Capital is the lifeblood of any business venture and for startups, securing enough capital to become operational and profitable is a daunting challenge. Here is a look at the pros and cons of five startup finance strategies.
1. Friends and family: Asking friends or family to invest in a new business is a very informal financing strategy. This is among the simplest ways to finance a startup business. The pros – can offer quick turnaround and usually doesn’t require an extensive business plan. The cons – borrowing money from friends and loved ones can destroy relationships.
2. Crowdfunding: This is the newest startup finance option. Here, small amounts of money are raised from a large group of people via crowdfunding websites. The pros – can offer quick turnaround and a great deal of flexibility. The cons – not all business ideas are right for crowdfunding; requires creativity, tenacity and extensive self-promotion.
3. Equity investors (angel investors or venture capital): Equity investors are the holy grail of startup finance—particularly among technology startups. Entire business models are developed around the end goal of securing substantial equity investment. The pros – can offer significant amounts of capital. The cons – owners have to give up equity and the investor may want to be very involved in the day-to-day operation of the business; due to the high risk of financing new ventures, equity investors are very selective about which projects they will finance with less than one percent of pitched projects getting funded;
4. Banks: Bank financing used to be an attractive option for funding a startup. But since the 2008 global economic meltdown, today, bank financing for startups is available to only those persons who are deemed among the most creditworthy. The pros – if it is available to you, business loans and lines of credit can offer reasonable, consistent interest rates and flexible payment plans. The cons – unattainable if you have poor credit and banks require fully developed business plans and financial models.
5. Government grants: Contrary to popular belief, there are not billions of dollars in free government grants to enable someone to start a new business. The federal government does not give out grants to start a business—even if you are a woman, veteran or member of a minority group. Government grants are only awarded to businesses conducting activities that support particular priorities. If your business or project is aligned to one of those priorities then government grants can be an attractive option. The pros – government grants do not require the owner to give up equity or control and the funds do not have to be paid back. The cons – the business grants landscape is highly competitive with only the best of the best getting funded; grants come with lots of strings attached.
Also, grants cannot be obtained just by ‘asking for them’ or ‘sending a letter’ as is often said by certain loud-mouthed television marketers. To get a grant you need to prepare and submit an often times very complicated proposal. In addition, there is a tremendous amount of competition for grant funds and most proposals that are submitted do not get funded. For instance, the National Science Foundation receives about 40,000 grant proposals every year and only funds about 1,000 of them. By some estimates, in some of the most competitive grant programs as few as 3% of all proposals submitted will get funded. Winning a grant award requires a lot of hard work and preparation.
However, there are some Federal grant opportunities that are not exclusively focused on research and development open to small business applicants. There are also ways that a non-research project can be reframed as a research project. This can be accomplished by including a legitimate research component into your project or by partnering with an eligible entity such as a college, research institution or nonprofit organization. And if your needs cannot realistically be repositioned as a research project, there are still lots ways in which your business can gain access to government grant funds.
Finding the best way to finance a startup requires research, analysis and thoughtful reflection about long-terms business goals. Regardless of how you decide to finance your startup, it is critical that you understand the short- and long-term implications of your choice.