It can be hard to find the money to start a business. I don’t know many small business owners who were able to skip this challenge entirely. When you’re looking for capital to start your business, the good news is that you have a lot of options. And each option comes with its own set of pros and cons.
Self-Financing vs. Other People’s Money
Self-financing is one path of small business funding, and it includes using your savings, home equity, stocks, bonds, 401k/retirement accounts, and credit cards to fund your business. When you go this route, you are very likely to use some bootstrapping techniques to get more bang for your buck. The problem with this is that you may not have enough liquidity to move at the pace you want. And most importantly, it’s risky. You are completely on the hook for the success or failure of your business when you do it alone.
Other people’s money (OPM) is the second path. It comes in many forms including bank loans, investors, family and friends, venture capital and angel investors, crowdfunding, and vendor financing/leasing.
Why Using Other People’s Money Works
There are many benefits to using other people’s money to start your business, including less personal financial risk, the potential for guidance and advice from someone who has been down this path before, and often a better chance to build a viable and growth-oriented business.
Using other people’s money also buys you time and gives you an opportunity to do things in your business you may not have been able to do if you financed it yourself. You have more options, increased reach, and the ability to make a bigger impact much quicker as you start your business.
Reasons Not to Use Other People’s Money
I bet that sounds great, doesn’t it? It sure does! But before you head out to look for an investor, consider these reasons not to use other people’s money.
The biggest reason some entrepreneurs avoid using other people’s money is that they don’t want to lose control of the business. In most cases, you will typically have to relinquish a significant amount of ownership and control. You’ll have someone else to answer to and the decisions to be made are no longer just your own.
This also means your business goals will likely change, and sometimes even your business idea itself will morph into something larger, or just completely different. This can actually be a good thing, but you have to be open to this type of change and flexible enough to adjust the big picture you had before.
Another reason using other people’s money is dangerous for small business owners is that you are making a lifetime commitment to someone else — lifetime of your business, that is. Getting external funding is like a marriage; it’s structured and it has legal ramifications. It can be very hard to get out of it if the relationship goes sour.
If these reasons aren’t enough to turn you away from using other people’s money to start your business, then you have your work cut out for you. The competition for other people’s money is fierce, so make sure you have a solid business plan in place and that you’re ready to put in the elbow grease to locate the capital you need.
If you’re not sure what you need to start and grow your business, grab a copy of the Small Business Kickstart Kit which includes a start-up capital worksheet to help you figure it all out.
How did you fund your small business? Share your financing advice and lessons learned in the comments.
Alyssa,
This is a GREAT read, you nailed this topic with a good overview of a very complex subject.
You didn’t mention one of the big risks of OPM: they will want it back. I respectfully disagree with your categorization of your own money and OPM. To me, your own money consists of actual liquid assets that you control and are in the assets side of a balance sheet, unconnected with a liability. So, your personal savings, stocks/mutual funds, retirement accounts, etc. will count in that definition.
OPM, on the other hand, is when another person/entity gives you money. To me, this includes credit cards, mortgages, HELOCs, LOCs, crowdfunding, angels, VCs, etc.
I’d further subdivide the OPM category into three separate notions: equity based funding, debt based funding, and asset/receivable based funding. In the first, you’re giving up some share of your company in exchange for cash. Angels, VCs, and potentially crowdfunding falls into this category.
I’ll skip to the third category: asset/receivable-based funding. It’s possible to get funds based on either your business assets, such as a loan backed by a piece of equipment, or on your receivables. For example, you could factor your receivables and get, as a sample scenario, $.90 for every $1 that you invoiced. The benefit is that you get cash now, but the downside is that you’re taking a haircut to do so. See http://www.nabfonline.com for an example.
Then, there’s debt financing. With debt financing, unless your business is truly established or you have a long track record of success, no lender is going to simply allow you to get a loan based on your DUNS number. You’re going to have to personally guarantee that loan. If your business doesn’t succeed, you’re still going to be on the hook to pay back that debt. So, you have to be comfortable with the notion that if it doesn’t work out, you’ll be able to find another source of income to be able to service that debt. It also changes how you do business in the meantime. I can attest to the stress of having to worry about whether an invoice was going to get paid in time so that I didn’t have to make a choice between payroll or a line of credit payment.
If you’re going to go down the debt route, make sure that you have clearly established milestones and evaluation points for determining if you’re going to keep going. You don’t want to keep shoveling money into a fire pit in a naieve assumption that prosperity is right around the corner if you’re in an untenable business position.
Great info, Jason. Thanks for sharing! Would you like to write a guest post that delves a little deeper into the subject? :)
Hi, Alyssa!
Sure thing! I just sent an e-mail to info at thiswebsite dot com. If there’s a better way to connect (LinkedIn/Twitter/smoke signals), let me know. Also, feel free to delete this comment.
Thanks!
Jason
Awesome post! Looking forward to reading your guest post!