You’ve got a stellar business idea. You’ve done some market research. You’ve even pulled together a business plan. You’re ready to hit the ground running – all you need is some capital to get started.
Every entrepreneur knows that financing can be one of the most important and challenging aspects of running a small business. Asking people for money – whether it’s a family member or a banker – can be intimidating and the thought of failing can be scary. The mere choice of deciding who to approach first can be overwhelming for some entrepreneurs.
The truth is, most small businesses piece together their funding from several different sources during the startup period. No single source of funding is necessarily easier to come by than another. It depends on the type of business you’re starting, projections and how well you can sell yourself to potential financial partners.
In this article, we’ll break down five common options for financing a business.
Your assets and savings
The most straightforward method of funding your business is using your own money to get started. This can take the shape of savings you’ve accumulated over the years, your retirement nest egg or a personal loan where you put up your home or your car as collateral. This may make some entrepreneurs nervous – and rightly so. There is significant risk to cashing out your 401(k) or using your emergency funds. That’s because your income streams will be entirely dependent on your business doing well, which can be a scary prospect in the startup world.
Friends and family
If you have friends or family members who have built up savings, you may have another potential way to finance your business. After all – the people who know you best are most likely to believe in your idea. While borrowing from friends and family can have its pitfalls, it comes with its unique advantages such as low- to no-interest payments and avoiding the hassles of bank contracts.
If you decide to proceed with this approach we recommend you always put the terms of your loan in writing. This clarifies that the money is not a gift and ensures that both parties are on the same page. The terms of a loan agreement should be signed by both parties and include the loan amount, purpose of loan, time period of the loan and payment amounts. For example:
On August 1, 2014, Bill Smith agreed to lend Anna Smith $2,500 to assist in the establishments of her new business. In return, Anna Smith agreed to pay Bill $100 a month for 25 months for a total of $2,500. Anna will make the payments by the 5th of each month beginning Aug. 5, 2014.
Small business loans
If you need a significant amount of capital to fund your business, a small business loan can provide you with startup funds at a relatively low interest rate. All things considered, a small business loan is one of the less expensive ways to secure funding.
Before you approach a financial institution for these types of loans, make sure you shop around. You want to approach those banks that have local decision-making and a dedicated team of business bankers who can assist you with the process. MidWestOne Bank, for example, is an SBA-preferred lender, which means quicker processing and local decision-making.
Crowdfunding platforms like Kickstarter, Indiegogo and others are relatively new to the scene, but that doesn’t mean they should be dismissed. Here’s how they work: you make your pitch and post it on the platform, and people can contribute toward your fundraising goal. In some cases, you can keep the money you raise even if you don’t make your goal; with others, it’s all or nothing. The downside of these platforms is that the transaction cost can be quite steep.
These types of campaigns tend to work best for business that are easily understood by the consumer and have a universal appeal.
Angel investors are typically professionals such as doctors or lawyers, former business associates – or better yet, seasoned entrepreneurs interested in helping out the next generation – who are willing to invest in your business in return for a piece of your business.
Angel investments can be perfect for businesses that are established enough that they are beyond the startup phase, but are still early enough in the game that they need capital to develop a product or fund a marketing strategy.
The downside is that you’ll have a fiduciary responsibility to act in the best interests of the business and its shareholders. Attracting angel investors can also be tricky. Know your business plan, be transparent and build a relationship based on trust.
If you’ve got a business idea and are ready to take the next step, don’t hesitate to reach out to our team of business bankers for help.