One of the most difficult challenges for any entrepreneur is obtaining capital. Many people find it hard to secure financing for starting a new venture or expanding an existing one.
A business needs capital to survive and to move from one stage to another. That is why entrepreneurs must identify the best sources of finance to establish or improve their businesses.
The obstacles and problems involved in obtaining money — particularly from lending institutions — are often designed to filter out those who may not be prepared to survive in business.
The trick to finding capital, according to many entrepreneurs, is obtaining it from the right sources and in the right sequence as the business grows and evolves. This means that when searching for funding, every available avenue should be explored.
The following are some of the best sources of financing for a business venture:
Banks
Winning over a bank is one of the highest hurdles a start-up business faces. Banks are important to small business operators for two reasons:
- They provide a safe place to store money.
- They can be a source of financing and other financial services.
Unfortunately, most banks prefer lending money to individuals and businesses that appear least likely to need it.
Corporate Venturing
Some companies lend money to entrepreneurs in the hope of establishing a working relationship with them. This practice is known as corporate venturing.
Naturally, the entrepreneur’s product or skill must benefit the company being approached and must be supported by a solid business plan. The company may also request an equity share or partial ownership agreement in return for its investment.
Crowdfunding
The practice of raising money through public donations has existed for centuries. For example, the construction of the Statue of Liberty was partially funded through a newspaper campaign. Selling war bonds to finance military campaigns and writers collecting money from future readers before printing books are also forms of crowdfunding.
Today, many crowdfunding platforms operate online, including GoFundMe, Kickstarter, Indiegogo, Patreon, and Crowdfunder.
Crowdfunding usually involves either pre-selling a product or offering some form of equity in the business. However, attracting attention from the public can be difficult without an established network or strong media involvement.
Equipment Loans
Expensive equipment such as machinery, display cases, or tools can sometimes be purchased through extended low-interest loans provided by the company that manufactures or sells the equipment.
In return, the entrepreneur may be asked to promote or display the supplier’s products within the business. Entrepreneurs should speak with suppliers and manufacturers for more information about such arrangements.
Family and Friends
Entrepreneurs who can demonstrate reliability, trustworthiness, and a solid business plan may be able to secure funding from family members or friends.
However, these individuals should not automatically be rewarded with management positions, as this may create future conflicts. It is also generally unwise to ask friends or family to invest their life savings into a business, since there is always a risk of losing the money.
Because borrowing from family and friends is highly personal, it should be approached carefully and thoughtfully.
Government Assistance
Local and national governments sometimes offer financial support to small businesses that meet certain requirements. Examples may include businesses that:
- employ people with disabilities or marginalized groups,
- operate in economically disadvantaged areas,
- help protect the environment, or
- address local social or economic problems.
Entrepreneurs should contact local economic development offices for more information about available programs.
Grants
Grants provide money that does not need to be repaid. Common sources of grants include universities, professional organizations, governments, trade associations, and sometimes international organizations.
Young entrepreneurs, unemployed individuals, artists, pensioners, and people establishing businesses in underdeveloped areas are often more likely to qualify.
Although grants are usually modest in size, even a small amount of money can greatly help a new business reduce expenses. Grants may also be available for employee training, marketing, research, or insurance.
Entrepreneurs should not hesitate to apply for grants, but they should be prepared to complete substantial paperwork both before and after receiving the funds.
Issuing Shares
Issuing shares is a financing option available only to incorporated businesses. The advantage is that investors who buy shares do not need to be repaid like lenders.
The disadvantage is that shareholders become part owners of the business and may hold the entrepreneur accountable for business decisions.
Shares can also be used creatively. For example, some businesses issue shares to employees as part of their compensation packages.
Soft Loans
Loans are considered “soft” when they do not require security or collateral, have long repayment periods, and allow flexible repayment schedules.
However, soft loans must still be repaid with interest, just like regular loans. Small Business Development Centers, local governments, business-oriented banks, corporations, and business associations are often good places to search for soft loans.
Trade Credit
Some suppliers allow businesses to receive goods and delay payment for 30 days or longer. This gives the business time to sell the merchandise before payment becomes due.
If a business has a reliable customer base and strong sales potential, trade credit can be an effective way to reduce inventory costs and operate with less startup capital.
Venture Capitalists
A venture capitalist is an individual or group that finances businesses in exchange for partial ownership and a share of future profits. Venture capitalists typically expect rapid growth and high returns on investment.
Because many venture capitalists are experienced businesspeople themselves, they are often skilled at identifying strong commercial opportunities. However, most venture capitalists are more interested in fast-growing businesses with large profit potential than in small traditional businesses.
Final Thoughts
Entrepreneurs should be very careful when selecting the best source of financing for their businesses. If a business is medium-sized or large, issuing shares may be an effective way to reduce liabilities and spread financial risk.
Combining several funding sources can also be beneficial, but entrepreneurs should avoid relying too heavily on loans with high interest rates, as excessive debt can place serious pressure on a business.