The Most Effective Ways to Finance Your Business

It’s somewhat safe to say in America most people have an idea for a business or a passion they are excited about and enjoy spending time doing, they would like to be able to monetize. Plentiful are these ideas as is the eagerness to get started working on their profitability yet the “how” is often scattered, multidirectional and ambiguous. Understanding what the steps to take to get started is a question all entrepreneurs are confronted with, the most important of which rests on the raising of financing.

Without the capital means to fund a startup, it simply remains an idea or hope, never really having the chance to start up at all. Financing is the vessel to put an idea into action, the seed to create a tangible entity through which an identity and brand can form, grow and flourish.

Just as a plot of land needs to be cultivated and worked to create a fertile ground before planting a seed for growth so does your business need to be ready to welcome capital in order for it to be deployed efficiently for growth.

The analogy of a well-tended farming section regarding a business, rests in its operations, planning and strategy to scale. A company needs to have a concise, targeted and strategic business plan created to outline every detail of the brand, from conception of the business to outlining its pathway to profitability including the steps to get there. A business plan is a roadmap, a step-by-step manual for the operation of the brand, a process distinctly outlined so when capital is injected, it can be deployed in a direct and efficient manner.

A vision put in writing, not only helps internally once capital is obtained, but it is also imperative in the process of procuring said investment from the various outside sources available. Which leads us to the second part in growing crops for harvest: acquiring the seeds.

There are many avenues to gain investment or funding, the three most prevalent or widely defined are: organic, debt, and equity financing. We’ll briefly delve into each of them and highlight their characteristics and some benefits and risks associated; it should be noted neither one is better than the other per say, decisions to engage in either is based on circumstance and risk-tolerance.

Organic funding, boot strapping, self-funding there are a variety of terms to describe it, is financing a business with the owner’s personal cash or savings. This is by far the most prevalent form of funding for startups where an entrepreneur puts up his or her cash to get an idea off the ground. Organic funding is often used in the initial stage of the business, it’s formation, creation of a business plan, R&D etc. Creating a foundation for what the brand is and how it will operate, a demo or pilot sampling of its services is done principally through this type of financing with the hope of gaining larger amounts of investment through other means to expand to full operation.

Debt financing is where a business is either issuing debt or taking on debt to finance their operations. In most cases debt financing is done to obtain larger amounts of capital and carry a greater inherent risk compared to the aforementioned organic funding, in the forms of interest paid on debt financed or paid on debt instruments issued to private lenders. While debts can come in many forms, loans secured, (backed by an asset or cash reserve) or unsecured, (backed by faith and guarantee of creditor) carry their own expenses and risks. Interest rate risk or expense is the most dangerous for brands, especially early-stage businesses.

A small business loan or a secured loan borrowing off equipment or a mortgage are typically lower in interest, however, need to be backed by a tangible asset. Putting up one’s house or critical equipment as collateral for a loan may grant more preferable interest rates on the cash financed but risk an important part of a business or individual’s livelihood. Unsecured debt, while backed by the creditworthiness or income of the debt holder, carry much higher interest rates and often limit the amount of borrowing power compared to traditional secured loans. Credit cards are a common example of unsecured debt.

Businesses can also issue debt to private investors in the form of commercial paper, where the business receives funding at a fixed rate of interest with the obligation to return the borrowed capital on a set date or over a set period of time plus interest.

While any type of debt financing has its risks it carries the benefit of funding a company without having the obligation to the issuance of shares or ownership stakes to any party or individual.

Equity financing is selling a portion of the business and thereby rights to its earnings in the form of shares to an individual investor or entity, allowing for the proportionate distribution of the profits and losses of the business to the shareholders. While there are different forms of shares and stock holdings an investor can be issued or buy, the main element is they are entitled to a portion of the business’ profits and can also carry influence over the brand based on their stake in the company.

This is put into practice through a business selling a stake in their company based on the value of the business. An investor may buy or invest an amount of money in the business at a cost basis linked to the overall value of the business. In simple terms, a business with a valuation of $1 Million 10% of the company is valued at $100,000. An investor can purchase 10% for 100k 20% for 200k and so on.

The owners can deploy the capital to expand or operate the business and based on the terms of the shareholder agreement; the shareholders will receive a percentage of the profits in proportion to their stake.

With the different forms of financing outlined above there are indeed many nuances to them, that being said, a key component is for business owners to be very strategic on the quantity, terms and conditions and overall efficient use of the capital they acquire before engaging in any type of fundraising. Where many start-ups or small businesses fall short is the misuse of available funds, by taking any of these forms of capital and investing them unwisely into their businesses.

Analyzing your business, where to deploy capital and by what quantity within it, is more crucial than procuring the cash itself. This harkens back to sticking with the basics, creating fool proof business plan, understanding what the end result or objective is and the most efficient path to get there. Just as a farmer would need to buy a plot of land, fertilize it, buy a seed, plant it and watch it grow, it would be all for nought if there was a field of crops and not plan to harvest or process them into a valuable consumable product.

So too goes a small business, while fundraising is imperative to overall success, so is understanding the different types of instruments to raise it and the best ways to invest that cash within.

To gain personalized guidance for your business on this topic and others contact us.

- Vince Calace

Founder - Venture Business Development