Introduction
If an entrepreneur wants to be successful, they must study, understand and take advantage of every conceivable source of capital. Once the entrepreneur understands all the options they must “creatively cobble together a diverse mixture of financing techniques to kick-start their venture. Oftentimes this strategy calls for molding the business model to fit the financing available rather than trying to fit the financing to the model.”[1] This can sometimes be very difficult for some entrepreneurs looking to start a business. It is not enough to simply have a great product or service. However, it's far better to make progress by “adapting to what's available then to stubbornly wait for something that is not and may never be.”[2]
Importance of Adequate Funding
Part of this ‘flexibility’ will invariably entail ‘selling’ your business concept to others. Therefore, it is important that entrepreneurs be able to prove their business concept before they can convince other to ‘invest’. Most businesses require some sort of initial capital for things like inventory, marketing, physical facilities, incorporation expenses, etc. According to the U.S. Small Business Administration (SBA), "While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second."[3]
Sources of Funding – Prentice Hall
According to Bruce R. Barringer & R. Duane Ireland, ‘seed’ money for a business venture will most likely come from three sources. These sources of start-up capital are personal financing options that include: personal saving, mortgages and credit cards as well as various forms of sweat equity. After that the next likely source will be ‘love money’. Friends and family are the “second source of funds for many new ventures. This form of contribution is often called “love money.” Love money can consist of outright gifts, loans, or investments, but often comes in the form of forgone or delayed compensation or reduced or free rent.”[4] The final source of funding is generically called ‘bootstrapping’. Bootstrapping is the “use of creativity, ingenuity, and any means possible to obtain resources other than borrowing money or raising capital from traditional sources.”[5] Some examples of Bootstrapping can include:
- “Minimizing personal expenses and putting all profits back into the Business
- Avoiding unnecessary expenses, such as lavish office space or furniture
- Establishing partnerships and sharing expenses with partners
- Leasing equipment rather than buying
- Sharing office space or employees with other businesses
- Utilizing the services or a university or community incubator
- Buying items cheaply but prudently through discount outlets or online auctions, such as eBay, rather than at full-price stores”[6]
Alternatives to Personal Financing
Two most common alternatives for raising money
Alternative
|
Explanation
|
Equity Funding
|
Equity funding means exchanging partial ownership in a firm,
usually in the form of stock, for funding. Angel investors, private placement, venture capital, and initial public offerings are the most common sources of equity funding. Equity funding is not a loan—the money that is received is not paid back. Instead, equity investors become partial owners of a firm. |
Debt Financing
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Debt financing is getting a loan. The most common sources of
debt financing are commercial banks and the Small Business Administration (through its guaranteed loan program).[7] |
Source of Funding – About.com
According to Scott Allen, there are six forms of funding that entrepreneurs should take advantage of. They are:
“Friends and family are still your best source for both loans and equity deals. They are typically less stringent regarding your credit and their expected return on investment. One caveat: structure the deal with the same legal rigor you would with anyone else or it may create problems down the road when you look for additional financing. Prepare a business plan and formal documents--you'll both feel better, and it's good practice for later.
Credit cards are a great tool for cash flow management, assuming you use them just for that and not for long-term financing. Keep one or two cards with no balance on it and pay it off every month to give yourself a 30 to 60 day float with no interest. And the low introductory rates on some cards make them some of the cheapest money around. Managed well, they're extremely effective; managed poorly, they're extremely expensive.
Bank loans come in all shapes and sizes, from microloans of a few hundred dollars, typically offered by local community banks, to six-figure loans by major national banks. These are much easier to obtain when backed by assets (home equity or an IRA) or third-party guarantors (e.g., government-sponsored SBA loans or a cosigner). If you obtain a line of credit rather than a fixed-amount loan, you don't start paying interest until you actually spend the money.
Leasing is the way to go if you need big-ticket items such as equipment, vehicles, or even computers. Your supplier will help you explore this.
Angel investors fill the gap between friends and family and venture capitalists, who now rarely even look at investments below $1 million. Enlist a savvy financial adviser to structure the deal.
Private lending represents a viable alternative when the bank says "no". Private lenders are looking for the same information and will conduct similar due diligence as the banks, but they typically specialize in an industry and are more willing to take on higher-risk loans if they see the potential.”[8]
The Most Often Used Sources of Funds
It seems clear that the most common form of funding for entrepreneurs looking for sources of funding to launch a venture are from savings as well as friends and family. In many ways this makes sense. If the entrepreneur is determined enough in their project to invest their own time, energy, and money into a project there is reasonably justifiable resolve on the part of the entrepreneur to show commitment to see their venture succeed. If outside funding is required it is also reasonable that it would come from friends and family. They will be easier to convince than investors and there is significantly greater chance that it will be given as a gift without interest and without a controlling stake in the venture.
The Role of Venture Capitalists
Barringer & Ireland describe venture capital as “money that is invested by venture-capital firms in start- ups and small businesses with exceptional growth potential. There are about 650 venture-capital firms in the U.S. that provide funding to about 3,000 to 4,000 firms per year. Venture-capital firms are limited partnerships of money managers who raise money in “funds” to invest in start-ups and growing firms. The funds, or pool of money, are raised from wealthy individuals, pension plans, university endowments, foreign investors, and similar sources. A typical fund is $75 million to $200 million and invests in 20 to 30 companies over a three- to five-year period.”[9]
There are advantage and disadvantages to working with venture capital. Venture capital can be a great source of funding. However, because “investors take on a much higher risk than lenders, they are typically far more involved in your company. This can be a mixed blessing. They will likely offer advice and connections to help grow your business. But if their plan is to exit your company in 2-3 years with a substantial return on their investment, and your motivation is the long-term sustainable growth of the company, you may find yourself at odds with them as the company grows.”[10]
Conclusion
For the entrepreneur, all sources of funding need to be considered before, but also during all aspects of the early life of a business venture. There are lots of options for ambitious people to make great strides but conviction, hard work and a little perseverance and luck are required. Each entrepreneur will have to figure out if their venture is feasible. They will need to devote their own money and sweat equity into the venture as well as petition friend and family for funding or benefits to make their dream a reality. If that is not enough or the business starts taking off and needs more of a push to get it where it needs to be venture capital can be an attractive prospect especially if you can’t get a loan from a bank. It is important to understand what you are getting into with venture capital and remember not to give away too much for the sake of investment money. Ultimately all these factors need to be weighted and decided on by the entrepreneur. The rest will be revealed in time.
[1] http://www.startupjunkies.org/finance.html[2] http://www.startupjunkies.org/finance.html[3] http://entrepreneurs.about.com/od/financing/a/startupfunding.htm[4] http://www.scribd.com/doc/2673997/Entrepreneurship-Getting-Financing-or-Funding[5] http://www.scribd.com/doc/2673997/Entrepreneurship-Getting-Financing-or-Funding[6] http://www.scribd.com/doc/2673997/Entrepreneurship-Getting-Financing-or-Funding[7] http://www.scribd.com/doc/2673997/Entrepreneurship-Getting-Financing-or-Funding[8] http://entrepreneurs.about.com/od/financing/a/startupfunding.htm[9] http://www.scribd.com/doc/2673997/Entrepreneurship-Getting-Financing-or-Funding[10] http://entrepreneurs.about.com/od/financing/a/startupfunding.htm
