Big ideas don’t prosper on their own. If you want to build a startup that stands the test of time, you’ll need more than a smart idea and a solid work ethic: you will also need adequate funding. Whether you’re hoping to be the next YouTube or buy a food truck, this guide offers insider tips on financing that can help you get your startup up and running.
Bootstrapping Your Startup Through Alternative Funding
Alternative funding options run the gamut, from tapping into your own savings to getting help from angel investors. Contrary to popular belief, less than 1 percent of startups receive venture capital funding, at least in their earliest stages.
Here are some of the alternative funding sources to consider as you look for ways to get your idea off the ground.
1 Stage One Look for the
For alternative funding sources, you may first want to turn to friends and family – or even yourself.Personal Savings
If you have enough funds in your savings account, you can use it to fund your own business pursuits. The benefit of this strategy is that you won’t have to take out a loan. However, if your business fails, you can expect your financial investment to disappear along with it.Business Credit Cards
If you can’t qualify for a traditional business loan, a business credit card is a smart alternative. With a business credit card, you can secure your own flexible microloan. You will, however, need to personally guarantee repayment and pay high interest rates. “I absolutely recommend that you get a business credit card instead of using your personal card, because it clearly delineates your business expenses versus personal expenses,” said David Ehrenberg, founder and CEO of Early Growth Financial Services, a San Jose-based company that provides financial services and assistance to private venture-backed startups.Family and Friends
With business loans hard to secure, funding from family and friends is often more readily available. If your loved ones believe in your business venture, they might be willing to loan you the funds you require. Just make sure to get your agreement and repayment plan in writing.
2 Stage Two Expand
Some small businesses are eligible for grants available through organizations like the Small Business Administration (SBA), although requirements can be strenuous. The SBA’s grant search tool can connect you with options that might work for your startup.Peer-to-Peer Lending
Peer-to-peer lending firms like Lending Club and Prosper have become increasingly popular for business owners and aspiring entrepreneurs who cannot secure funding elsewhere. With this type of borrowing, your lender is comprised of individual investors who fund your loan. You may be able to qualify with bad credit, but you’ll get a better interest rate and loan terms if your credit is better than average.Microloans
Whether offered through the SBA, a private local lender or a government program, microloans can provide you with the rush of funding you need for various stages of business growth. While microloans are generally for less than $50,000, they can serve as a lifeline for your business if secured at the right time.Crowdfunding
Crowdfunding websites like Kickstarter and Fundable are helping business owners and startups get off the ground all over the nation. While nearly anyone can apply for funding through one of these methods, a solid history is generally required to receive meaningful amounts of funding. Remember that anyone can throw up a GoFundMe page; if you truly want to get started through crowdfunding, you need a solid business plan to share.
3 Stage Three Getting into
When it comes to securing a large amount of money through an alternative funding source, there are times when it can pay off to step up your game. With any of the funding strategies below, you’ll need to create an airtight business plan, have a step-by-step growth process in place and perfect your elevator pitch. As you pursue these options, you may often hear “no.” But remember, you only need to hear “yes” once.Incubators and Accelerators
Both incubators and accelerators offer opportunities and funding options for aspiring entrepreneurs. By and large, incubators provide funding for new and disruptive ideas, whereas accelerators provide funding for existing startups and small businesses. Both incubators and accelerators tend to be extremely selective, which means you should have your proverbial ducks in a row before you apply.Angel Investing
Angel investors are people who invest their own money into a startup or business idea with the goal of extracting profit. To find an angel investor, you can reach out to your local network, join an angel investing network like Angel List, or connect with investors through an angel investing forum such as Funding Post. “There are also super angels, who are folks that invest heavily in early stage companies,” Ehrenberg said.Private Equity
Private equity is similar to angel investing in that it uses private funds, except that it pools together funds from several investors to spread out risk and increase buying power. Private equity investment firms can be found the same way as other types of big league investors – through networking and online platforms. Before meeting with a private equity firm, perfect your pitch much like those who have shared their business ideas on the popular network show “Shark Tank.”Venture Capital
A form of private equity, venture capital is a type of funding provided to new and unproven businesses thought to have high potential. Like angel investors, venture capitalists can be found through networking or through portals like Funding Post. “We’ve seen a new crop of investors that are micro venture capitalists,” Ehrenberg said. “They typically have a fund that is anywhere from 5 to 50 million, and they tend to do quite a bit of investing at the seed level.” Once you connect with a venture capitalist, you’ll want to make sure your business plan and elevator pitch are pitch-perfect, leaving little room for doubt in your investor’s mind. VCs typically require a seat on the company’s board.
