Whether it’s a new idea that needs money to start, or an existing business that needs money to grow, there are a lot of funding options that don’t require sharing ownership with investors.
Don’t get me wrong; I am an angel investor, a member of a group of us in Oregon. I’m not saying anything against the investors. But the fact is that taking in investment means sharing ownership and having new co-owners. You no longer own the business yourself. Even if you manage to bring in investors without losing majority control, all shareholders have rights. Your decisions are no longer your own.
Crowdfunding has finally, after years of delay, started. It was allowed by the JOBS Act of 2012, but required detailed regulations that are still coming slowly. If it goes well—the results aren’t in yet—it may offer another way to get investment for a business to start or grow. But it is still investment, which means shared ownership.
Funding from family and friends is also investment, and means distributed ownership amongst those parties. Friends and family funding normally means smaller amounts, contributed by individuals or groups a business owner or entrepreneur already knows.
But what are the other options? There are a lot of other ways to get some working capital and fund your business, without sharing the ownership.
Not All Businesses Need Funding
The common assumption that all businesses need funding is simply wrong. Millions of service businesses don’t require expensive assets and startup expenses to get going. The consultant, graphic artist, bookkeeper, and freelance writer, to name a few, can start a business without anything but expertise and a first client.
A variety of professionals, such as doctors, lawyers, architects, and accountants, need years of schooling, licenses, and certifications prior to launching and seeking funding for their business. Oftentimes, these professionals spend money on office space, office equipment, logos, websites, and branding—but they don’t have to initially.
For a lot of these businesses, what they need to start is a first client. Additional money is nice, but not needed.
The best financing is early sales.
I know of several people who turned to Kickstarter to successfully raise money from pre-sales. Where I live, there’s a healthy yoghurt business that raised $20,000 for startup equipment by offering bundles of future purchases at an attractive discount through Kickstarter. There’s also a healthy juice food cart that gave cloth shopping bags and pre-paid collections of juices (to be redeemed later, after the cart opened) to customers, before opening, to get funds to buy and outfit the cart. I even prepaid a book over Kickstarter to get an autographed copy when it finally came out.
I mention Kickstarter because it’s the biggest and most well-known crowdfunding platform, but it’s not the only site providing ways to let people pre-buy product or services to facilitate early capital. You can also research Indiegogo, Rockethub, and many more that are cropping up. The idea is giving people incentives in order that they buy products and services that aren’t yet available. Then startups can borrow money based on the commitments made over these sites.
Pre-ordering or pre-sales aren’t confined to such platforms. Even before the web, it was possible for a startup to get early money from a future customer, sometimes, by offering the right deal. For example, I know of a deal between a software company and a magazine, in which the magazine committed to buying 1,000 units of a software product before they were available. And sometimes a pre-order or pre-sale will help finance the development of a product or service. That’s unusual, but it happens.
And some businesses can focus on the low-hanging fruit in the business to get revenues quickly, and use the early revenues to fund later growth. The most obvious example is the person who rents a food cart and starts serving customers, then uses the money from successful food cart sales to eventually contract a location and open the full restaurant.
Banks don’t invest in business plans. Banking law prohibits banks risking depositors’ money on a business plan.
Still, banks are nonetheless one of the most common sources of business financing. How can that be? Because small business owners borrow from banks, using personal assets like home equity, to finance their businesses. My wife and I had liens on our house for years because we were using a bank credit line to finance our software business. A business that has been around for a few years generates enough stability and assets to serve as collateral. Banks commonly make loans to small businesses backed by the company’s inventory or accounts receivable. Normally there are formulas that determine how much can be loaned, depending on how much is in inventory and in accounts receivable.
One of the most popular functions of the Small Business Administration (SBA) is to help fill the financing gaps for small businesses by guaranteeing loans that a lender makes to small businesses that they would otherwise not be able to finance. The SBA guarantees up to 85 percent of a business loan to support the business and offset risk to the bank. The majority of SBA loans are applied for and administered by local banks; however credit unions, non-profit lenders, and other lenders may also participate to provide SBA guaranteed loans. Your primary point of contact will be with a local lender throughout the process.
For startup loans, lenders participating in SBA’s programs will normally require an equity injection (investment) from the applicant small business in addition to any financing that the bank would provide. SBA does not have a minimum requirement for equity, and participating lenders apply reasonable and prudent standards based on the business’s ability to repay the proposed loan. Depending on the size of the loan, the lender must consider collateral such as any asset being financed with proceeds, other business and personal assets for collateral. Delegated Lenders participating in SBA programs can take as little as three days to approve an SBA-guaranteed loan to an eligible small business. If your own bank isn’t an approved SBA lender, you may contact your local SBA District Office (in every state) to request a list of participating lenders, or access additional information at www.sba.gov.
Non-Bank Business Loans
Aside from standard bank loans, an established small business can also turn to accounts receivable specialists to borrow against its accounts receivables.
The most common accounts receivable financing is used to support cash flow when working capital is hung up in accounts receivable. For example, if your business sells to distributors that take 60 days to pay, and the outstanding invoices waiting for payment (but not late) come to $100,000, your company can probably borrow more than $50,000. Interest rates and fees may be relatively high, but this is still often a good source of small business financing. In most cases, the lender doesn’t take the risk of payment—if your customer doesn’t pay you, you have to pay the money back anyhow. These lenders will often review your debtors, and choose to finance some or all of the invoices outstanding.
Another related business practice is called factoring. So-called factors actually purchase obligations, so if a customer owes you $100,000 you can sell the related paperwork to the factor for some percentage of the total amount. In this case, the factor takes the risk of payment, so discounts are obviously quite steep. Ask your banker for additional information about factoring.
In addition, equipment manufacturers often offer their own financing for major purchases. This is similar to a car loan to fund the purchase of a business van. It’s also common with equipment for restaurant kitchens, shrink wrapping, and other businesses.
Words of Warning
Never, never spend somebody else’s money without first doing the legal work properly. Have the papers done by professionals, and make sure they’re signed.
Never, never spend money that has been promised but not delivered. Often companies get investment commitments and contract for expenses, and then the investment falls through. Avoid turning to friends and family for investment. The worst possible time to not have the support of friends and family is when your business is in trouble. You risk losing friends, family, and your business at the same time.
Most businesses are financed by home equity or savings as they start. Only a few can attract outside investment. Investor deals are extremely rare. Borrowing will always depend on collateral and guarantees, not on business plans or ideas.