Starting a new business isn't cheap. Even on the internet, I've seen
more than a few entrepreneurs experience surprise when they start to
realize how much it costs to get a venture off the ground.
Making sure your new business is well-capitalized is an important part of achieving success. For that reason, it's important to ask the question: how much do I really need and where am I going to get it?
When it comes to the latter part of that question, here are the most common methods for financing a new business, along with the advantages and disadvantages of each.
Savings or retirement. If you have money in the bank (or a retirement account) and it's enough to finance the startup of your new business, raiding it is a quick and easy way to obtain startup capital.
Advantages: Being able to finance the startup of your own business means you don't have to spend time raising money and it also means that you don't have to give up any equity -- two very desirable things.
Disadvantages: Your savings and retirement accounts provide a personal safety net and risking them is not for the faint of heart. Chances are you don't have an unlimited amount of cash, so it's important to realistically assess where you can get with what you do have. It's also important to consider any tax implications of cashing out retirement accounts early as in some countries you may have a lot less money than you expect after you pay the taxman.
Income. It may not be easy to do but some entrepreneurs don't quit their day jobs when building a new business. They stay gainfully employed, using their discretionary income to finance the business. Work is typically done nights and weekends.
Advantages: Security. Most new businesses don't take off overnight and leaving behind a decent job to start one is very risky, especially if you don't have the financial wherewithal to keep the electricity turned on and water running for at least a year. By staying employed, you can take things slowly and don't have to worry about running out of cash. If your new business takes off, you can quit your job without hesitation; if it doesn't, you've minimized your risk.
Disadvantages: Building a business is hard to do when you're limited to working nights and weekends. After all, somebody could be working full-time on something similar. And depending on how much discretionary income you have, your income may or may not provide enough cash to realistically get you where you need to go.
Debt. For entrepreneurs with access to credit or a significant asset or two, debt may be an appealing option. You've probably heard stories of entrepreneurs who financed wildly successful businesses with credit cards, a home equity loan or some other form of debt.
Advantages: As with using savings or retirement to finance a new business, debt enables entrepreneurs to skip the fundraising process and to retain full equity early on. And in some countries, there are loan programs with favorable terms designed specifically for the startup of new businesses.
Disadvantages: It's debt. If things don't go as planned, you could find yourself in a world of hurt (bankruptcy, the loss of collateral, etc.).
Friends and family. When looking to raise money for a new business, friends and family are often the most likely people willing to provide it.
Advantages: For most, raising money from friends and family is far easier than raising it from professional investors. And unlike professional investors, your friends and family will likely be happy to take a passive role in their investment.
Disadvantages: Unless you have a rich uncle, the amount you can raise from friends and family is usually limited. It's also very important to tread carefully when doing business with friends and family for obvious reasons.
Professional investors. Behind many of the most successful startups you'll find angels investors and venture capitalists -- professional investors that specialize in attempting to find the next big thing.
Advantages: For startups that need a lot of capital, angels and VCs may be the only ones who have it. The best of them can also bring experience, industry connections and professional assistance (management recruiting, referrals to trusted service providers, etc).
Disadvantages: Equity financing may seem cheap but it's the most expensive form of financing available in the long-run. Because you're dealing with professionals, investment terms are often tough. Additionally, raising money from angels and VCs can be extremely difficult and time consuming, especially if you're a first-time founder and/or lack connections.
What's the best option for you? There's no easy answer. Only after an honest financial assessment and proper business planning should one make a decision. The good news: tedious number crunching and business plan writing will not only help you choose the best financing option, it will help you increase your chances of success.
Photo credit: greggoconnell via Flickr.
Patricio Robles is a tech reporter at Econsultancy. Follow him on Twitter.
12:08PM on 8th September 2009
An important source of income is prepayment. If you have a business that can incentivise customers or clients to prepay some or all of the work/goods/services then you will be able to generate cash flow at a quicker rate than normal which reduces the need for capital injection of any sort. We launched Cheeze with a £5000 overdraft and funded the rest of the growth through incentivised prepayment which enabled us to grow profitably and maintain complete ownership of the agency with no debt.
Tech Reporter at Econsultancy
6:26PM on 8th September 2009
Jamie,
That's a good one worth adding to the list. Obviously, pre-payment probably works best for service-oriented businesses.
9:35AM on 9th September 2009
The question asked by many new entrepreneurs is "Can I get a grant?". The answer is almost always "No".
Usually, they’re only available to specific types of people or businesses, often in economically disadvantaged places. Even where they are available, the application procedure can be long and match funding can be required. For further information about grants, speak to your local Enterprise Agency or Business Link. More good advice here
11:13AM on 9th September 2009
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5:56PM on 9th September 2009
That's a great article on how to finance a business. One thing to consider is the cash operating cycle. If you adopt a business model where you receive cash from the customer before you have to despatch, such as online retail, then you may not need that much finance in the first place. I found some interesting articles at http://www.smallbusinessfinancetips.com/how-to-finance-a-business.html
10:31AM on 17th September 2009
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11:26AM on 19th September 2009
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12:23PM on 6th October 2009
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2:33PM on 7th October 2009
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9:04AM on 20th February 2010
Given that I'm currently working for a financial institution and that I have been developing web services solutions for a while now, I could only dream of ever seeing a book titled “Web Services in Finance”. When I picked it up, I was hoping to see web services technologies applied to real and concrete financial case studies. However, I must admit that the reality was quite different.
The book is very well written but its content has not much to do with what the title advertises. The book does not provide much information as to how to use web services for carrying out hardcore financial business. The author merely uses some financials terms here and there for explaining basic web services concepts and for showing some toy examples. He voluntarily stays at a very high level which completely defeats the intent behind the title he has chosen in my opinion.
Even though I expected something else, I still found this book to be a fun read. It can definitely be valuable for beginners in that it provides a very good introduction to the fundamental web services technologies, such as SOAP, WSDL, UDDI, etc, and it also goes into important topics like security and qualities of service. My biggest complaint is just that the box does not match the description that stands on it.
6:26AM on 6th May 2010
I prefer the bootstrapping method. It takes longer to get moving, but avoiding debt makes business so much more pleasurable! Nowadays there really are lots of business opportunities that can be started with little or no money…
6:16AM on 27th July 2010
Hello;
Well let me give you the "old guy" low down on starting a business and developing the coin to pull it off.
First of all spend some time actually putting a business plan together for yourself and those who you will at some time find it necessary to ask for serious cash.
This process will either make you more passionate or show you the error of your way.
Good luck;
McClain
10:31AM on 21st October 2010
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