It’s a complex process that involves uncovering sources of money, using the proper means and evaluating whether the timing is good. If the economy is slow, it’s more difficult to raise cash — no matter how clever your business plan is.
Financing is often done through “rounds,” which occur over time and involve one or many sources. The process usually takes longer than you expect, so be realistic and expect to wait about six months from initial contact to the transfer of funds. And valuation increases can be expected between rounds. The terms and amounts of money doled out in rounds likely depend on business growth factors such as more customers and new products and services.
There are several ways to initially fill your coffers including personal funds, cash injections from family and friends, loans, venture capital firms that specialize in financing new businesses and wealthy angel investors who have no institutional affiliation.
Because the process is complicated, consult with your legal advisor before embarking on a funding search to ensure that any deals are made in your best interest.
A major consideration is the amount of control you keep in the company. After all, it’s your idea and you don’t want to lose ownership.
Here’s a quick rundown of the major sources of start-up financing and how they can affect the owners of a new business:
Personal funds: This is the most common source and is often preferred at the outset because it lets you and your co-founders keep control of the company. Most importantly, however, it shows your commitment, which can help you develop a strong position for later venture capital financing. Another advantage of using your own cash is that it gets you into business faster, without the delays that can accompany efforts to attract outside capital. One source of financing is the cash value of whole life insurance policies you’ve taken out over the years. If these policies have been in force for any period of time, you may have accumulated a considerable cash surrender value that you can borrow against.
Venture capital: If the terms are reasonable and acceptable, this could be a good source of money. Difficult negotiations include the terms of your control over the company and the return that venture capitalists expect from their investment. Some investors may insist on taking an active role in strategic planning and company operations. Get a financial advisor involved in these negotiations, particularly when bargaining power may not be equal on both sides of the table.
Friends and angels: This is one way to get some good terms from a financing arrangement, but be wary of unrealistic expectations. Friends, relatives and angel investors may be unsophisticated and have unbalanced portfolios, and that can lead to friction down the road. They tend to become more vocal and intrusive during the volatile ups and downs that accompany most start-up companies. And money from them is also likely to be a one-shot deal, with little chance for boosting the investment later.
Other sources: Of course, there are loans from banks and the Small Business Administration and you should investigate any programs at state financing agencies. Sometimes, you can find other companies that may be willing to finance the development of a product in exchange for some interest in it or possibly acquiring it at some point. Former employers or industry peers might also be tapped in this way.
The rest of the process: Of course, digging up the initial capital isn’t the end of the story. You want to determine what the best means is for acquiring the money by choosing between stock offerings, loans, mezzanine financing, and the like. And the economic climate has a significant effect on how you raise money, how much you get, and how fast you grow.
Get legal advice before you even begin the process and continue consultations to ensure you get the best deal with the best terms. For example, proper guidance can help minimize your tax bill and bring you through a successful initial public offering when the time is right.
Finding and signing the right deal takes good planning. The success of your venture and continued control over the business is at stake.
10 Myths When Starting a New Business
1. “I’m broke, so it’s a good time to start a business.” New ventures drain bank accounts fast, so plan on having at least two year’s worth of income in addition to start-up costs, which vary depending on the business. Then, you can devote all your time and energy without having to hold down a job at the same time.
2. “I need a little more practice before I launch my business.” Many people start new businesses based on their experience, but it’s easy to keep putting it off because you need “more practice.” At some point, you have to take the leap from “practicing” to “owning a business.”
3. “I hate being told what to do, so I’ll start my own business.” Like it or not, business owners have lots of bosses — called customers.
4. “I’m not renting an office so I don’t need much seed money.” Make no mistake about it: Even if you’re home-based, you need lots of money for supplies, desks, phone service, memberships, license fees, accountants, lawyers, business cards, Web designers, consultants and more.
5. “I don’t need a business plan.” Every business needs a plan, but don’t worry about creating the “perfect” one. Life changes and plenty of things steer you off track. Create a flexible plan and review it in six months.
6. “I don’t need a marketing plan.” Get one right away. You might have the best product or service in the world, but it won’t sell unless people know about it.
7. “My Web site will bring in lots of business.” Cyber-marketing is effective only if your ideal clients are found on the Web and you do Internet marketing. It’s not automatic.
8. “I can do it all.” Nobody knows everything. Network, take classes, develop a support base and hire professionals. New businesses take lots of time and energy. If you try to do it all, you’ll burn out. Take care of yourself, keep your energy level up, and try not to spend every waking moment thinking about your venture.
9. “My family and friends are all the support I need.” Sure, they’re supportive, but they may only offer warm and fuzzy feedback. Objective parties can give you the absolute truth about what you’re doing right and wrong.
10. “Starting a business will be a breeze.” New ventures are almost always harder than the founders anticipate and most business owners go through an “I can’t do this anymore” stage. The successful ones get beyond it. Try to ride out the discouraging times and lean on your support network to get you through.