If you’re unable to draw on personal savings and your immediate network, you may need to look into some innovative ways to get started. Here are a few ways to secure funding outside of traditional loans:
Loan Options for Serious Startups
Banks are generally wary of lending to individuals and new businesses that haven’t proven themselves in the marketplace. However, there are loans out there for startups, notably the ones backed by the U.S. Small Business Administration (SBA). Here’s what they are and how they work:
The SBA’s most popular loan program, the 7(a) loan program, has a maximum loan amount of $5 million in funding from local lenders, with the average in 2015 being $371,628. With this program, the SBA isn’t lending you the money; your bank is. The SBA simply acts as an intermediary and provides a guarantee of repayment if you default. Here are some more details on this program:
7(a) Loans are most commonly used for working capital to keep a business running, but they can also be used for equipment and asset purchases or improvements.
The SBA can guarantee as much as 85 percent on loans of up to $150,000 and 75 percent on loans of more than $150,000.
Anyone with an ownership stake of at least 20 percent is required to personally guarantee a 7(a) loan.
SBA loans like the 7(a) loan program are targeted at small firms and startups with less than $7 million net worth and less than $2.5 million in net income.
The 504 loan program was created to help small businesses and startups fund their land or equipment needs, and loan amounts are based on what goals they support. While your loan is actually funded by a bank in your area, the SBA guarantees 40 percent of the assets you purchase for up to $5 million dollars for job creation and public policy goals, and up to $5.5 million for small manufacturing. Generally speaking, 504 loans require a contribution of up to 10 percent equity by the borrower and the project assets being financed are used as collateral. In addition:
The 504 loan program helps the lender reduce exposure by allowing the SBA to guarantee the loan.
Applicants for the 504 loan program must have less than $15 million in net worth and net income less than $5 million after taxes for the preceding two years.
Borrowers must personally guarantee each loan, putting their own personal credit on the line in case of default.
Created solely for startups, the 7(m) microloan program provides up to $50,000 in funding to grow or start a business. Instead of a loan from a traditional bank, however, the 7(m) microloan program uses funding directly from the SBA. Here are some additional details:
Although 7(m) microloans are built with funds from the SBA, they are administered by community-based nonprofits.
The average microloan offered is $13,000, and loan amounts are capped at $50,000.
A microloan usually requires collateral and a personal guarantee.
Debt Financing Versus Equity Financing
Debt financing involves taking on debt to grow your business, while equity financing involves giving investors a stake in your business with the expectation that you’ll make them money when your business becomes successful.
“Debt financing is usually preferable because when you do equity financing, you are giving up [some] ownership in the company, and that’s almost always more expensive than debt,” Ehrenberg said.
Debt financing, however, can be hard to achieve until you have real assets on your balance sheet. “So unless you have revenue, unless you have accounts receivable, or fixed assets that are really worth something, it’s really hard to get debt financing,” Ehrenberg said.
Equity financing, on the other hand, has its own problems.
“You really need to be going after a large market opportunity, and you need to have the ability to really get a lot of traction in that marketplace,” Ehrenberg said. “And – fortunately or unfortunately – equity markets can be very fickle. Something can be really hot today and not so hot tomorrow. Eight years ago clean technology was huge, five years ago social media was huge, today augmented and virtual reality and AI is big. That’s one of the drawbacks of equity – what’s hot can change very quickly.”
To find out more about funding for small businesses and startups, we reached out to Ehrenberg and William Keenan, CEO of Pango Financial and an expert in the startup landscape.
How do I know how much capital I need?
I’m a huge fan of milestone financing. We work primarily with venture-backed technology startups, so when our startups go out to raise money, what’s really important is to understand what key milestones you’re going to be able to achieve with the money that you raise.
We want to make sure that any time our clients go out to raise money, each time they raise money they are doing it at a higher valuation. [In other words] each time they go out to raise money, the company should be worth more money. So, for example, if you get a million dollars in equity financing today, and then you get $1 million in equity financing in 18 months, you’re giving up less stock for the $1 million in financing you are getting in 18 months because the value of your company has gone up. So you want to make sure that any time you raise money you can hit key milestones that will ensure that you have an up round.
So what we do with our entrepreneurs is, we sit down and we figure out what key milestones they need to hit, and then they need to raise money to be able to hit those milestones. And we always tell them to raise 20 to 25 percent more than what they think they need because things always take longer and are always more expensive than anticipated.
I think the milestone financing is a key thing to think about when you raise money. It’s less important with debt. When you’re going out and raising debt, what’s important is understanding your cash flows and understanding how you will be able to repay the debt and how it will impact your overall cash flow.
What are some creative ways for someone to finance their business?
Rollovers as Business Startups (ROBS) are becoming increasingly popular for gaining capital for business, but you have to be careful that you work with a funding provider that can help gain access to those retirement savings without paying penalties or fees.
Crowdfunding is also another source of financing that many entrepreneurs have started to investigate as a potential resource for capital. While it’s still fairly difficult to use as a sole source of business funding, it allows small businesses to be donation-based or investor-based and potentially more connected to business partners and the community.
