For many people, starting a business may not be exactly a cakewalk. Entrepreneurs are required to discharge a wide array of functions that includes apart from defining their value proposition, the setting up of operations, offering economically viable solutions, create brand equity for their businesses, managing a clientele and generating regular revenues. Although, in their journey of success, entrepreneurs face numerous challenges that of acquiring the seed capital or the startup capital for their business is indeed one of the most stressful ones.
Although, there is not much difference in the amount of startup capital required to start a business today than what was required a decade ago, the options available to people to get this capital are definitely more. Raising funds for a business is now a much easier job, all thanks to the multitude of financing options available to people. On the flip side, each of these sources needs the entrepreneurs to dispose certain obligations and formalities, with which credit seeking individuals must be acquainted with. Here, educated individuals will have an edge as they may have prior knowledge about these.
The following are the major sources of funding for entrepreneurs-
1) Personal finances-
2) Friends and Family-
3) Angel Investors
4) Debt financing
5) Equity financing
6) Customer financing
7) Government–sponsored programs
Personal finances- Entrepreneurs start their businesses at different stages of their lives and careers. A sizeable portion of entrepreneurs start their businesses at later stages of their lives and have personal assets that they would like to invest in their businesses. An advantage of investing their personal finances in their business is that it indicates that entrepreneurs are confident about their idea. This in turn also inspires confidence in potential investors. Moreover, people who are not able to invest their personal finances in their business may find it difficult to raise money from friends or family. However, entrepreneurs should first carefully analyze their business idea before investing their finances in it, as they stand to lose it as well in case the idea doesn’t work out as expected.
Friends and Family- Friends and family are an important source of financing as they trust an entrepreneur belonging to their family and would like to see that individual succeed. These loans can be obtained more easily and are based on interpersonal relationships rather than any financial considerations. However, friends and family may consider it their right to suggest measures of improving the business, which sometimes may create friction between the entrepreneurs and their family members. Thus, it becomes important for entrepreneurs to minimize such incidents of friction between family members. For this, they should plan to pay off the loan as soon as possible.
Angel Investors- Some people also invest in other people’s businesses in hope for financial gain. Such people are successful professionals with money to spare for investment. This type of financing is called informal capital as such investments are not conducted in established markets. Such investors are also referred to as business angels. In U.S, they are one of the oldest and biggest contributors to the venture capital industry. On an average, a typical angel investor invests more than $200,000 a year. Angel investors often assist entrepreneurs in suggesting the best methods to take a business forward. Despite the convenience with which such type of financing can be sought, sometimes these investors can be a little demanding. Therefore, entrepreneurs should lay down the rules or limits within which the angel investors should limit them when it comes to managing the business. Further, angel investors may not be willing to invest in businesses in which the entrepreneurs themselves are not willing to invest their personal capital.
Debt Financing- Another option available with entrepreneurs is through debt financing from banks. Although some angel investors do provide debt capital, commercial banks are the main providers of debt capital to small companies. Banks tend to advance loans through line of credit, mortgage and term loans. A line of credit is the largest amount of money that an individual can borrow from a bank at any one time. An entrepreneur must request a bank in advance before obtaining a line of credit, as banks need to be sufficiently assured about the various aspects of a business so that they can be satisfied about its financial viability. In addition to line of credit, banks also offer five to ten year term loans that are generally meant for financing equipment. As the corresponding financial gain from an investment in equipments spans over a period of more than a year, banks are generally willing to invest in equipment. Moreover, people can also resort to mortgaging as an option for financing. Mortgages are loans that are advanced against a collateral or security. Debt financing has its own pros and cons. Although debt financing has a higher rate of return on investment (ROI), and allows entrepreneurs to retain much of the control on management, yet it also exposes them to a greater risk as well. In order to ensure that banks get their due share of returns on the investment, they make the agreements accordingly.
Equity Financing- In contrast to debt financing, equity financing involves the transfer of the risk to the investor rather than the entrepreneurs. Equity financing involves the sale of common or private stock options by entrepreneurs to investors. This implies that entrepreneurs transfer a part of their control of the company’s management to their investors. Although angel investors also offer equity financing, it is venture capital institutions that are biggest players in the equity financing market. Institutional venture capital firms manage large funds and usually invest in companies with high growth potential. Whenever a venture capital firm invests in a company, they take a seat in the company’s board of directors and help in the company’s management. They also have ample say in matters of hiring and firing of employees. Moreover, raising venture capital is no mean feat; as it requires businesses to show solid potential before these firms even consider their case.
Customer Financing- Large corporations or potential customers finance the entrepreneur through debt or equity routes. They provide financial as well as technical assistance to the smaller organizations. Examples of large corporations that have often invested in smaller firms include giants such as JC Penny, Ford Motors, Motorola, Micron, and Cisco.
Government Sponsored Programs- The government has initiated several programs that help small businesses with financial capital. The government has a rich past of extending financial assistance to smaller firms via its federal programs, a few of which are mentioned below-
Small Business Administration (SBA)
Small Business Investment Companies (SBIC)
Small Business Investment Research (SBIR)
Small Business Technology Transfer (SBTT)
Recently, the UPA government has voted to increase the size and scope of these programs. Apart from the Union government sponsored federal programs for financing, the state and local government are beginning to initiate programs as well for financing small businesses. Although it is possible to raise money with low interest rates and equity through this route, entrepreneurs must have the patience to go through the time-consuming government bureaucratic processes.
Despite of the existence of many financing resources, it is important that entrepreneurs carefully plan their capital raising strategy. Raising capital via equity or debt financing depends considerably on the type of business, the potential or viability of the business idea and the company’s economic environment, for e.g.- whether the lenders or investors are pessimistic or optimistic about the future. Ideally, entrepreneurs should start with the process of raising seed capital for their business as soon as they are convinced about its viability and are ready to assure investors about the same. The next step for entrepreneurs then would be to identify the possible sources of finance for a company and focus on them only. Entrepreneurs should be patient, as raising capital is generally a time consuming process.