Entrepreneurs have several avenues to find money for their business, but no matter which source you use it is not easy.
There is no free money as we have all heard. Even a grant has requirements and criteria that you must comply with. Let’s spend some time looking at the different ways that businesses can to find money.
The first place most entrepreneurs and business owners look for funding is to their own savings. This is the easiest money source. It is your money that you are putting into your business that you believe in more than anyone else.
If you are planning to start a business you should begin by putting together a business plan that tells you how much money you will need and put back as much of that as you can before you make the move. Personal savings has little cost except the interest money lost from a savings account.
The next place most people go for money is to friends and family. Often friends and family members will invest, give or loan their savings to you to grow your business. This is also a relatively easy and inexpensive way method.
Another source of funding for businesses is debt financing. Debt financing involves borrowing money from a bank or financial institution. This requires that you put together a business and financial plan and a personal financial statement. You will usually be required to put some money of your own toward the loan. This is called your personal investment and is similar to a down payment on a house.
There are very few places where you can get a 100 percent business loan. The typical owner investment ranges between 10 percent and 30 percent of the total project cost. With debt financing you pay interest and make monthly principal and interest payments. You will also have to provide collateral to secure the loan if you don’t pay back the money.
Many things can be used for collateral including assets of the business such as equipment, inventory and accounts receivable. But often you will still need to provide additional personal collateral, such as your home.
Contrary to what most people believe, a bank is not only looking to see if there is sufficient collateral for them to take if the loan goes bad.
They don’t really want that to happen so they are more concerned with the business plan and the confidence they have in the business’ ability to be successful. There are many different loan programs from the Small Business Administration that works with banks to provide a government guarantee to the bank for your loan. There are also loan programs locally through our area development districts that work with your bank lender.
Everyone hears about the free grants that are available to business owners and entrepreneurs. While there are some grant programs, these are not available to every business.
Most grants are to fund research and technology-based businesses, people who have been innovative and developed something new with intellectual property. Most grants are federally funded although Kentucky has some grant programs for those types of businesses and ideas. Grants are extremely competitive and restrictive in how you can use the money. Most retail and service businesses do not qualify for grants.
The last way businesses raise money is through equity financing.
Many entrepreneurs say they want to find venture capital, but they do not really know what they mean. Equity financing means that you give a qualified investor some level of ownership in your business in exchange for money. You do not have to give away control of your business, however, you do have someone else who owns your business with you. There are two basic ways to get equity financing: with an angel investor and with a venture capital group.
Angel investors are private individuals with a high net worth. They are interested in receiving a high return on their money and helping build new businesses. Angel investors, individually and in groups, typically invest less than a million dollars.
Venture capital groups take money from investors to create a fund and that fund invests in a business.
These groups are professionally managed and are looking for companies that have the potential to grow very big quickly, and provide a high return. They often take a large ownership interest and are actively involved in the company’s management. They look to invest larger amounts of money into companies that have begun establishing a market and have sales.
Most businesses that look to equity financing cannot obtain debt financing because they do not have sufficient collateral or other reasons. This is the most expensive form of financing, but can also help grow a company faster because you do not have to make monthly payments like you do with a bank loan.
If you are in business, or looking to start a new business, you should carefully consider all the financing options available to you and apply for the ones that make the most sense for what you are trying to accomplish.
In columns to come, I will talk about what an angel investor looks for and how to prepare for equity financing.
Loretta Daniel is director of the Murray State University Regional Business and Innovation Center. She can be contacted at 270-809-6071 or loretta.daniel@murraystate.edu.
