Launching a business requires full commitment and persistence. But before taking the plunge, there are a few things to consider. Every business needs startup capital. According to the Bureau of Labor Statistics, 18% of small businesses fail after their first year in operation. After five years, that number jumps to 50% and after ten years, 65% of small businesses have failed.
The legal structure of your business is important. You must decide whether your business will be a sole proprietorship, LLC, general partnership, C-Corp or S-Corp. There are tax and liability implications of each format. In terms of sole proprietorships, 86.4% are non-employer businesses while just 14.4% are small employer businesses.
In a sole proprietorship, the owner and the business are essentially one and the same. The owner gets to keep all the profits, but his or her personal assets are exposed if something goes wrong. Setting up an LLC is an option to separate personal assets from your business liabilities. Further, an LLC offers some tax advantages, since the business itself is not responsible for taxes on its profits, as is the case with C-Corp. Deciding the business format of your operation is important. Fortunately, advice is available from your attorney or accountant.
A common reason why startups fail is because they are underfunded. Inevitably, a new business will encounter unexpected delays of all sorts. The opening of a business can stall because of a wide variety of reasons, including a lack of materials, inability to find contractors, weather, government paperwork, health issues, accidents and other unplanned events. Delays cost money, and underfunding is a common reason why small businesses never get off the ground.
Ways of financing a new business
Personal investment.
Self-funding your business allows you to enjoy full control over your financial decisions and not worry about the input from investors or lenders who may choose to pull their support. Self-financing your business means that you will make 100% of your profits if you choose to see it through. But few people have enough money at their disposal to launch and operate their business without some type of outside investment.
Most entrepreneurs will look to find capital from other sources. However, it’s important to know that lenders will want to know how much skin you have put into the game. After all, if you are unwilling to invest in your firm, why should they?
Family and friends.
Borrowing money from a family member or friend is also a common way of obtaining capital for your business. Family and friends are much less likely to ask for your tax returns, bank statements, or other documents that lenders require to give out small business loans. Similar to self-investment, your family and friends may have your best interest in mind and allow you to make your own business decisions.
On the other hand, mixing family and business often leads to bad results. Not everyone has the best intentions when it comes to the world of business so make sure you understand who you are allowing to invest not just in your business, but in your future. Things become complicated when family is involved:
· An uncle may insist that his ne’er-do-well son joins the business.
· Lending money can make family members feel entitled to be in on decisions.
· Family relationships can become strained over disagreements about running the business.
· If the business fails, will other family members fault the entrepreneur and disown him for not paying the startup money back?
Credit Cards.
Small businesses secure funding in many ways, entrepreneurs have frequently “maxed out their credit cards” to get their companies up and running. Often, it’s because the entrepreneur has personal credit cards at their disposal. The downside, however, is that credit cards come with high interest rates. Currently, many credit cards have an annual percentage rate of 20% or more. Maxing them out means there will be a lot of money to pay back and at a high cost of capital.
Start Up Loans.
It is much more challenging for a startup company to secure funding than it is for an established business. An existing business will have a credit history, and if the company has a track record of timely debt payments, securing capital should not be a problem. Lenders’ primary concern when issuing a loan is whether or not the borrower would be able to pay it back. A business in the infancy stage likely does not have a credit history to speak of.
There are also loan options for women-owned and minority-owned small businesses. The SBA has programs for both women and minorities to help them acquire capital, including the 8(a) Business Development program and the Women Owned Small Businesses (WOSB) Federal Contract program.
SBA Microloans give smaller sized loans of up to $50,000 and are a great option for women and minorities, but also for those with bad credit. The ACCION Opportunity Fund is a financial support system that provides business owners with access to capital, networks, and coaching.
Government grants.
There are also a number of federal grant opportunities for small businesses. Grants.gov offers over 2,500 different opportunities and are sorted by funding type, category, eligibility, and agency.
The SBA also offers federal grant programs. The Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) programs are highly competitive programs that encourage domestic small businesses to engage in Federal Research (R&D) with the potential for commercialization. Through a competitive awards-based program, SBIR and STTR enable small businesses to explore their technological potential and provide the incentive to profit from its commercialization.
Equity Funding.
Equity funding is a great low-risk option for small businesses who are unable to acquire a loan. Private equiry firms provide businesses with the funds they need in return for percentage of ownership in the company. This means an entrepreneur can secure funding and not run up big debts. In return, the business owner gives up a portion of ownership and total control.
Equity financing is particularly valuable for startups in that might take a long time to get up and running and that might not be able to pay back the capital quickly.
Business loans.
Big banks often request 2-3 years of financial statements before approving a small business loan. This is not possible for a business that has not launched yet.
Regional and community banks, which typically are more lenient in their lending parameters and are more likely to process government-guaranteed SBA loans, are more likely to approve funding requests than big banks. In July 2023, big banks approved only 13.3% of the business loan applications they received, according to the most recent Biz2Credit Small Business Lending Index. Smaller banks granted 18.9% of their funding requests.
Banks are not the only sources of small business funding. Credit unions provide business loans, often at reasonable rates, but they are handcuffed by regulations that limit the percentage of their assets that they can lend. Institutional lenders increasingly have become active in the small business lending space. Alternative lenders provide financing in return for a percentage of future earnings. While these non-bank lenders are willing to provide capital when others won’t, they charge a premium rate that is much higher the the interest rates of traditional bank loans.
Peer-to-peer lenders/ Crowdfunding.
Peer-to-peer (P2P) lending is a way that people can burrow money from each other without having to go through a bank. These loans can go up to $40,000 but certain qualifications are needed for P2P lending including a credit score over 600. According to Precedence Research, the market size for P2P lending in 2023 was valued at $133.5 billion and is expected to double ever three years.
Crowdfunding is similar to P2P lending but with multiple people at once. According to Statista, the transaction value in the crowdfunding market is said to reach $1.14 billion in 2023. However, FounderJar reports that only 22% of all crowdfunding operations become successful.
Opening a business involves a certain level of risk. Startups, which by definition are unknown and unproven, often find it challenging to secure financing. However, it is not impossible. Knowing where to start is a good first step.
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