Choosing the Right Financial Path
Knowing the options for financing a business or generating donations for a non-profit along with their associated advantages and disadvantages will inform the decision-making process on who and how to engage with external organisations or individuals for financial support.
- Recognizing options and opportunities
- Overview of financial options
- Asking the right questions
- Advantages and challenges of external financial support
- Whether the goal is to start-up a non-profit or a business, it is important to know the what to expect from external financial support
Options for financing a new venture fall into three main categories:
1.Self-funding
- Most startups begin with their own savings.
- READ: Self-Financing Your Startup (entrepreneur.com)
2.Friends & Family
- Our closest contacts are often the first to buy into our business ideas.
- READ: Getting Seed Funding from Friends and Family the right way (jonathanhung.com)
3.Fools
- Sooner or later, most businesses look externally for funding options.
- Banks
- Investors
- Fundraising
- Grants
Ask the right questions
Seven important questions to ask when creating a funding strategy:
What funding path best suits your business growth strategy?
The growth trajectory you envision for your business should have a major influence on your funding strategy. You should know what you want the business to look like in one, five, and 10 years before you make decisions on what type of funding makes sense.
(How to Choose the Best Funding Path for your Startup, Lighter Capital, 2015)
How much capital do you need?
- A well-thought-our business plan and capital-raising strategy can help you figure out how much capital you need. Your business plan should tell you what your growth milestones are in 6 months, 1 year, and 3 years. Then figure out what you need to do and how much it will cost you to go from one milestone to the next.
- Be aware of the pitfalls of raising too much money
- The more you raise, the more you need to pay back
- Easy money can take you off-track
You might not be ready for rapid growth
How much equity are you willing to give up?
- If you are looking to remake a market and need millions of dollars to scale, the venture capital path is likely to be the only route to get you the firepower you need. In this scenario, you will likely need to give up 10 to 45% of equity in exchange for the big infusion of capital you require.
- If you are looking to build a more modest company without a $1 billion exit but with recurring revenues and clear paths to profitability, it might be smarter to first explore debt options that don‘t dilute equity.
- Even if you plan to eventually raise venture capital, growing your company beforehand can also improve your company‘s valuation, which means you will need to give up less equity for the amount of funding you raise.
What are you willing to risk to fund your business?
- Personal financial risk
- Traditional loans might require proof of phyisical assets as collateral before approving a loan. This could put savings or personal property at risk.
- Loss of control
- When giving up equity in your company, contol over decision-making can be diluted
- Traditional bank loans have fewer strings attached, but may impose limitations on how a loan may be spent
- Risks to personal relationships
- Personal connections that invest in your business may not be prepared to stay invested over the long-term. An exit plan for such instances can help prevent strain on important relationships
How do you want to repay the money?
Most financing requires not only repayment, but also interest.
- Fixed payments
- Must be paid on-schedule, regardless of how profitable your business is
- Revenue-based financing
- Repayment based on the ebb and flow of a businesses revenue
- Expectations
- The fine print
(How to Choose the Best Funding Path for your Startup, Lighter Capital, 2015)
Do you want guidance in growing your business?
- Who makes decisions
- Who influences decisions
- Who has control
(How to Choose the Best Funding Path for your Startup, Lighter Capital, 2015)
How long can you spend raising funds?
Time spent chasing money is time not spent running your business. Before you seek financing, consider how long it will take to raise funds and how much of a distraction it will be. How much time will you spend courting potential investors? How much time will you spend gathering financials and filling out paperwork for a traditional bank loan? Can your business thrive while the CEO is out raising funds for an extended period of time?
(How to Choose the Best Funding Path for your Startup, Lighter Capital, 2015)
Advantages of External Financial Support
- Preserving Your Resources
- One of the advantages of external funding is it allows you to use internal financial resources for other purposes. If you can find an investment that has a higher interest rate than the bank loan your company just secured, it makes sense to preserve your own resources and put your money into that investment, using the external financing for business operations. You can also set aside your internal financial resources for cash payments to vendors, which can help improve your company’s credit rating.
- Growth
- Part of the reason organizations use external funding is it allows them to finance growth projects the company could not fund on its own. For example, if your business is growing to the point that you need additional manufacturing space to keep pace with demand, external financing can help you get the funding you need to build your addition. External funding can also be used for making large capital equipment purchases to facilitate growth that the company cannot afford on its own.
- Advice and Expertise
- Organizations willing to finance your business can often also be useful sources of expert advice. Your banker, for example, has funded many other small businesses and may be able to offer guidance as to how to avoid pitfalls that created problems for some. An investor in your technology start-up likely has technology expertise of his own to offer, and even if not, may be able to steer you towards useful sources of advice.
Challenges of External Financial Support
- Ownership
- Some sources of external financing, such as investors and shareholders, require you to give up a portion of the ownership in your company in exchange for the funding. You may get that large influx of cash you need to launch your new product, but part of the financing agreement is the investor is allowed to vote on company decisions. This can compromise the vision you originally had for your company when you founded it.
- Interest
- External funding sources require a return on their investment. Banks will add interest to a business loan, and investors will ask for a rate of return in the investment agreement. Interest adds to the overall cost of the investment and can make your external funding more of a financial burden than you had originally planned.
- It’s a Lot of Work
- Securing external funding can be a nearly full-time job in its own right. You’re faced with the task of identifying potential sources of funding, preparing a slick business plan, practicing a presentation, and calling dozens of people to arrange – or try to arrange – a face-to-face meeting. All of these tasks take a good deal of time and resources. None of them are a guarantee that you’ll get the funds you’re seeking.
Lighter Capital, 2015, “How to Choose the Best Funding Path for your Startup, Lighter Capital”