Start-up businesses are as varied as the people behind them (“founders”), but their funding follows a pattern. Business funding comes in two flavors: equity and debt (but like soft-serve ice cream you can get a swirl that combines elements of both). Equity is money invested in your company and debt is money borrowed by your company. Many founders, however, will also rely on personal credit to borrow (from credit cards, second mortgages, etc.) to put money into their new companies.
Before you put a penny of your money in the company (and certainly before you take other people’s money), invest your time, intellect and passion in writing a business plan. Do not buy a business plan. If there’s a study comparing success and failure in businesses with individually-developed versus canned plans, I would love to hear about it. Until I’ve seen that study, I have to go with my gut, and my gut tells me a plan you write is more likely to succeed because it will be more exciting, accurate and believable, and not just to your potential investors, but to you too.
Make sure your business plan is more accurate than this.
Fortunately, plenty of help is available for folks writing business plans. Here is my post with links to business resources in Colorado, including business plan help. Your plan must contain a budget covering the early stages of the business; how else will you know how much money you need to raise? This is not the time to skimp. Start-ups don’t fail because they are over-funded, but the opposite constantly happens. Some telling advice from the trenches: double your best estimate and then double it again.
Equity
A new business does not get off the ground without invested funds. First dollars come from the founders, from funds saved or borrowed. The depth of their pockets and the ambitions of the business plan determine when additional investors are needed, if ever. After founders, equity typically comes from family and friends, then from a wider circle of friends-of-friends in “private” offerings, followed by professional investors—angel investors and venture capitalists, and finally, from a public offering. Start-up investments from beyond your inner circle are going to be hard to find in today’s market.
Good for lawyers, bad for you, each stage of equity is loaded with legal issues. The private offering exemptions that will keep you out of the public company morass are complex. Even if you fit an exemption, every investor still presents twin risks of investment fraud claims and plain-vanilla business disputes with your “partners.” So, if you are going to skimp on legal fees, do it in another area of your business. Always talk to a lawyer before adding owners to your human-owned business.
While all companies require investors, most will rely on lenders, too. Founders often divide their support into investments and loans for income tax planning reasons. This step can backfire and create tax and personal liability problems if not done properly, so check with your advisors first. Lenders other than founders are your next funding source.
Borrowing
The trouble with borrowing by start-ups used to be finding terms acceptable to the founders. In the current environment, many start-ups and even established companies can’t find loans under any terms. Start-ups that do find loans often get them from lenders other than banks (banks want collateral that start-ups and their founders often lack) and end up paying very high interest rates. Interest rates reflect the lender’s risk of getting repaid. You accept your start-up’s risk because it’s a dream you believe in. The lender sees a potential nightmare and wants to be paid accordingly.
Start hunting for a business loan where you conduct your personal banking. Established relationships and trust may not seem as valuable as they once were, but when order returns to the credit markets I think they will be more important than ever. If you don’t find what you want or can afford there, expand your search to lenders specializing in loans to emerging businesses. (Some non-bank lenders in Colorado are listed in an earlier post.)
Small loans based on a compelling business plan (and a personal guarantee) can be found, but larger or longer-term loans typically require results not projections. With faith in your business plan, founder’s capital invested, and maybe a small loan, you might have to launch the business to prove your dream.
If the current crisis proved anything, it proved that attention to details counts. If you are going to borrow for your new business, you will make sure you have thoroughly read and understand the loan documents before you sign them, won’t you? A lawyer can help here, too; not to negotiate, but to make sure you understand what you are signing and to make sure the documents reflect your deal.
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