You have a terrific idea, but how do you raise the capital to turn it into a viable business? It’s one of the biggest challenges facing entrepreneurs. Most very quickly discover traditional lenders like banks are reluctant to lend money to start-ups without a significant track record of success, an impeccable credit history, and money already in the bank. If you had that, you wouldn’t need to borrow money!
While a Small Business Administration loan (SBA) loan is backed by the government and, thus, preferred by lenders for small business borrowers, they aren’t usually easy to obtain.
If borrowing from a bank is out, then, what’s an intrepid entrepreneur to do? Here are five financing alternatives to get you started with funding your start-up.
Many new business owners turn first to their credit cards for financing. While not ideal, credit card financing does offer some advantages. First, unless you have a bad credit history, credit cards are easily accessible, so you can get cash fast. Also, you can spread out your debt over multiple cards. You also can play “interest rate roulette.” This is when you move your debt from card to card based on the interest rate. Of course, there are disadvantages to credit cards, to wit:
- High interest rates—in some cases 21 to 24%
- Very quickly getting into debt over your head
- If the business fails, you may be stuck with a pile of unsecured debt and no way to pay it back, which could leave you with ruined credit—and in bankruptcy. If you choose to use credit cards to finance your business, proceed with caution. Set a limit for how much you are willing to invest in your business in unsecured debt before you call it. Or maybe combine credit card debt with other capital sources, such as the next one on the list: side hustle.
Rather than tapping into existing resources such as your day job or your life savings or retirement funds to help you pay for your start up, consider taking on a side hustle such as freelancing work or a part-time job and using that money as investment capital for your new business venture. It’s not a glamorous approach, and it may take you longer to get where you want to go, but it’s a more conservative option.
For instance, let’s say you want to own your own digital creative advertising agency. You might have a day job at an agency. If your employer permits, you could take on freelance graphic design work on the side, saving up that money for a year until you have enough to start your own business. The downside is you can’t tell your boss to take this job and shove it until you are sure you have enough saved. The upside is: when you do leave, you’ll have a decent-sized portfolio, a few clients of your own, and some seed money to get started.
Friends and Relatives.
Even though there’s an old adage about never doing business with friends and relatives, this is still a primary source of capital for many start-ups. There are a couple of ways to go about this. The first is to just borrow the money outright: “Mom, Dad, may I borrow $10,000 to open my new business?” The other is the ask several friends and relatives to invest in your business: they put in cash and, in exchange, they become “owners” of a percentage of the business just like any other investor.
The advantages of borrowing from friends and relatives is that they usually love you and want to support you in your efforts. The disadvantage is if things do not go as anticipated, you could lose not only your money but theirs as well. This could seriously damage relationships. For example, let’s say your parents lend you money from their retirement account, and you to lose it all, while they might forgive you, you might never be able to forgive yourself. Think carefully before borrowing from friends and relatives. If you do borrow, do so only in small amounts, and make sure they only lend what they can afford to lose. Reiterate to them that a start-up is a risky business investment in which there are no guarantees. Also, just as with other investors, make sure every arrangement is in writing.
With the popularity of TV shows like Shark Tank, it seems like every start-up gets an opportunity at some point to pitch investors. That’s not usually the case, though. Angel investors and venture capitalists typically look for very specific types of companies in which to invest. Your business may or may not qualify for those types of opportunities. However, it’s always worth being on the lookout for pitch competitions in your industry.
With this method of financing, founders usually give up ownership of some part of the business in exchange capital. Typically, start-ups seeking venture capital have prepared a strong business plan and a pitch that demonstrates how the money will be used and how the enterprise can become profitable. Investors will be looking for how much of their own time, money and effort the founders have already invested, and the viability of the business opportunity. The number one consideration: profitability. The prospective investors will want to know how quickly they can see a return on their investment and how much of a return they can expect to see.
Borrow from Retirement/Equity.
Borrowing from your own retirement accounts or against the equity in your home or other investments also are popular options for serious entrepreneurs who are “all-in” on their start-ups. The risk, again, is that if it doesn’t pan out, you’ve lost some serious investments. In Florida, your retirement account and home are protected from creditors in bankruptcy. The minute you borrow against them to invest in a business, however, you put these assets at risk. That said, if you are young enough (to recover if things go wrong), and your business idea is solid enough, it might be a better option to borrow from your own assets than to borrow from others.
So, when it comes to financing your start-up, what’s the right choice? That really depends on the time the type of business you’re opening, how long you think it will take to become profitable, what your goals are for your business, and your risk tolerance. Regardless, it’s important to consider all your options before making a decision.