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.