The image of "pulling yourself up by your bootstraps" is a revered American value. The idea of a self-made man or woman has been an inspiration for millions of people. And when we talk about "bootstrapped" businesses, we mean businesses that the entrepreneur built without outside capital.
For many businesses, however, securing outside capital is required not only to start up but to grow as well. But how do you choose a financing option that suits the scale of your enterprise and plans for expansion? You may end up with a hybrid approach, but it's worth understanding all of the options available.
Here's an overview of financing options you might consider for your business:
Debt financing is where most entrepreneurs turn first. In the simplest terms, debt financing means that you borrow money either from an institution like a bank or an individual and promise to return the principal (the amount of the loan) and an agreed-upon level of interest on that principal. In finance, debt is also referred to as "leverage."
The drawbacks of debt financing for early stage businesses is clear: lenders expect to be paid back, often immediately, in installments. If your cash is tied up in inventory or equipment, or customers haven't materialized yet, it can be difficult to pay that money back.
In order to find out if debt financing is for you, consider:
Is this money being used toward fixed or variable costs? If you need money to invest in a piece of equipment, consider how long that equipment will need to be in use before it pays for itself. Variable costs, on the other hand, may help you to cover expenses related to a client or product that have associated cash inflow.
What is my cash flow like? Do your customers consistently pay on time? Are there ways to give them incentives to pay early?
How old is my business? At the very early stages of setting up your business, debt financing may be riskier. Many businesses lose money at first, or have such a low income that the tax advantages of debt financing will be minimal.
It can be a crushing blow -- you've worked hard on creating an airtight business plan, gone and shopped it to the banks, and gotten absolutely nowhere. Should you give up? Well, maybe not. Consider private lending as alternative funding. In this scheme, you'll look for a private lender who is a "specialist" in your particular type of venture. A specialist may see potential in your plan that the banks do not.
Besides being in a position to fund projects the banks rejects, a private lender may also creatively structure loan repayment and sometimes be a helpful resource. Private lending can also be a good alternative to equity financing for those who balk at giving up a significant portion of their businesses to a board or investors.
While the traditional path to business financing in through loans and debt financing, another option is equity financing, or issuing stock in your company. You sell shares of your company to investors, generating cash to operate your business and offering investors the chance to make a return.
Finally, consider the value of building business credit with vendors or suppliers you deal with regularly. Companies that supply your business will often allow you a grace period before having to pay for goods you purchase. Vendor or trade credit allows you to generate at least some revenue before paying back the credit.