At some point, your business will need to raise money. Maybe it’s because you’re running out of startup funds, or perhaps it’s because you’re looking to expand your operations. Whatever the case, you’re going to need to bring in some more cash.
Now, you’re faced with an important question: Which source of capital makes the most sense to pursue? It’s important to not only understand what your options are, but also what the cost/benefit trade offs are for each of those options. To put it another way: What will it ultimately cost you to raise different forms of capital relative to what you get out of it?
In this post, I’ll explain the six most common methods for raising money for your business, and give a brief overview of their benefits and drawbacks. Let’s get started.
This won’t be a surprise to any of my long-time readers, but sales is the option I always advocate trying first when it comes to raising money. If you have a product or service that is ready to be sold, sell it! If your company isn’t quite ready to release your stuff out onto the market, you can still do pre-sales. This includes things like Kickstarter and Indiegogo, which are really just another take on a pre-sale platform.
I won’t go too deeply into the power of sales, as I’ve written about it in-depth before. What I will say is that creating a professionalized sales process as early as possible is something you won’t regret. It will dramatically reduce your need for outside funding to fuel growth, which (ironically) makes your company more attractive to investors.
2. Self Funding
Self fund for as long as you can. If they want to be taken seriously, founders need to invest their own cash into their business. When it comes time to meet with outside investors, those people will want to see that you’ve got some skin in the game. They want to see that you’re willing to put your money where your mouth is.
It doesn’t have to be a ton of money, particularly if you don’t have a lot of money to begin with. Your self-funding could be personal debt, like credit card debt, unsecured loans or home equity lines. Why take that risk? For one thing, when it’s your money on the line, you’ll be much more careful and thoughtful about how you use it. It’s going to be scary, but it’s exactly the kind of dedication that investors look for and respect.
It’s worth noting that most investors won’t be impressed with opportunity costs. Telling a sophisticated investor that you’re leaving a high-paying job for your startup — forgoing those earnings as a demonstration of belief in your vision — just doesn’t carry the same weight. What investors are looking to see is that you have put something on the line.
This can be bank loans, or private loans from investors. If you’re an early stage company, you probably don’t have a lot of bankable assets yet. This generally means your only other option is a personally guaranteed bank loan — a secured loan — and it almost always involves some form of collateral. Putting something like your house on the line to secure a loan is never fun, and you always need to careful. If you truly believe in your business, however, it can also be the right move to make.
What are the advantages of debt? The biggest is that you don’t give up any ownership of the business. You just owe money. The bank or lender ultimately doesn’t care how you manage the business, and in many cases, they don’t even care what kind of business it is in the first place. They don’t care what partnerships you take on, if you have to pivot to a new product or business model, or how much you pay your support staff. They just want their money back, with interest. How you accomplish that repayment is entirely up to you.
The disadvantage of debt is that you have to pay it back, which you don’t have to do with other kinds of capital. As you pay it back, that monthly loan payment will take valuable cash flow away from your business. If it’s a secured loan, you will also have the added stress of possibly losing your house if the business fails.
People throw the word “equity” around a lot, but what does it really mean? It means someone is buying a piece of your business. When an investor has equity, they become a partner in the business. This is important, because even a minority business partner has rights. Their investment has bought them a voice in how the business functions for as long as they hold an equity stake.
The first investments in early stage companies are often referred to as “seed capital,” and they make those investors minority partners in the business. Even if you retain majority control of the business, they’re still business partners. They have rights, and those rights are legally enforceable if need be. Just what those rights are will depend on how the business is organized, and the laws in your jurisdiction, but they should never be overlooked.
An equity-based business relationship is inherently more complex than a loan, and you want to be extremely careful and thoughtful with it. You’re trading a slice of both ownership and control of the business for a cash injection, and that’s never something you want to do lightly. That person will be involved in the company forever, or at least until they sell their equity stake. In many cases, it makes perfect sense to raise money through selling equity, but it shouldn’t be the only option on the table.
Hybrid options are exactly what they sound like, combining elements of different instruments to create a new opportunity. A great example would be “convertible notes,” which operate like a loan first, but can convert to equity in certain situations. If a company is sold, for instance, the “loan” from the convertible note might be triggered, turning the debt into equity at a predetermined rate, allowing those investors to get full value from the sale.
Revenue-sharing agreements are another hybrid. These are essentially a loan that gets paid back with a share from every sale. It’s similar to a sales commission, and it’s paid until the lender gets their principle and their interest back.
This cannot be overstated: There’s a lot of free money out there! If you’re in a business which is popular for grants, there’s no reason not to seek those grants out. Depending on the nature of the business, your personal background, the population you serve, or even the physical location the business is based in, there may be a variety of grants available to you.
There are countless foundations out there, and it’s their sole job to put money into the hands of people who are doing the things the foundation supports. Grants are also the best kind of outside capital you could ask for, because it’s money that you don’t have to pay back.
How do you know which of these money-raising options are best for you? Every entrepreneur has a different tolerance for things like taking on debt or giving up ownership, and there is no one-size-fit-all answer. You might end up making use of all six methods over the life of your company, or you may decide that you can power through on just one. The important thing is to give any approach to money-raising plenty of careful thought, and to educate yourself on the risks.