SelfInformed

September 2012


7 Ways to Fund Your Startup

Tuesday, September 04, 2012

By Kim O’Connor

By the time you start looking for cash for your startup business, you’ve put in a considerable amount of hard work.

You had a million-dollar idea and completed the research to make sure it’s viable. You drafted a detailed business plan and determined how much money you needed to get off the ground. You even planned precisely how you’ll spend that money, down to the dime.

Now all that’s left is the final—and crucial—step of finding the funds.

Not sure where to begin? Here’s a primer to help you navigate the options.

1. Bootstrapping

More of a philosophy than a funding source, bootstrapping involves making the most of minimal resources to avoid taking on debt.

Bootstrapping startups operate on a shoestring budget, employing aggressive cost-cutting measures and creative workarounds. They might, for example, shop for office furniture at the consignment shop or keep inventory stored in a friend’s garage.

Some businesses lend themselves more readily than others to bootstrapping. It works best for service-based startups with little overhead.

But even if your business requires external funding, the bootstrapping mentality holds valuable lessons.

Before you approach a funding source, scrutinize your startup expenses and cut corners wherever you can. Maybe you could meet clients in a restaurant instead of leasing an office space. Or set up terms with suppliers instead of securing an outside line of credit.

When in doubt, go with the cheapest option; you can upgrade later.

2. Traditional Loans

Many small businesses rely on commercial loans from banks or credit unions to pay for startup costs. The process is straightforward, if not exactly simple.

First approach the institution that handles your personal banking, then shop around locally to make sure you secure the best terms. Be prepared to share your business plan, tax records and other financial documents.

A traditional loan is one of the most efficient ways to fund your startup—if you can get one.

In recent years, banks have tightened their belts and raised the requirements for most borrowers. People with flawed credit histories or few assets will likely need to pursue other options.

3. SBA Microloans

If you don’t qualify for a traditional loan, ask your banker whether you’re a candidate for the microloan program administered by the U.S. Small Business Administration. 

The SBA is not a direct lender. Instead, it backs loans made through third-party lenders like banks and credit unions. The federal government guarantees your loan to minimize the lender’s risk.

The average microloan is $13,000, with the maximum topping out at $50,000. Interest rates run from 8 to 13 percent. All of the SBA microloans must be repaid in full within six years.

4. Loans From Friends And Family

Borrowing money from friends and family is almost always easier than getting a bank loan, which makes it an attractive option for funding your startup.

But, it can also be dangerous option.

“Everybody wants to help out their kids or their spouses or their siblings,” says Gene Fairbrother, the lead consultant for the NASE’s Business 101 program. 

“Resist the urge to go to them because they’re an easy touch. Go to them because you have a viable business opportunity. If you don’t have anything to offer them, there’s probably something wrong with your business model.”

When you borrow from friends and family, formalize the arrangement as much as possible to prevent misunderstandings.

Make sure you sign a promissory note. A paper trail will help prevent any misunderstandings and will make it easier to get funding if you apply for a traditional loan later.

5. Peer-To-Peer Lending

Another source for alternative loans is a practice called peer-to-peer lending, which is usually facilitated by websites like Prosper.com and LendingClub. 

Peer-to-peer lending connects small-business owners (and other individuals) who need money with regular folks (not institutions) who have money to lend.

Potential borrowers are vetted by most peer-to-peer lending websites. For example, Prosper.com and LendingClub assign letter grades that gauge borrowers’ creditworthiness.

But, it’s up to individual lenders to decide which ideas are worth funding.

Peer-to-peer lending can be a great resource for startups, but make sure to do your homework. Start by researching the policies of the lending website and the terms of a given transaction.

It’s important that you understand the terms of any loan, but lenders that aren’t bricks-and-mortar institutions may require extra scrutiny.

“You need to know who you’re dealing with,” says Fairbrother. “You have to be cautious about the 'cost' of the money you borrow.”

6. Crowdfunding

Another Internet-based fundraising platform is crowdfunding, which has been popularized by websites like Kickstarter. 

Kickstarter uses a patronage model to fund creative projects such as documentaries. People who help fund the project do so with no strings attached. They may receive a reward, such as the finished DVD of the documentary they helped fund. But, the funds they give are essentially donations or gifts.

That’s what makes donation-based crowdfunding so attractive to startups. You have the opportunity to raise capital without giving away equity in your new company or having to repay any loans.

Although Kickstarter has been wildly successful in its niche, the crowdfunding model was not widely applicable to small businesses outside of the creative community. But new legislation (the JOBS Act, signed by President Obama in April 2012) has made it possible for startups to use crowdfunding to raise capital.

The government is still developing the regulations for this alternative way of financing a startup. But, small businesses should have greater access to crowdfunding within the next year.

As always, educate yourself on the terms for any given transaction, and watch out for administrative fees imposed by crowdfunding websites.

The NASE offers much more detail in this blog item: Crowdfunding—An Innovative Way To Fund Your Startup.

Plus, here are five crowdfunding sites worth exploring:

■   AngelList

■   Crowdfunder

■   Crowdtilt

■   Indiegogo

■   Peerbackers

7. Credit Cards

Compared to most loans, credit cards carry high interest rates. Therefore, plastic tends to work better as a stopgap solution than as a viable source of long-term funding for your business.

It’s fine to use credit cards for relatively small purchases like a new computer or office furniture. But as a rule, it’s best for startups to avoid heavy credit card debt.

Consider credit cards only if you’re confident your business will quickly generate a positive cash flow—and even then, they should be your last resort.


Kim O’Connor, a freelance writer based in Chicago, often writes about best business practices.



Learn More

Want to know more about the dos and don’ts of financing your startup?

Check out these NASE resources. They’re online now. They’re free. And they’re exclusively for NASE Members.

■    Ask the Experts: Microloans

■    What Retirees Need To Know Before Starting Their Own Companies

■    No More IOUs

■    Bootstrap Your Way To Success

■    NASE Members Reveal Their Smartest Financial Moves



7 Ways The NASE Can Help

The NASE offers a network of resources to help you take the right steps to start, run and grow your micro-business.

1.   Finance and accounting experts

2.   Online NASE Business Startup Kit

3.   Business strategy experts

4.   Business credit cards

5.   Tax experts

6.   Business formation services

7.   Business law experts