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Alternative Funding Sources for Businesses

Main Source of Start-up Financing

Main Source of Start-up Financing

The question that we keep hearing from potential entrepreneurs is: where do I get start-up cash? Well, there are two types of start-up financing: debt and equity. Consider what type is right for you.

Debt Financing is the use of borrowed money to finance a business. Any money you borrow is considered debt financing. Sources of debt financing loans are many and varied: banks, savings and loans, finance companies, and some government agencies such as MARA and PNS are the most common. Loans from family and friends are also considered debt financing, even when there is no interest attached.

Debt financing loans are relatively small and short in term and are awarded based on your guarantee of repayment from your personal assets and equity. Debt financing is often the financial strategy of choice for the start-up stage of businesses.

Equity financing is any form of financing that is based on the equity of your business. In this type of financing, the financial institution provides money in return for a share of your business’s profits. This essentially means that you will be selling a portion of your company in order to receive funds.

Venture capitalist firms, business angels, and other professional equity funding firms are the standard sources for equity financing. Handled correctly, loans from friends and family could be considered a source of non-professional equity funding.

Equity financing involves stock options, and is usually a larger, longer-term investment than debt financing. Because of this, equity financing is more often considered in the growth stage of businesses.

Main sources of start-up financing:

1) YOU: Self-financing Investors are more willing to invest in your start-up when they see that you have put your own money on the line. So the first place to look for money when starting up a business is your own pocket.

Most entrepreneurs dip into personal or family savings to pay for their company’s launch. If you decide to use your own money, don’t use it all. This will protect you from eating Maggi noodles for the rest of your life, give you great experience in borrowing money, and build your business credit.

There’s also no reason why you can’t get an outside job to fund your start-up. In fact, most people do. This will ensure that there will never be a time when you are without money coming in and will help take most of the stress and risk out of starting up (nope, William, I am not moonlighting!).

2) Credit Cards. I hate to recommend this, given the number of people getting in trouble with credit cards. But if you really must, it’s still a choice. You may finance some of your start-up costs, including equipment purchase etc. with your credit cards. However, do ensure you make the necessary payments on time, as credit cards have some of the highest effective interests among all form of financing.

3) Friends and Family. Money from friends and family is the most common source of non-professional funding for start-ups. Here, the biggest advantage is the same as the biggest disadvantage: You know these people. Unspoken needs and attachments to outcome may cause stress that would warrant steering away from this type of funding.

4) Angel Investors. An angel investor is someone who invests in a business venture, providing capital for start-up or expansion. Angels are affluent individuals, often entrepreneurs themselves, who make high-risk investments with new companies for the hope of high rates of return on their money. They are often the first investors in a company, adding value through their contacts and expertise. Unlike venture capitalists, angels typically do not pool money in a professionally-managed fund. Rather, angel investors often organize themselves in angel networks or angel groups to share research and pool investment capital.

5) Business Partners. There are two kinds of partners to consider for your business: silent and working. A silent partner is someone who contributes capital for a portion of the business, yet is generally not involved in the operation of the business. A working partner is someone who contributes not only capital for a portion of the business but also skills and labor in day-to-day operations.

6) Commercial Loans. If you are launching a new business, chances are good that there will be a commercial bank loan somewhere in your future. However, most commercial loans go to small businesses that are already showing a profitable track record. Banks consider financing individuals with a solid credit history, related entrepreneurial experience, and collateral (real estate and equipment). Banks require a formal business plan. They also take into consideration whether you are investing your own money in your start-up before giving you a loan.

7) Incubators. Incubators are designed to encourage entrepreneurship and nurture business ideas or new technologies to help them become attractive to venture capitalists. An incubator typically provides physical space and some or all of these services: meeting areas, office space, equipment, secretarial services, accounting services, research libraries, legal services, and technical services. Incubators involve a mix of advice, service and support to help new businesses develop and grow.

8) Venture Capital Funds. Venture capital is a type of private equity funding typically provided to new growth businesses by professional, institutionally backed outside investors. Venture capitalist firms are actual companies. However, they invest other people’s money and much larger amounts of it (several million dollars) than seed funding firms. This type of equity investment usually is best suited for rapidly growing companies that require a lot of capital or start-up companies with a strong business plan.

By Jennifer Lee, www.business.com.my