- Before you jump into fundraising, think through potential legal forms for your business (such as limited liability company or C corporation), and get set up properly.
- If you accept funds from friends or family, consider writing up terms for the investment and having your agreement notarized to prevent later misunderstandings.
- While it may be tempting to bankroll your new business's growth with your credit cards, this can be an extremely risky and expensive source of funding.
So you've got an idea for a business, and you're ready to bring it to life.
Once you've done some market research, drawn up a business plan, kicked the tires on your idea, and worked out the initial steps you'll need to take to get it off the ground, you'll likely need some funding. Maybe you need to rent commercial or office space, get the first batch of your product manufactured, or hire some employees.
Whatever the purpose, you'll have a few potential funding sources to consider, each of which comes with its own set of hoops to jump through (and pitfalls to avoid). Here is an introduction to some of the main types of funding, and key tradeoffs to be aware of for each.
First things first
Ready for a fundraising bonanza? Slow your roll.
Before you raise a penny, you should think carefully about what type of business structure is appropriate for your new venture (such as a limited liability company, C corporation, sole proprietorship, or limited partnership) and do any necessary setup work.
That's an important first step because it can affect, say, whether your company or you personally are on the hook if you're having trouble repaying borrowed money.
1. Small-business loan
How it works: You apply to borrow money from a lender, like a bank. If your application is approved, you typically receive a lump sum of money that you'll have to repay, with interest, according to a certain time frame. (Or if you borrow with a small business line of credit, you'll instead have access to a revolving line of credit, similar to a credit card.)
Pros: Loans backed by the US Small Business Administration (aka "SBA loans") can come with highly competitive interest rates. Plus, taking out a loan—rather than taking on equity investors—means you get to own more of your business's potential success.
Cons: These loans can be difficult to obtain, and borrowers typically must pass a rigorous application process. Prospective lenders may scrutinize your business plan and your company's financial statements, and may want to see that your company has already established a credit history. They may also want to evaluate your personal finances, in addition to your business finances.
Key tip: If you're considering this route, look into whether you might qualify for one of the SBA's loan programs and apply with SBA lenders before you consider a non-SBA-guaranteed loan.
2. Help from friends and family
How it works: Perhaps your best friend from college (or the “bank of mom and dad") believes in your idea and wants to give you a boost. If so, you'll need to agree on whether the money is really a gift, a loan, or an equity investment in your business, plus agree on terms and draw up paperwork.
Pros: With (typically) no lengthy applications or credit checks involved, this can be a simple and quick way of raising funds.
Cons: Even if all parties go into the arrangement with best intentions, it's possible that feelings could change down the road. If your business makes it big, your friends and family might regret not receiving equity (or you might regret that you gave it to them). And if the business fails, you might disagree over what sort of repayment they're owed.
Key tip: Even if you don't work with an attorney, write up a formal agreement that spells out all parties' rights and obligations, and have it notarized. While it may feel like an awkward step, think of it as an expression of your mutual respect: your respect for their financial resources, and their respect for the legitimacy of your business.
How it works: You write up a description of your business, your funding goals, and what you plan to use the money for, and post it on a crowdfunding platform (see a list of some of the major platforms). You can then receive funds from friends and family—but also strangers—who come across your crowdfunding campaign online. Depending on the crowdfunding platform you use, the funds you receive might be in exchange for some kind of reward (like a "thank you" on your website or a sneak peek of your product), might be structured as a loan (in the case of peer-to-peer lending), or might even be equity investments in your company.
Pros: Launching a crowdfunding campaign can be easier to set up than many other funding options. And repaying funders with "rewards" might be a lighter lift than repaying a loan or taking on investors.
Cons: Unless your campaign goes viral, you might have difficulty raising as much money as you need this way. Plus, crowdfunding platforms generally take a cut of the money you raise.
Key tip: If you go this route, be extremely cautious about choosing a platform to work with, and make sure you know its terms inside and out (and are comfortable with them). Use just as much care structuring your campaign as you would agreeing to a loan or traditional equity investment. And know that there may be important tax or legal ramifications for receiving these funds, so check with a tax professional or attorney.
Thinking of using credit cards? Tread carefully.
Although it might be tempting to tap the plastic in your wallet for your funding needs, it can be a risky (and highly costly) proposition.
Credit cards are typically one of the most expensive ways of borrowing money, and it's easy for a few charged expenses to spiral into an unmanageable balance. Plus, using your credit cards puts your personal credit score on the line—meaning any missed bills can harm your personal finances for years down the line. In extreme cases it could even lead to personal bankruptcy, which can have even more serious consequences, so think very carefully before using this option.
5. Employee stock ownership plan (ESOP)
How it works: You set up a formal plan to pay your employees partly in company stock, making them investors in your company and reducing the amount of cash compensation you need to pay. Although an ESOP probably won't suffice as your first or only source of funding, it can help to reduce the total funds you need to raise from other sources in your business's early years.
Pros: In addition to trimming your cash expenses, letting your employees build equity in the company can help them feel more invested in its future and success.
Cons: You'll face some up-front expenses to set up a plan, plus ongoing costs to administer it. And an ESOP can't defray all your fundraising needs, so you'll likely still need to pursue other sources.
Key tip: Think about how an ESOP could affect your ability to hit your total funding needs, but also weigh how you truly feel about bringing on your employees as co-owners. Consider as well what would happen if they decided to leave your company.
6. Venture capital
How it works: Gain an introduction to venture capital investors, and put together a killer pitch for your company. If you're successful at winning these investors over, you'll then need to negotiate the terms of their investment, like the valuation of your company, how large an ownership stake the investors receive in exchange, and any other rights their investment may entitle them to. These negotiations can be high-wire acts, and any agreements you make will have lasting implications for your business.
Pros: If you're successful, venture capital can provide a substantial source of funds. It could also help to raise your company's overall profile, and give you a reputational boost when it comes to future investors or business relationships.
Cons: Unless you already have connections to the venture capital world, it can be challenging to gain an audience with these investors (and even more difficult to actually get your pitch accepted). Plus, accepting venture capital money typically means giving up some ownership (and control) of your company's future success.
Key tip: Although venture capital might be the most buzzy source of funding, it's far from the only game in town. So don't get discouraged if it doesn't work out.
And remember that it's not uncommon for new companies (even ones that eventually go on to great successes) to suffer plenty of setbacks as they're getting started. Not every loan officer or prospective investor will believe in your idea, so trust your vision, and keep at it. After all, if starting a company were easy, we'd all be CEOs.