If you run a startup, or a small business, then you know that you need a lot of money. Entrepreneurship is an endeavor that requires a lot of funding, and as such, you’ll need to figure out how you want to handle finances as you grow.
At Business Plan Experts, we’ve had the opportunity to meet many small business owners, startup founders and their teams, especially in Canada. As we work with them on building their business plans, one of the things that they are concerned about is making it attractive to “potential investors” (by the way, we are very good at that). But is taking a loan or giving up part of your equity in your best interest? Or are you better off attempting to continue financing yourself?
The short answer? It depends on you and your startup. Interested in knowing the longer answer, well, you should probably read this to the end, shouldn’t you?
Start-ups vs Small Businesses?
Before we go on to start talking about finances and how to raise cash for your business, perhaps we should attempt to define what a startup is, and differentiate it from a small business. Startups are probably one of the hottest buzzwords in the industry right now. Everybody wants to be called a startup. Even if they are not necessarily one. One of the best definitions we’ve seen of a startup is given by Investopedia. It defines a startup as a young company founded by one or more entrepreneurs to develop a unique product or service and then bring it to the market. The major difference between a startup and a regular small business is that the startup is attempting to solve a problem by providing a unique solution. A small business is a young company that is solving a problem, but not necessarily, with a unique solution
So, if you started a shoe-making company, then you are a small business and not necessarily a startup because there already exist companies that do what you do. However, if your business model involves a new type of shoe that has not been created before then you would qualify to be a start-up.
Financing your Business.
Now let’s talk about Business finance and financing your business. There are three major ways that you can raise capital for your business. The first is personal Investments or bootstrapping, another way is taking out a loan whether is a conventional bank loan or a special type of loans geared towards business. Lastly, you could give investors equity in your company in exchange for capital. Let’s take a look at each of these options and see the one that best suits you and your company. Even if your company is not strictly a start-up, most if not all of these options available to you.
The whole idea behind bootstrapping is to use your personal finances or internally generated revenue to keep running your business. The goal is to minimize expenses as you go on. Many entrepreneurs have taken to bootstrapping in recent times, this means that they have to look for financing via unconditional ways. So, these ways could include renting out or mortgaging their home, crowdfunding, or even emptying their savings. The major advantage of this method is that the founder or founders get to retain complete ownership of the business throughout this period. Some businesses also use crowdfunding to raise capital for a start-up. Crowdfunding basically involves you pitching your idea to millions of people who can then support it with a few dollars. Imagine that a thousand people see and love your idea, and give $100 each towards it, that’s $100,000 easy. Bootstrapping is attractive to some entrepreneurs because it allows them to retain control of the enterprise for a while longer, and as such, they can steer it in any direction that they choose.
On the other hand, if the business should fail, that’s it for the founders. All their funds are tied to the business and so are their options. You should keep this in mind as you consider bootstrapping.
Loans are another option when it comes to raising seed capital for your business. By borrowing money, you can generate more money than you are personally capable of generating. At the bottom of this ladder is borrowing from friends and family. Really, we consider borrowing money from your friends and family a simple leg up from bootstrapping because there are usually no formal terms involved. However, it can be quite painful and awkward if you are not able to pay back the loan on time or even at all. Just imagine how awkward the next thanksgiving dinner would be.
You can also try for a loan from a bank. You can apply for and receive Small Business Loans (SBL/CSBFL). You can get seed capital from the Business Development Bank of Canada, for example. This kind of loan is specially designed for the first 12 months of a business, which makes it an unsecured business loan. Unsecured business loans mean that you don’t need conventional collateral to collect such loans. The loan can be used as working capital to fund marketing and other fees that your business might incur in its infancy.
Furthermore, there are many microloans that can help get your business get on its feet or scale to the next level. You can get Business loans from various banks and organizations starting from $5,000 up to $70,000. Most of these loans are meant for start-ups in specific niches, such as green technology, or financial technology.
Apart from conventional loans, there are also various types of Government financing and direct interventions that your business can benefit from. Usually, these loans and grants are aimed in the direction where the Government or larger industries are looking to invest or solve a problem. For instance, if there is an issue with transportation in your city, then a local or federal government agency might decide to inject investment into that sector by giving loans or grants to businesses in that particular space. Thus, you should be on the lookout for industry-specific loans that apply to your start-up.
That being said, it’s in your best interest to have a business plan when requesting a loan, even from your family. At Business Plan Experts, we help you develop the perfect business plan that will chart a future for your company and also help you get the kind of financing you need. Because we have created over 3200 business plans over the past decade, you are guaranteed for business plan that suits your needs. Click here to learn more about the 3 easy steps for creating a perfect business plan.
