If you’ve decided to take the leap and launch your own business this year, you could be thinking about all the different ways you can finance it. There’s a lot of information out there for new business owners who want to expand and seriously set up an enterprise. There’s government support, creative ways to find money from your IRAs, crowd funding, and factoring.
Every financing option comes with its set of pros and cons. There’s a downside to everything and you need to carefully consider your options before you take the next step. Funding your business from the wrong source could jeopardize your work and leave you out of pocket later. So, to simplify your options it’s important to understand that there are really only three ways any business can be funded; debt, equity, and retained earnings.
For a start-up business this means you can either borrow money, sell a part of the business, or bootstrap your way to growth. Here are the pros and cons of each option:
Bootstrapping a business is the most straightforward strategy. You start the business with whatever money you can find in your savings and then rely on the cash flows from the business to keep expanding. Not only is this process tediously slow, it could also be the least efficient method of financing. Most new businesses don’t start off profitable and managing cash flows becomes difficult if you need to keep saving to fuel future growth. You may also have to turn away some big clients and big opportunities since you lack the capacity to handle big orders initially.
But this option has its upside. Organic growth lets you keep complete ownership and control over the business you started. There’s no risk of defaulting on a loan or losing control to an investor who owns a significant chunk of the business.
Borrowing money is a good idea considering how many businesses start off with borrowed capital and how low interest rates are at the moment. The government might offer you a small business loan, or you could get a better deal on one of the credit cards for small businesses on offer.
Borrowing money to start a business lets you hang onto complete ownership of the business, but it burdens the operational cash flows and makes the venture riskier. If you miss payments on your interest your credit rating could take a hit, making it more expensive for you to borrow later.
The option that gets the most attention in the media is selling equity. Finding an angel investor or business partner who can supply the cash is a great way to get started. Some investors and venture capitalists also offer to help out by mentoring you and giving advice. Also, by selling equity you share the risk of the venture with your investor. Your business isn’t compelled to pay out cash on a regular basis. You can choose to pay a dividend to yourself and other investors when the business is established and profitable enough. Of course you won’t own the whole business, be the sole decision maker, or get all the rewards.
Picking the best option from these three depends on the nature of your business, the prospects for growth, and your ability to manage the risks. Financing is a crucial part of the journey to create a business from scratch, so take the time to think about your options carefully.