Non-Venture Funding Option Pros and Cons
Non-Venture Funding Option Pros and Cons
Whether you’re preparing to launch a startup or want to grow your business, one thing is for certain: You’re going to need money. Equity and debt financing are two different financial strategies: Taking on business debt means borrowing money for your business, whereas gaining equity entails injecting your own or other stakeholders’ cash into your company.The major benefit for debt financing for business, unlike with equity financing, is that you’ll retain full ownership. The interest on business loans is also tax-deductible, and you’ll build your credit. A traditional bank loan is obtainable – so long as you have good credit, enough equity to cover the payments and you’re not already carrying heavy debts. Banks are also reluctant to loan to unestablished businesses. Commercial finance companies are another good source for lending money and are willing to fund riskier ventures to businesses that don’t have solid financials. These loans are based on collateral and include asset based lending, inventory financing, and purchase order funding, to name a few. There are reputable firms, like Business Capital, who can find the most intelligently structured and affordable loan to suit your particular situation.
Source: Forbes.com, June 13 2012, Kate Harrison
Every start up has one thing in common – a need for cash. A good entrepreneur is extremely resourceful (we beg, borrow and barter for everything we can), but at the end of the day there are some things only money can buy. For this reason, CEOs spend a lot of time and effort worrying about money and trying to raise capital for their idea. But not every company is suited for venture, and even if yours is, other commercial financing options might be better for your company in the long run.
There are two primary categories of funding: debt financing and equity financing. In their simplest forms, debt financing is when a startup agrees to pay back a loan with a predetermined timeframe and interest rate and equity financing is when the business sells ownership shares in exchange for funding. There are many different types of instruments to accomplish these two ends, with options, conversions (forced or otherwise), warrants and many other negotiable terms. However, these nuances are material for another day, because before you can even think about a term sheet, you need to understand the larger funding landscape and make a decision about which sources of funding are the best match for your business plan and needs.
To help wade through the business funding landscape quagmire, I called upon, Zoë Gorman, a talented Yale student, to create this simple chart.
Debt Financing Options:
|Banks.Local banks continue lending money when larger banks might slow transactions||PRO||You won’t have to pay interest on a line of credit until you start spending the money.|
|CON||Obtaining a loan could be difficult; high interest rates. Banks also want personal guarantees, which means personal risk.|
|Credit Unions.Non-profit, member owned institutions can help finance your start-up.||PRO||Non-profit institutions with reasonable interest rates.|
|CON||Startupowners must have excellent credit and track record.|
|Peer-to-Peer Lending. Debt-based lending transactions occur directly between individuals through websites such as Prosper.com and LendingClub.com.||PRO||Startups with good credit rating might be able to negotiate lower interest rates.|
|CON||Loans above $25,000 are often unavailable. Loan and company information is publically available on the internet.|
|Crowd Funding.Ideas are funded online through a public platform and investors are repaid in goods or services such as inventory, equipment or real estate.||PRO||Asset-based financing does not relinquish control of the company.|
|CON||This method normally does not raise enough revenue per investor, $25,000 or less. With programs such as kickstarter.com you do not get any of the funding unless you raise the entire amount.|
|Credit Cards. Forty-four percent of companies advance payments with credit cards.||PRO||Cheap, convenient money.|
|CON||Interest rateswill leap up for long-term financing past a month at a time, especially after multiple late payments.
|SBA Loans. The Small Business Administration will guarantee a proportion of loans made by private investors.||PRO||Helps small businesses gain additional funding without going to traditional banks.|
|CON||Startup must prove sufficient cash flow for repayment, which is hard for most young companies to do.|
|Retirement Funds.The ERISA law stipulates constituents can invest existing IRA or 401k funds to purchase a business.||PRO||Use of retirement funds for business does not incur early distribution penalties.|
|CON||Risky to the individual’s future livelihood if the start-up fails.|
Equity Financing Options:
|Factoring.The firm sells its accounts receivables to a company at a discount, and the company assumes responsibility for collecting the receivables.||PRO||The start-up can obtain funds quickly without plans or statements.|
|CON||Factoring companies can charge high fees., depending on the risk of the receivable and you have to have ongoing business with a volume of receivables.
|Angel investors.Private investors that finance start-ups for equity ownership stake.||PRO||Open to lending smaller amounts for longer time periods; lenders specialize in an industry and might be willing to take on higher-risk for potential profit.|
|CON||Angel investors can take a significant stake in your company depending on the terms. Investors will investigate cash flow and credit standing, and finding “a band of angel investors” can take time.|
State Investment or Grants. Many states now have their own investment arms and are writing loans and grants to stimulate job growth. PRO The terms of these investments tend to be very friendly for businesses and some of the programs like CT’s Small Business Express Program provides grants and other incentives that put risk-free money in the hands of entrepreneurs. CON These invetments often come with conditions on how the money can be used which can lock you into a plan. They may also require up to 5 years of residency in the state following the funding.
As a starting entrepreneur I encourage you to use this graph as a starting place for deeper investigation and to pick your path carefully. Venture funding is sexy but it is not appropriate for most companies. Many paths can lead to success, but which source or sources of funding you pursue will impact what that success looks like and your experience along the way.