The challenges that are faced by the small business owners at the start of their entrepreneurial adventure, can almost be observed as a universal rule. The first challenge thereto is without a doubt the $$$money$$$. This is something you cannot get away from no matter what your business is, as having a solid financial background and plan is the key prerequisite for your business to survive its lift-off.
This is simply the way it goes, anything you do requires financing, from setting up your business to developing the product, purchasing equipment, hiring digital marketing agencies, etc. If you are starting your small business and don’t know where to start in the strategical sense – read this article as this is surely your starting point.
So, the point we’ll discuss here is how you can secure initial financial resources without overly relying on your personal savings and mortgages backed with your personal assets.
From this article, you will find several tips on how to secure some money for your business. But most importantly, we will explain some of the key aspects of each financing method in a nutshell so that you can be properly informed.
So, let’s kick it off!
The Universal Step 1 – Build a Strong Brand
Before you do anything outside your four walls, make sure that you have built a strong brand and business plan, or at least an idea of it. What do we mean by that?
Well, imagine somebody comes to you and says „hey, I need you to lend me $50K so I can start a business? “. Say you have the money, would you just give the money away, or would you be curious about the idea? What’s the first question you’d ask? Would it be a question or questions? Well, the answer is obvious, we just wrote this so you can feel good because you know the answer.
Naturally, you’d want to know everything possible about the business idea – what will this person do, with who, what’s their plan, the product, the structure of the organization, etc.
Then, the next and the most important question (as you’re just becoming an investor) you’d ask is the WIIFM, or What’s In It For Me? You’ll want to know what money you will make from making this investment and how soon. This is called the ROI, or the Return on Investment. You don’t want to buy in if there’s no ROI unless you are a „Santa Claus“ investor.
And this is the point where the negotiations will begin.
Do you get the idea? Always, and without any exception, the first thing you need to do if you want somebody to give you their money is to make a strong business plan that will answer any questions your investors might have.
If you don’t know how to do it – ask for help, read, inform yourself, and do your research. Do anything that it takes, as without this there will be no money for you.
In the next 3 tips, you will understand the difference between individual financing models, and how the risk factor is distributed among them.
Tip 1: Seek Loan-Based Financing
By loan-based financing, we mean when somebody gives you their money, you return it incrementally, plus you pay interest as a „fee“ for using else’s capital.
You can get this from a bank, your friends and family, or anybody willing to grant you a loan. Also, you can look if there are local government incentives for simulating small businesses and self-employment. At this point, having a strong business plan can be useful, as you will use it to explain why somebody should give you the loan.
What do you need to know about this?
A loan is a quid-pro-quo transaction. Nobody will give you a loan to „help“ you (unless maybe your parents), but to make money from it. This is why you need to take this very seriously and make sure that you will be able to return the loan.
As regards the risk distribution, know that the loan grantors (especially if we’re talking about a bank) will want minimum risk i.e. they will want to be as sure as possible that you will pay the loan back. This is why they will ask you for „security“, and most likely you will have to put a mortgage on your house or equipment. So, if you don’t pay the loan back, the bank will initiate the sale of the secured asset and collect the money from the sale.
In conclusion, if you are positively sure that your business will have a solid cash flow in the initial years (say you already have a contract with several vendors for a certain period), asking for a loan could be the proper way to obtain financial resources. This way will keep your business operations independent, as the loan grantors will not have interest in your business operations as long as the loan is returned.
But, if you are in a volatile industry or still don’t have vendors but, have a good idea, maybe you should consider other methods of financing. The ones where somebody will share the risk with you.
Tip 2: Attract Private Equity Investors
Let’s start by explaining what Private Equity (PE) is. In a nutshell, PE is a way how your business can be directly financed, either by wealthy private investors (a.k.a. Angel Investors), or PE firms or funds.
There is no rule or template for PE transactions, as there are countless alternatives and deal structures. Maybe you should ask for legal counsel here to advise you on how to get the best deal. But some things are in common with any PE transaction that you should know.