What’s the likelihood of being chosen for a small business loan as a startup, and how can I make myself and my business a good candidate for a loan?
The traditional lending environment is fairly tough today compared to pre-2008 before the recession hit, but the SBA has really opened the door to small business funding. Small business loans are attractive to lenders because, unlike consumer banking relationships, there is more potential income with these business customer relationships. The more attractive the income potential is for lenders, the more available these options become. Those business customer relations are actually really sought after in today’s lending world.
As helpful as the SBA is though, there’s still the need for equity for your business. A healthy amount equity, when combined with borrowed funds, can help businesses operate on a solid foundation.
In most cases, there will also be an aggressive investigation of your business’s debt-to-worth ratio. The best way to increase your chance of getting one of these small business loans is to have strong personal credit and offer collateral. It also helps to have a sound business plan and at least some experience in whatever industry your business is in.
This depends on what stage you are at, but if you’ve been around for a while and are in business, it’s very important to have your financials in order and to make sure they are in compliance with generally accepted accounting principles (GAPP). You want to have a good platform for your financials, so you need a good accounting system and recordkeeping system in place. [And] you want to make sure you are in compliance with regulatory requirements (things like making sure your taxes are up to date, making sure your business license is up to date, if you are a Delaware C Corp you want to have your Delaware C Corp filing done, those kinds of things).
After that, it depends on whether you’re going for equity financing or debt financing. If you are going out for equity financing, you need to have a pitch deck prepared, which presents your business plan, and you’ll need to have an executive summary ready. There are different elements you’ll want to include in your pitch deck.
Typically, if you’re going out for debt financing, it’s more about having good financials and a traditional business plan in place.
How do you meet an angel investor or a venture capitalist? Other interested partners?
Ways to meet potential investors or business partners [include] networking events, trade shows or business associations, and a growing number of online resources that are helping connect investors with the startup community.
What about peer-to-peer lending?
When you’re a startup and thinking about raising money for your business, everything should be on the table. These platforms are different in what they do. Some of them are financing projects you want to do, while with other platforms you are actually pre-selling your product or your service. And now we are starting to see platforms that allow you to raise equity. We are big fans of Indiegogo.
You are much better off if you can get traditional angel and venture financing, because that creates much more of a platform and it allows you to raise future rounds much easier. But if you’re not able to raise angel or venture financing and if you can’t get debt, these things should be on the table and they are worth considering. They aren’t the best method, but if you can’t raise money in other ways, you should consider everything.
How should you prepare to talk with venture capitalists?
In my experience, venture capitalists and angel investors want to feel confident in what you’re pitching to them — don’t walk in unprepared or pitch them off the cuff. When you walk into that meeting, you need to have a clear idea of what you want and what aspirations you have as a future business owner. Are you looking to start a small, family business that offers a nice income and a valued service to your community? Or are you trying to build a high impact business with the hope of becoming the next Google? These are obviously two different worlds in regard to venture capitalists, so knowing which road you want to take is crucial.
Is the elevator pitch really that important?
Absolutely. While the traditional elevator pitch has certainly changed over the years, it still acts as a crucial buffer between you and your potential investors. Not only can your elevator pitch get you in front of those potential investors (in the traditional sense), it can also improve your own impression of your business plan. It’s hard to say sometimes, but not every business plan is brilliant. An elevator pitch gives you an opportunity to highlight key points, and recognize which parts of your business really has the “wow” factor. If you’re not able to recognize those within the elevator pitch, there’s a good chance no one else will either.
How fast can my startup safely grow?
Milestone financing is important here. You want to be sure you are hitting your key milestones.
We’re big fans of the lean startup methodology. It’s a good philosophy about how to grow a business. It’s all about being lean and being careful with your spending. It focuses on things like outsourcing your engineering or accounting and finance initially instead of hiring people and coming up with a business plan or a plan of action, but iterating quickly so you can be aware of your results and change course as needed. The idea is to operate the company in as lean a manner as possible. Don’t spend any money you don’t have to spend right now. Don’t build infrastructure for the future, just build infrastructure you need to achieve your key milestones in the immediate short term.
Read more about the SBA’s most popular loan program for startups and small businesses.
This online business portal connects entrepreneurs and small business owners with investors who are looking for profitable business opportunities to invest in.
Fundable is a newer startup aimed at helping entrepreneurs secure the small business funding they need.
Learn whether your small business or startup qualifies for a government grant that could help your business grow.
This government portal provides details on a wide range of grants available to small businesses, startups and existing organizations.
The Minority Business Development Agency (MBDA) offers a unique resource on the various grants and loans available to minority business owners and entrepreneurs.
The Small Business Administration (SBA) offers considerable detail on an array of loans and grants available to both small businesses and startups.
As a small business funding source, Microventures has successfully raised over $85 million dollars for successful startups like Facebook.