Angel Investors and Venture Capitalists
As your start-up continues to grow, you might need a large injection of capital to scale up to the next level. These are where Angel Investors and Venture Capitalists come in. In both of these cases, you are trading equity or a percentage of the ownership of your start-up in exchange for funding.
Angel Investors are a good place to start. They are usually successful and well-established business people with high net-worth and are looking to invest in newer and smaller companies. Your “angel” would typically invest in your business near its infancy, say within the first 3-5 years. The amount they invest in their valuation of your company but can range anywhere from a few thousand dollars to a few million. It is relatively easy to find angel investors, they don’t hide. You can ask other entrepreneurs within your network, check out AngelList, a list of individual angel investors or check out the Angel Capital Association, which has over 300 angel investor groups in the US.
Venture Capitalists are similar to angel investors, only that they are stricter, but would probably be willing to invest more into your business. Venture Capitalists or VCs invest in multiple businesses for their clients, who are also investors, with the hope of making money to provide profit for the investors.
Angel Investors and Venture Capitalists will generally give you funding for a percentage of your company’s equity. In this situation, you are not going to pay back the money, because it is not a loan. But at the same time, you are giving up ownership of a part of your company. They would usually require a seat on your board or some other form of oversight, such as their signature before you can make some decisions that will involve spending above a particular amount
When approaching Angel Investors and VCs, in addition to a flawless business plan, you will need to show some level of proof that the business model of the start-up is workable. Remember that we said that a start-up is a company that doing something that was not done before, and so, you want to show proof that the new thing you are creating actually works. This is why angel investors and venture capitalists rarely invest in a business that’s anything below 2 years in the market.
Which Option is the Best?
As we said, there isn’t a straight answer when it comes to the issue of Business finance, especially for financing your business. In fact, you can run through multiple sources along the journey of your business, especially in Canada. However, let’s take a look at how a typical business can run through these types of funding as that business grows.
At different stages of your business’s growth, it may make sense to consider different financing options.
Pre-seed and seeding Stage
At the beginning of your business, after gaining an idea and forming a team. Next, you should have a good business plan (from business plan experts, of course); the next step should involve launching out.
Because of the uncertainty that surrounds a business, most of them start with boot-strapping. After all, why get into debt over something that you aren’t sure anybody is going to buy yet. This period allows founders to actually stamp their vision all over the business and make changes very quickly to the business model and product chain. The goal of this stage is to develop a working prototype.
Depending on the kind of industry that you are in, you can go for a loan once you have a prototype; these are however seldom available for businesses in state-of-the-art industries, such as biotech, computing, blockchain or other high-tech spaces. This is because it is very hard for the banks and other conventional sources of funding to comprehend the direction that the business is heading or how viable the business is going to be. Thus, many high-tech start-ups turn to angel investors almost immediately after bootstrapping for a while.
Early Funding Stage
Here, the business has gotten their very first customers, they’ve built and refined their working prototype and are ready to reach out to the early adopters and early majority. At these points, it might make sense to go for an angel investor if you cannot get a loan. However, if you are financially capable or the demands of finding and acquiring customers are really low, you can still consider bootstrapping at this stage. It is not uncommon for angel investors coming at this age requesting for 20% equity or even more, depending on how much they have to invest. Of course, the more equity they have, the more control they can exert on your company. The capital injected here can range anywhere from $25,000 to $5 million
Late Funding Stage
At this point, you are now a star, your product works and people love it. Ideally, the demand for whatever you have created should exceed your capacity to supply. As you move forward, you want to get an angel investor or even a venture capitalist to come in. Not only would you need their money to scale up and hit the market big, you also need their experience and guidance as your company goes through the transition from a start-up to a fully-fledged business.
You are going to need industry connections, completely staffed teams for departments like marketing and HR. For this, you’ll need between $5 and $20 million. There’s no way you’re bootstrapping that.
When it comes to financing your start-up, it’s an exchange between control and resources. You can have access to more resources in the form of VCs and Angel Investors, but you’ll have to give up some level of control. Or you can decide to bootstrap and never grow beyond a certain point. However, if what you have is revolutionary, then you might not have a choice. Remaining small and bootstrapping will allow competitors catch up and do it fast. Imagine Uber was still confined to just one state or city, they’d have been taken out of business by their competitors by now.
So, our advice? Bootstrap your business until you gain enough traction, but when your demand begins to overwhelm how fast you can deliver, then it’s time to load up the big guns and receive an influx of funding.
Business Plan Experts, established in 2010, specializes in business planning and fund raising for startups and SME businesses. To book your complimentary one hour consultancy please drop an email on email@example.com or call us on our toll free number 416-566-0387.