Basically, there are two ways to fund a new business: debt and equity.
Debt, commonly thought of as a loan, requires that the borrower/guarantor has an adequate cash flow or has enough unencumbered liquid assets to pledge as collateral. This collateral covers the debt’s principle and any liquidation costs and discounts in the event that the borrower cannot make the agreed upon payments.
Related Post: The Debt Continuum
In contrast, equity (also called risk capital) is generally the only way to get funding where there is no established cash flow that can be used for repayment, such as before a business launches or when it has plans to scale that requires more money than its current cash flow can support.
Equity can be further broken down into the following six sub-categories:
- Gift Equity is when a family member, friend, or donor (such as from a charitable crowdfunding campaign) gives you time and/or money with no expectation of repayment because they simply believe in you or your mission.
- Sweat Equity is equity that is created as a direct result of the hard work or free labor by the owner(s).
- Owner Equity represents the owner’s cash investment in the business.
- Customer Equity is where the cash flow from pre-sales or actual sales is used to grow the business.
- Angle Funding is usually cash plus leverage in the form of contacts or access to knowledge provided by an outside investor who has a vested interest in your business’s future success.
- Venture Capital is cash plus sometimes leverage provided by a fund whose main obligation is to provide a return to the fund’s investors across a series of investment, sometimes at the expense of the founders.
With respect to angel funding and venture capital, you have to remember they aren’t giving you money out of charity. The minute you take their money, the obligation to the investor really starts. Sometimes it perplexes me when I see a company’s founders celebrating receiving outside equity funding from an angel or venture capital fund. In short, the founders just gave away a huge part of their business to a stranger and are now beholden to their demands. Often this funding will force the business to grow along a path not envisioned by the founders.
Related Post: The Tech Startup Fallacy – Why your business may be at risk of when you accept Venture Capital funds.
Generally, bootstrapping is your best option to start and grow a business. However, under certain situations, angel funding or venture capital funding is the best course and makes the most sense. Such cases generally are related to the need for an accelerated launch or ramp-up schedule to beat out a competitor’s position.
From what source will your funding come from?
Related free course: Funding Your Small Business Startup
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