If you crack open most entrepreneurship textbooks, you’ll find that they talk a lot about how entrepreneurs finance their businesses.
These books are targeted at students in courses that focus on the creation of high potential businesses, they spend a lot of time discussing venture capital, angel investing, and other sources of external equity capital.
As a result, they don’t describe how most entrepreneurs finance their businesses.
During the life of most any business, the owner will need to seek out cash to help with its growth or to keep it going through a rough patch.
In truth, that are four patterns that prevail in how an entrepreneur fund their business:
1. Most New Businesses are Highly Capitalized
Most entrepreneurs don’t need much capital to get started.
The Entrepreneurship in the United States Assessment, found that the typical American start-up only needs $15,000 in initial capital.
2. Much of the Money to Finance New Businesses comes from their Founders
The most common source of that capital is the founder’s own savings, with the majority of businesses only obtaining money from this source.
As a result, more people finance their startups with their own money than get money from banks and friends and family members combined.
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Starting with online research about the right loan for your company will save you from any hassle in the future.
Asking your friends and family for money might seem like a daunting prospect, but tapping those closest to you is often a good first step before getting external funding.
While your favorite aunt may probably not be in a position to finance your entire new social network for dog owners, she may be impressed enough to toss you a couple grand to help you get rolling.
Before you ask your friends and family for money, you should have a business plan at the ready.
This way, you can explain to them exactly what you’re selling, what you plan on charging, how you’ll make money, and whether you’re asking for a loan, an investment, or a gift.
Personal money invested in a business is treated as your equity. If you decide in the future to source external funding, a lender or investor will see your investment as a commitment from you that you really believe in the business.
Consider the risks associated with going all in with your personal savings. If something goes wrong, how will the loss of that money affect you?
Did you sell an important asset that you hoped to recover?
When you’re investing your own money into the business, put it in a separate business bank account.
This is important because at tax time, you can show a separation between your personal spend and business expenditure, and claim a tax deduction wherever applicable.
3. External Financing is More Likely to be Debt than Equity
When companies get external capital, it mostly takes the form of debt.
A study of young firms in Minnesota, Pennsylvania and Wisconsin found that less than ten percent of the firms had received an external equity investment, but half had borrowed money from an external source.
Even including the equity provided by the founders, most of the money used to fund new businesses takes the form of debt, especially credit card debt when it comes to millennials and Gen Z entrepreneurs.
The Federal Reserve’s Survey Small Business Finances shows that approximately half of the funding for businesses less than two years old takes the form of equity, while the rest takes the form of debt.
4. Much of the External Borrowing is Personally Guaranteed
The Federal Reserve’s Survey of Small Business Finances indicates that the owners of between 25.1 and 48.1 percent of small businesses less than five years of age personally guarantee their businesses loans, with the exact percentage depending on whether the businesses are sole proprietorships, partnerships, S-corporations, or C-Corporations.
In short, unlike the textbook example of a start-up raising external equity from a venture capitalist or business angel, the typical real world start-up is financed by its founders either from their own savings or from debt personally borrowed or guaranteed.
Finding funding can be the hardest part of getting your business off the ground, but also the most rewarding.
Once you’ve saved, gotten approved for a loan, or found other people to invest in your business, you can get back to, or start, your dream job.
Though it can be a long road to success, finding allies along the way (whether they’re friends, angel investors, or venture capitalists) to help keep your business afloat can make all the difference in the world.