First, a PE investor needs to recognize your start-up as potential buy-in. This is where the first tip on a business plan jumps in again. But investors won’t come to you – you need to reach out. Create your LinkedIn network, participate in conferences and business events, and impose yourself. And of course, make a good presentation and be persistent to appoint a meeting to pitch your idea. If your e-mail or call is ignored 200 times, maybe the attempt no. 201 will be a success. As Jocko Willink would say: Get after it!
Then, after the investors do their due diligence, they will want to purchase a certain percentage of your startup’s shares. Some investors will want majority shares, some will want a minority share. Some will take a passive approach and will not interfere in business operations, and some will want to enter into the management structure to control the business operations and guide the further development of the business. Don’t see this as a bad thing, know that the only investor’s goal will be to make your business as profitable as possible.
But, you need to make sure that you retain desired level of control over your business (voting rights, dividend distribution, key decisions, etc.). We will not talk about this in detail, as there are books and studies on PE transactions. But we hope you got the idea, and that we’ve given you some information to know where to scratch when it itches.
Finally, after say, 4-6 years after the entry, the investors will want to exit. They will aim to sell their shares at a much higher price.
PE investments are by far the most popular in the IT and Software industry. But if you have a good idea outside this market segment, why not try.
What you need to know is that in this way, you can get substantial investments where the investor will share the risk with you. You won’t need mortgages. But, you will need to work with the investor and give away some aspects of your independence. Again, this doesn’t have to be a bad thing.
Just be careful when selecting your partner.
Tip 3: Crowdfunding and Crypto
If you are interested in more innovative ways to raise money, you can have a go at the Crowdfunding or maybe launch an Initial Coin Offering (ICO).
In a nutshell, crowdfunding means that you will raise your money via services that work similarly to public auctions. You will launch your idea, explain why it is interesting (again with the business plan tip), and ask anybody who sees your idea to give some money to you. The most popular crowdfunding platforms are Kickstarter and IndieGoGo.
It seems quite simple, and it is. There are several crowdfunding methods, one of which can be a simple donation where the „Investor“ expects nothing in return. But the most usual one is where you ask for a relatively small amount of money in exchange for a later reward of some kind. Say, you ask the „investor“ to pay you $500, and you promise to give a free product to the investor in one year. The crowdfunding investor usually pays a relatively small amount of money, but this is where the law of big numbers comes in. $500 is not much, but if 20.000 people pay you $500 each, well…do the math.
But what you need to know is that this is not risk-free. Keep in mind that you do promise some kind of reward in exchange for money. When two people agree on mutual performance, that is called a legally binding contract. If you don’t deliver what you’ve promised, you could be facing lawsuits.
What is ICO
If you are into state-of-the-art technologies, maybe you should try to raise money through the blockchain and crypto world and launch your first ICO.
ICO is like the IPO (Initial Public Offering) when the company goes public by listing its stocks to be traded on the public market. Through ICO, your company will go public in a way, as different buyers will gain stocks of your company. But the difference is that the blockchain platforms are decentralized, meaning that they are not under government agencies’ control.
What you will do is create a „token“ that will be somehow connected to a share in your company. The investors will buy your token on a crypto market and gain a certain percentage of the shares in your company.
Some of the biggest ICO deals weighed more than $200M!
Note that this is the extremely simplified version of an ICO, and you would need a lot of prep work to do, but it is an idea you can consider.
What we hope you’ve taken away from this text is that having a solid financial background is extremely important when starting a small business. There are many methods how to raise the money needed for your operations, but the key and most important thing is that you fully understand your business and its potential so that you can select the method best for you.
This is why it is very important to first start with a solid and comprehensive business plan.
Each financing method has its ups and downs. Each method can reward you with high profits but also can bury you in debt and kill your business.
So, inform yourself properly and make the right call!