Lack of capital is a key reason many startups fail. Obtaining all the money you need before you launch improves your odds of success. Armed with the truth about how startup financing really works, you will be better prepared to succeed.
This is the fifth in a series of columns that provides several helpful business topics for new small business. It is based on one of SCORE’s recent projects developed with the help of and in partnership with FedEx. This project is called “Startup Roadmap” and outlines every step in starting a business. A SCORE mentor may use this program to help you reach your goal smoothly.
“Where will my startup capital come from? How can I get it? How will I repay it? What happens if I can’t?” If you are asking yourself these questions, you’re not alone. Worries about financing haunt many startup entrepreneurs — and even keep some from pursuing their dreams.
At the other end of the spectrum, some startup entrepreneurs buy into the myth that startup capital is there for the taking. You may have seen ads claiming that the government gives away grants to help people start businesses or heard that SBA loans are “easy money.”
The truth lies somewhere between these two extremes. Startup capital is not easy to get, but it can be had. In fact, there are more financing options for small business owners than ever before. You just need to know what options exist, how they work, and which one is the best fit for your startup. I urge you to consider the following suggestions.
Step 1: Assess your personal financial picture, Your funding needs, and your creditworthiness.
Before you consider different financing sources, you need to know how much money you have available from your own resources, how much you will need from outside funding sources, and how easy it will be for you to borrow money based on your personal creditworthiness.
Before seeking financing, you must know the specific amount of money you need. This helps you determine the best places to look for financing. Some sources offer small amounts of capital and others offer large amounts. Since there are costs associated with obtaining capital, borrowing more money than you need can become very expensive.
Finally, check your personal credit score. As a startup, your business doesn’t yet have income, assets, a track record or a credit score of its own, so lenders must turn to your personal credit score in deciding whether to finance your business. Lenders want to know if you can and will repay the loan; your personal credit score is the best indicator of how you handle your debts.
Step 2: Investigate potential funding sources.
First, it is important to understand debt vs. equity financing.
Debt financing is something most of us are already familiar with. When you take out a home mortgage loan, get a loan to buy a car, or buy something with a credit card, you’re using debt financing. A person or organization is lending you money that you will pay back with interest. Debt financing for business startups includes bank loans, SBA guaranteed loans, credit cards, borrowing against your assets and borrowing from friends and family.
Equity financing means an individual or organization gives you money in return for a share of ownership in your business. For startup businesses, equity financing typically comes from individuals such as your friends and family or angel investors. (Venture capital and public offerings are other ways of getting equity financing, but these methods are for established businesses.)
Investigate the pros and cons of each of these potential sources of funding:
- Bank loans.
- SBA guaranteed loans.
- Nonprofit lenders.
- Credit cards.
- Borrowing against your personal assets.
- Home equity line of credit/home equity loan.
- Borrowing from your retirement account.
- Personal loans.
- Friends and family.
- Equipment financing.
- Angel investors.
- Grants and awards.
Step 3: Learn how to pitch to lenders or investors.
Now that you’ve identified your best options for startup financing, take a closer look at what is involved in applying for financing. You will need to know what information the funding source you’ve chosen expects to see from you, how best to present your business idea, and what you can do to improve your odds of success. You will feel more confident going into the financing process and be more likely to get the money you need.
At this point, you have completed one of the most arduous legs of your startup journey. Getting the financing you need to start your business is an achievement to be proud of. It is proof that someone else thinks your business idea is good enough to risk money on. That’s a real vote of confidence!
Dean Swanson is a volunteer Certified SCORE Mentor and former SCORE chapter chairman, district director and regional vice president for the North West Region.