If you are going to need outside financing to get your new business up and running, then where do you start? These days, as credit becomes harder to come by and personal equity shrinks for the majority of Americans, the answer may not be so simple.
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The State of Start-up Financing Today
For those thinking of starting their own business, the state of the economy has certainly made the process more daunting. Though it may not sound so encouraging, the unavoidable truth is that the U.S. economy is struggling under a heavy load of pervasive, fundamental problems, and it doesn’t look like they’ll be much change for the better for a few years to come.
Due to the recession and the subsequent weak “recovery,” the rules of business finance in particular have changed somewhat. Traditional business lending- especially among small businesses- has stalled, not because there isn’t enough money available, but because banks and lenders are hesitant to lend out money to all but the most creditworthy borrowers (and more often then not, those ideal borrowers are not the people seeking loans in the first place). Moreover, there is a growing adversity even among would-be borrowers towards taking on debt. So what we have here is a case of plenty of fish in the pond and plenty of bait; but few are out fishing and even fewer are biting.
Instead, an increasing number aspiring entrepreneurs have been turning towards more non-traditional, and often less formal sources of financing to start up their businesses. In this post, I will list many of these sources of financing as well as some resources you can check out to see which options may be appropriate for your particular situation.
Frugal Start-up Financing Options
1. Turning to friends and family. Though asking friends and family for money is an age-old, tried and true method of getting financing, if you want to still be able to speak to your acquaintances afterward, it’s a good idea to “seal the deal” with a formal, written contract. It may seem a little awkward to write up a contract for mom and dad, but by doing so the message that you are sending to both yourself and your acquaintances is that you are taking the transaction and your business seriously.
This contract should include the amount of money received, the method of repayment as well as the specified repayment period. If your acquaintances will be shareholders in the business, then make sure you consult with an accountant or lawyer regarding how to set that up.
There are several sites that can serve as an intermediary to make the loan between you and any of your friends and family more official and binding. Each of these services come with various features, but each one offers some form of legal paperwork, payment processing, and loan status information. Here are four sites to check out:
2. Taking on a partner. One way to increase your available resources is by taking on a business partner. Business partnerships can take different forms. You can chose to go with a silent partner. This is someone who invests in the company but who does so without voting rights or authority. Usually, such a person will agree to receive a portion of the business’ profits in return for his or her investment.
On the other end of the spectrum is the active partner who becomes a co-owner of the business and who will also assume responsibility for running it. There are different levels of silent and active partnerships that fall in between. How the partnership is setup will really depend on the needs and goals of the business in conjunction with the needs and goals of the investor.
The most important thing to remember before taking on a partner is that you should have a formal business partnership contract in place. This is an essential and forward-thinking initiative that can save a lot of confusion, discord, and heartache down the road. It also almost goes without saying that in most cases it pays to get a lawyer’s assistance in writing up the contract’s details.
3. Seeking out micro financing. As the name implies, micro loans are small, short-term loans that can be used for business start-up, operation, or growth. Such loans can be offered by commercial lenders, non-profit organizations, even peer-to-peer lending sites qualify. If your capital needs are modest, then seeking a micro loan may be a good option. You may have even greater chances of getting funding if you fulfill one or more of the following criteria: you are a woman or a minority, you are poor, you are starting the business in an economically depressed neighborhood. With peer-to-peer lending, your chances of getting funded depend on having a good credit score (i.e. at least 600-650).
For more information on micro financing for small businesses as well as resources to help you locate a micro lender, see my previous post: 14 Sites to Help You Microfinance Your Business or Startup.
4. Try crowdfunding sites. Crowdfunding, an offshoot of social networking, is a relative newcomer as a source of business financing. With crowdfunding, groups of people pool together money in support of a project or organization. In this case, the borrower’s credit rating is not the main factor determining whether he or she will receive financing. Instead, significant emphasis is placed on the borrower’s online presence and reputation in addition to the idea behind the funding request.
Unlike more traditional forms of business financing, the money raised through crowdfunding is not directly repaid. Recipients instead may offer their investors a specified item or service in exchange for their pledge of money. Some popular crowdfunding sites include:
5. Join a business incubator. Business incubators are programs designed to facilitate the growth and development of start-up and early stage businesses through an assortment of business support resources, services, and networks. Though incubators may vary in terms of what they have to offer, how they are set up, and which kinds of companies they accept, they generally offer some combination of technical, logistical, and financial assistance including:
- Office space with high-speed Internet access
- Networking assistance
- Marketing assistance
- Help with accounting/financial management
- Access to bank loans, loan funds and guarantee programs
- Links to higher education resources
- Links to strategic partners
- Access to angel investors or venture capital
- Comprehensive business training programs
For some more information on business incubator in the U.S., here’s a good article at the Wall Street Journal. To locate a business incubation program in your area, go to the National Business Incubation Association.
6. Seeking out grants, scholarships, entrepreneur competitions. In some cases you may be able to qualify for a government or educational grant, a scholarship, or a competition aimed at recognizing promising entrepreneurial ideas.
For information on government grants see:
- A list of State Development Agencies for small business grants
- The Catalog of Federal Domestic Assistance
*Note: Though there are grants available for small businesses, they typically come with many requirements for approval and restrictions on the use of the money. Unless you know for sure that your business fits into a specialized, “grant worthy” category, I wouldn’t spend too much time looking for funding in this area.
For a list of entrepreneurial scholarships, you can start here.
For a calender of scheduled business plan competitions, go here.
7. And last, but not least… bootstrap your business. In some cases, none of the above options may be the best choice for start-up financing. Sometimes, the best and most frugal way to fund a new venture is by working another job or doing some kind of consulting or freelance work on the side so that money can be saved for the future business. Once the business starts generating income, that income can be reinvested into the company to help fund expansion. Though your business’ growth may be a lot slower should you take this route, it means fewer bills… and creditors.
***Note: Those interested in a more standard business bank loan, should take a look at the various loan programs sponsored by the Small Business Association to see if they qualify. Just be prepared for a lot of paperwork.
Those who want to tap outside investors for their start-up funding should take a look at this informative article by Paul Grahm of Y Combinator.
If you would information on finding angel investors and venture capital firms, you can start with the following sites:
- Angel Capital Association
- Inc. Angel Investor Directory
- Angel Capital Directory
- Go Big Network
If you are thinking of selling stock in your start-up company to the public (called an IPO), then take a look at this basic series of articles at Investopedia.