Funding can help you do things in your business that would otherwise be impossible with your current budget. If you need expensive equipment or workers, you may need outside funding instead of bootstrapping your business on your own.
In order to obtain access to funding, it’s often necessary to give up some control over the operations of the business. Businesspeople won’t give you money for nothing – they require something in return. In exchange for resources, your lenders or investors require value – interest, lease payments, or a share of the profits. They look for ways to decrease their risk of losing everything if the business goes under. To reduce this risk they ask for control, the ability to influence the operations and decisions of the business. The more money you ask for, the more control they will require.
If we look at funding options as a ladder, business owners start at the bottom and climb as far up the ladder as necessary. The higher the climb, the more funding and the more control you give up in exchange.
Starting up the ladder from the bottom:
Personal Cash – Investing your own cash is quick, easy and requires no approval or paperwork other than keeping records on what personal money you put into the business.
Personal Credit – If you need a few thousand dollars it may be easy to finance expenses with Personal Credit. Approval can be quick if you have good credit, and payment over time can fit in with your business cash flow. Your credit rating will be harmed if you can’t make payments.
Personal Loans – These are funds you get from people you know personally – family and friends. Think twice – the risk that you may not pay them back can have a very negative effect on your relationship and make otherwise friendly get-togethers very uncomfortable.
Unsecured Loans – Loans typically made by banks and credit unions in the range of a few thousand dollars, depending on your personal credit rating and ability to prove that you can pay back the loan. The loan can be in the form of a lump sum or a line of credit that you can use when needed. The interest rate may be higher on an unsecured loan than a secured loan, so be sure to investigate both options.
Secured Loans – Loans that require collateral. Your mortgage and car loans are examples. If you don’t make the payments, the lender can legally seize the property promised as collateral. Because the lender can reduce their risk by selling the collateral, these loans may be larger and have a more favorable interest rate.
Bonds – An investment bank offers purchasers the opportunity to loan your business money to be paid an agreed-upon rate of return on the amount for a certain amount of time. When the time is up, the bond “matures” and the company must pay back the original loan amount in addition to all the interest payments made along the way.
Receivables Financing – If people owe your business money, you may be able to use the Accounts Receivable as collateral for a loan. Since the lender controls the receivables, they can control what gets paid before anything else, meaning they could use the monies to repay themselves as a priority above payroll or Accounts Payable. You give up control on how your cash is used.
Switching to Capital from Loans:
Angel Capital – An angel investor is a private individual investor who is willing to invest in your business. In exchange they negotiate ownership of from 1 to 10 percent of the business. An angel investor is a bit like taking on a silent partner. They give you capital and in exchange you give them partial legal ownership of the business. Some angels provide advice and consulting, but typically do not have the power to make business decisions.
Venture Capital – VCs, as Venture Capitalists are called, are individual investors or groups of investors who pool their money together. They may offer larger amounts of capital than Angels. Funding happens in “rounds” that start small then grow as more capital is needed. Later rounds can dilute the ownership percentage of current shareholders, so there is typically a lot of negotiation involved. VCs require control in your business in exchange for large amounts of capital, which usually involves seats on the board of directors of the company.
Public Stock Offering – Typically done via investment banks, this means selling shares of your company on the public stock market. The IPO is the Initial Public Offering. Shareholders are partial owners of the company and participate in management decisions by electing board of directors. Whoever owns the most shares in the company controls it. Angel and VC investors may push for going public to cash out on their investments.
The more control you give up for each dollar of funding obtained the less attractive that funding is. The more people you are required to consult with, the slower your company will operate.
Investors have been known to remove executives of a company that is not performing well, even if those executives are founders of the company. The board of directors of Apple fired Steve Jobs from the company he cofounded in the 1990s. Before you take on large amounts of capital, be aware of how much power the board of directors will have over the operation of what was formerly your company.
Ralph Waldo Emerson said: Money often costs too much.