I’ve spent the bulk of my adult life analyzing numbers in some way, shape, or form, almost entirely for someone else’s business. When it came to deciding how to finance my own business, I found the process more emotional than I anticipated. But, truth be told, starting your own business is a personal decision that impacts more aspects of your life than simply your profession.
To start your business, you need…well…money. Every single business requires funding to start, and there are a number of options out there. You need to have a plan and decide which option is best for you. Here is my take on six funding options for startup businesses.
1. Crowdfunding. We live in a fantastic era where the sharing economy is booming. We actually did pursue a Kickstarter project and exceeded our goal by two-and-a-half times. Lots of other sites have popped up since then.
It was a fun experience, but it wasn’t free. We walked through our crowdfunding costs in this product-design tips article earlier this year. Truth is, we would have made more money if we’d taken on more contract work instead. Still, the experience was invaluable, and I am so happy we did it.
However, if your objective is purely financial, like most deals, it comes with costs, and that includes your time, which will be valued at $0 per hour for the life of the project and possibly beyond.
Check out singer/songwriter Amanda Palmer’s outline of where her Kickstarter dollars went.
2. Friends/Family. It’s the original crowdfunding—a community of supporters gathering behind you because they want to participate in your dreams. Awesome.
For me, this option was the most difficult to accept as we were seeding the company. I had a little savings that I was willing to put at risk. And I didn’t feel right about risking a friend’s capital ahead of risking all my own.
If you go this route, get very clear about what it is you’re getting from said friend/family member: a loan, with a guaranteed return on a specified schedule; or an investment, with no guarantees of any return but some expectation of ownership and oversight. Absent a clear, written agreement, this path has peril for your business and your relationships.
And, if you are okay with Aunt Betty asking for quarterly statements over Thanksgiving Dinner, don’t rule it out. The guys at Method Soap didn’t, and they made fortunes for those early believers. This New York Times interview post-mortems the sale. (And if you want a gripping read about building an amazing company from the ground up, read the founder’s book, The Method Method.)
3. Outside Investors. Angel investors, venture capitalists (VCs), private equity, incubators…they all amount to the same thing: an outsider assuming ownership of a portion of your business in exchange for their money, possibly some expertise/advice, and network. I know this world a little bit, and it is filled with brilliant, motivated investors who have made great contributions to growing startups.
But they do not work for free. They are not providing loans, and they are unlikely to be as interested in your self-actualization through starting a business as you are. So, if you are lucky enough to get a conversation going with a good VC, much less a term sheet, it’s important to understand that they are operating a business just like you. And their business is to invest in companies likely to experience “exits” in a three-to-five-year time frame. (And by “exit” I mean payday.)
Exits are liquidity events by which they get their investment dollars out of your company, hopefully at some high multiple of what they put into it. These exits happen when a bigger company buys yours, or you are big enough to sell shares to the public in an IPO.
Most ideas won’t be appropriate for VCs. And entrepreneurs funded here are likely to lose control of the business once the professional investors show up. Sometimes, founders even have to leave. Take Juicy Couture, instigator of luxury sweat pants, as an example. Selling the brand to Liz Claiborne triggered the ultimate exit of the founders and demise of the brand. In a recent Huffington Post interview on the topic, founder Pamela Skaist-Levy says, “It’s been painful to watch the brand fall down after we left.”
4. Credit/Loan. Whether you do it on your no-interest credit card, your high-interest credit line, or a small-business loan, this money has quantifiable costs that take some of the emotion out of the decision. If you have confidence in your numbers and are comfortable assuming debt, loans can be a very attractive way to finance your business in the short or longer term as you are getting started.
However, it is a legal commitment to pay someone back even if things go sideways. At times, this option can still be the cheapest money you’ll ever see financially and emotionally.
5. Bootstrapping. This is the stoic, stressful path of doing it yourself (aka, The One I Took). I was lucky enough to have some savings, and I put it at risk to start my business. I couldn’t get comfortable with asking friends or assuming debt given so many unknowns about a new business and new industry for me. What about VC funding for businesses like mine? I’m more likely to win a herd of unicorns. Based solely on numbers, this path was not the most financially savvy—using other people’s money almost always is—but it was the solution I could survive for all of the other factors that go into difficult decisions.
And now, my favorite—the one I wish I’d tried:
6. Pre-Selling/Advance Orders. Sell stuff that you haven’t made yet. Genius, right? If you have channel relationships, or even a simple e-commerce site, you can pre-sell products ahead of taking inventory.
You might need some degree of investment to get a working prototype or production-quality samples, but it really mitigates some of the risk in taking large amounts of inventory that some product businesses require. You’ll need some marketing muscle behind you to generate these pre-sales, but the upside of success is impressive. You get as close to a crystal ball as possible with respect to gauging demand and estimating appropriate inventory orders.
If you have a valuable enough product, you may be able to take deposits to fund next steps—with the understanding that you need to deliver the product or return the money. Also, vendors may be willing to negotiate payment terms with you—de facto financing—if you have solid proof of sales commitments. If you have confidence in your ability to execute, it’s a clean, risk-mitigated model.
For me, running the numbers was only part of the decision-making process with respect to financing. My tolerance for emotional risk was an important factor, too. Money tends to flow in and out of lives, but time only flows out and relationships are long-term investments.