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Today’s episode is a continuation of the series, “Top 10 Things to Consider Before Starting Your Business,” which was initiated by one of the show’s listeners, Kathy. She is making the shift from the corporate world to entrepreneurship, and is in the works of starting her first business; she asks, “What do you suggest that I consider and avoid before taking the leap of faith?” Tom discusses the fifth thing to remember before starting your business.
Key Takeaways
Tom works with entrepreneurs and startup businesses every single day, and the number one thing that Tom encounters through coaching and mentoring is the question regarding capital. In today’s episode, Tom discusses the 5 tips for understanding the basics of raising money in order of priority.
Tip 1: Understand the options
First and foremost, you need to understand what your options are, what their costs and benefits are, and what you get out of it. Your number one option to raise capital is always sales. Those that aren’t quite ready to sell can often pre sell to generate cash quickly. Crowdfunding campaigns such as Kickstarter and Indiegogo are excellent pre sale platforms.
Tip 2: Understand which options are best for you
The second option is to self fund the business using your own money. Not only will you preserve ownership and control, but if you plan to raise funds from investors they will expect you to have skin in the game. Generally, opportunity cost doesn’t count such as leaving a higher paying job for an entrepreneurial venture. The response from a potential investor may be that you might want to remain in that high paying job and that the startup world isn’t for you. Although you don’t have to invest a large amount of money, investors will want to see that you’re putting something on the line. One possibility could be credit cards. While this is scary and not something many advocate if you can avoid it, it’s an easy form of cash, but it can often be a trap so be super careful. In addition, home equity lines, if you have a house, can be borrowed from as well as insurance policies.
To explain ways you should seek out capital, Tom first breaks it down into a few categories. Bank loans may or may not be secure; if it’s secured, the bank will require that you can personally guarantee it. You will pay it back by providing some type of collateral such as your personal assets. Unsecured debt is a better option for you, but it also has a higher cost. The advantage of debt is that you won’t be giving up ownership, but the disadvantage is that you are required to pay it back and will take valuable cash flow away from your business. If it’s a secure loan, you may lose the collateral that you provided the bank if you can’t fully execute your business.
Another form of capital that is thrown around all of the time is outside capital, meaning that someone buys ownership in your company. Investors that become a partner in the business have rights; the Secretary of State can provide excellent resources for how to best organize them. The investor type of capital is popular but not without its limitations, which just goes back to picking the right people for the right reasons.
Additionally, the notion of hybrids, which combine two different instruments or options, can include things like convertible notes that convert into equity, revenue sharing agreements, free money, and private foundations. Convertible notes perform like a loan but can convert into equity if something occurs such as the sale of your company or another large funding event. Revenue sharing agreements, which are loans that get paid back with a share of your sales, are like commission. As you make your money, your investor will take an agreed upon percentage of everything you sell. Another option that is greatly understated is the allowance of free money. If your business fulfills the requirements for a grant, these programs can be some of the best to apply for.
Tip 2: Understand which options are best for you
Knowing which is the best for you can be answered with a few key questions:
Can you make sales right now? If the answer is no, then spend some time asking yourself why. You should be able to make sales even if they are pre sales. If it’s too early and you only have prototypes, then move on to number two.
Do you have any money to invest? Investors will want to see you take that risk.
Do you want to give up ownership? Your option, if you don’t want to give up ownership, is to take other equity and debt alternatives. You should go back to the third step above and pick the right partners for the right reasons. You should want to give up equity if it’s going to make your business better.
Will the business be able to make loan payments? If you do take money from the bank or a private lender, are you going to be able to service the debt?
Can you convince someone that your business is worth something when it’s still in the concept phase? Your business is game over if your answer is no. You can go to a lender who will say that they don’t care what you do with the loan because if you don’t pay them back, they will take your assets.
As a whole, raising capital is a full time job. The more sophisticated you get with your business, the more intensive the process can be. In today’s world, you can execute great pitch but can you survive the hard questions? Refined and expert investors will eat you alive if you aren’t prepared. Carrying out your options and promises it’s important.
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If you’re a first-time listener, Tom Ryan’s Success in Business Podcast is a weekday show that provides how-to advice for entrepreneurs and small business owners. Thanks for listening.