneur, you need more than just a great idea. The sad fact is that about 45 percent of businesses fail within their first five years.
While there are many reasons why so many new businesses don’t make it, one thing is clear: access to capital and cash flow is critical to a business’s success, especially in the early years.
Fortunately, when it comes to financing a business, entrepreneurs have more options now than ever before. Each financing option has its own advantages and drawbacks, depending on an entrepreneur’s situation.
Let’s take a look at some of the most common options for financing a business, so you can determine the best fit for your own company.
One of the most popular ways to finance a business is by relying on yourself and your own cash to get your business off the ground. Self-financing is often called “bootstrapping.”
Entrepreneurs can self-finance their new business in a variety of ways. For example, a person could use his or her personal savings, or earnings from another job, to fund startup costs and provide cash flow as a business is first getting started.
Alternatively, entrepreneurs often use a personal credit card (or cards) to finance their companies as well.
However, you’ll need sufficient savings or credit to self-finance your new company. Self-financing may also impact your credit or create other opportunity costs in your personal life as well; it is difficult to purchase a home or support your family if all of your savings are tied up in a new business that hasn’t started earning money yet.
Finally, if you only have a finite amount of personal funds to allocate towards your business, you may be caught short at a critical juncture when your company needs a critical cash infusion.
You could also miss out on a fleeting moment to gain a competitive advantage over your rivals if you don’t have the cash you need in your bank account.
RELATED: Small Business Grants.
Friends and Family
Another way to finance your business is by borrowing money from close friends or family members. Some of the mightiest companies in the world were launched thanks to the financial support from the friends and families of visionary entrepreneurs.
In fact, Jeff Bezos started e-commerce giant Amazon with a $250,000 loan from his parents. If you have someone close to you that has deep pockets, or who otherwise is willing to back your venture financially, this may be a good financing option to consider.
However, there are clear drawbacks to relying on friends or family to finance your business. If your business falters, or you opt to take it in a different direction than what you initially told your loved ones, you could put a tremendous strain on your relationship.
Your friends’ and family members’ increased involvement in your business could become a source of tension in your life as well. So, before you take a business loan from people close to you, make sure you’re confident your relationships can take it.
Another way to finance your business is through debt. You could opt to take out a business loan from a bank or other lender to finance all of your startup costs and provide the initial cash flow you need to get your business off of the ground.
Working capital loans are another debt option many businesses use. Working capital loans are usually short-term lines of credit that businesses can use to pay everyday bills and expenses; they are useful for companies that may have to wait long periods of time for customers to pay for goods or services that have been invoiced.
There are some drawbacks to debt financing, however. For starters, if you don’t have sufficient credit, it may be difficult to qualify for the amount of money you need for your new company.
Additionally, if your loan has a rigid repayment structure, it could really put the squeeze on you during lean times. So, if you don’t have much credit history or have bad credit, or you’re worried about being able to repay a loan, you may want to think about other options to finance your business.
Another option to get your company the funds it needs is through equity financing. With equity financing, external investors agree to provide the funding your company needs to get off the ground and begin operating.
In most cases, investors will recognize you won’t be able to pay them back immediately and will provide you more flexibility in repayment terms; after all, since they’ve invested in your company, they have an interest in seeing it succeed.
However, the flexibility inherent with equity financing usually comes with a price: control of the company, or a stake in its future profits.
Many equity investors will demand some level of influence within a company they invest in, which could be challenging to deal with; they may even seek to have decision making authority on a company’s direction.
Additionally, investors may demand a share in the company’s financial success later on. You’ll have to be willing to deal with these types of tradeoffs if you decide to pursue equity financing for your business.
Another innovative way to finance your business is through crowdfunding. There are several Internet platforms that allow investors to assess companies, then pool small amounts of their own money together with other investors to back the companies they select.
These crowdfunding sites give startups a great alternative route to pursue the financing they need and also allow smaller investors to back innovative companies and then reap the rewards.
Many of these platforms, such as AngelList and CircleUp, are equity crowdfunding sites, where the investors secure some ownership or other type of stake in the company.
Other platforms, such as Lending Club, employ debt crowdfunding; the investors lend their pooled money to small businesses based on interest and repayment terms that they (the investors) set.
Many of the same challenges that businesses face with traditional debt and equity financing are still present when using crowdfunding platforms.
Businesses will have to be willing to either relinquish some level of control or profits with equity crowdfunding or commit to a repayment schedule with debt crowdfunding.
Additionally, most of these crowdfunding sites heavily curate the companies they offer to investors; if your company and your business acumen are still immature, it may be difficult to find a crowdfunding platform that will list it.
Invoice and Purchase Order Financing
If your business is already selling products or services – or close to it – you could attempt to use these to finance your business as well. With invoice financing, you can obtain short term loans against the value of invoiced sales.
You can also sell the invoices to a collection agency to raise cash as well, a practice known as invoice factoring. Similarly, you can also use purchase orders to obtain short term loans to cover costs and keep your cash flow solid until your customers pay you.
While many entrepreneurs successfully use these techniques to finance their businesses, they do have drawbacks. You must have sales or commitments to purchase your company’s products or services in order to even consider invoice or purchase order financing.
Additionally, if you choose to use these financing techniques, you also have to involve a third party (the lender or collection agency) which can get complicated as well.
How To Fund A Business: Parting Thoughts
You’re going to have to have a solid financial plan in place if you want your business to be successful. So, take all of the different options discussed here into consideration, and develop a financing plan that will work best for you.
Thanks for reading our business financing article.
You may also be interested in How To Start A Business.