Last Updated: Apr 1, 2014
There are two major types of business funding. Know what they are and when you should seek them out to help your small business grow.
The hit ABC series, “Shark Tank” has given new attention to the world of business funding. Millionaire and billionaire investors listen to pitches from everybody from the soccer mom with an idea to the veteran business owner with years of experience and millions in sales.
“Shark Tank” sheds light on plenty of realities when it comes to entrepreneurship but one to focus on for this article is the fact that not every business is ready for investors.
How do you know if you’re ready?
Two Types of Funding
Before you go after funding, you have to understand the two types. Debt funding is what you might find at a bank. In exchange for money, you make regular payments complete with interest. The bank doesn’t want to own a piece of your company; it will ask you to put up collateral—your house, your car, your baseball card collection, anything the bank can do to lower its risk, it will.
If your business becomes the next Coca-Cola, the bank gets nothing more than its money back with interest. If your business ultimately closes its doors, the bank will tell you that its sorry to hear that things didn’t work out but it still wants its money back.
In short, debt funding isn’t dependent on how well your business is doing.
The second type is equity funding. If you receive equity funding, you’re receiving cash in exchange for giving the person some percentage of your company. They become your business partner and they’re probably going to want to be a part of the decision making process.
If your business thrives, they make money. If your business fails, they lose their investment alongside of you. Equity finance deals can come with any number of contingencies including royalty deals or debt funding built in but the main difference between the equity and debt funding is that equity funding makes the investor a partner where debt funding is nothing more than a loan.
When Should You Ask For Money?
You might think the answer is, “right now.” Most people who have an idea for a business don’t have a storehouse of cash ready to deploy to get the business off the ground. They need help before the business becomes the business.
The reality, however, is that most brand new businesses will not be eligible for any type of formal financing—debt or equity. Since you have no business, you have no income. Banks aren’t in the business of gambling so they’re likely going to say no. Equity investors are in the gambling business but even if they were ok taking a chance on an unproven business, they often want to see big numbers.
Spending their time on a startup that brings in $20,000 this year isn’t worth the risk.
Where do startups most often find funding? They ask friends, family, and other individuals that know them as somebody who is driven and has a track record of success in everything they do.
Through the United States Small Business Administration, some small business owners are eligible for SBA loans. The SBA partners with banks in your community to take on some of the risk of business loans. This allows small business owners who wouldn’t otherwise be eligible for a loan to get the funds they need. You can read more about SBA loans by going to its website.
If you’re beyond the startup phase, you’re likely eligible for multiple forms of equity financing. Start with the bank or credit union that holds your business accounts. You’ll need detailed financial statements and a rock-solid pitch that gives the banker an idea of what you’re doing, how the money will be used, and why you’re still going to be in business in five years.
Equity Finance Explained
Remember that equity financing comes from investors and although they’ll look at all of your financials, it often comes down to the investor’s gut feeling. Because of this, there are no set rules. Providing you can make a good pitch, it never hurts to ask but there are some realities to consider.
In most cases, you aren’t going to be attractive to equity investors until later in the growth of your business. Investors know that along with an investment of their money comes an investment of time and other resources. If the potential return isn’t high enough to justify the outlay on their part, they won’t invest.
Before asking for a meeting with every investor you can find, have an expert understanding of your business, your industry, your product, and your competition. If you’re not the smartest person in the room when it comes to your business, the answer will be no. That’s hard to do in the earliest stages of your growth.
But How Do You Know The Right Time?
Here’s the answer: If you’re too early, you might blow your one chance in front of that investor or lender. If you’re too late, you’ll come off as desperate.
If you watch “Shark Tank”, you’ve noticed the entrepreneurs who show up desperate. They say things like, “If I don’t get an investment, I have to give up on my dream.” That desperation indicates that the entrepreneur is too late.
The better time to ask for funding is when your business is ready to go to the next level. It’s healthy but needs a financial shot in the arm to grow. When you start to feel those growing pains, it’s probably time to seek funding—not necessarily because you NEED the money but because the money propels you forward.
Does all of this seem clear as mud? Money comes from people and people make emotional decisions. There’s never a perfect time to ask for money but if you’re looking for formalized financing, it’s best to not ask until you’re sure you have a viable, sustainable business.
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