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The founders of HotWifi have done extensive research on various funding methods for their startup and have used the experience of consulting companies in this field.
Obviously, the first source of financing will be the financial resources of the founders. However, in the process of development and growth of startups, huge financial resources are needed at different stages, which should be identified and then be planned to get in an optimized manner.
Financing includes acquiring funds, managing the finances of the business, and planning future expenditure. Funding is needed to start a business and ramp it up to profitability. There are several sources to consider when looking for start-up founding. But first you need to consider how much money you need and when you will need it. The financial needs of a business will vary according to the type and size of the business. Every business has different needs, and no financial solution is one-size-fits-all. Your personal financial situation and vision for your business will shape the financial future of your business.
Once you know how much startup funding you’ll need, it’s time to figure out how you’ll get it.
Debt and equity are the two major sources of funding. Government grants to finance certain aspects of a business may be an option. Also, incentives maybe available to locate in certain communities and/or encourage activities in particular industries.
Fund your business yourself with self-funding
When starting a business, your first investor should be yourself—either with your own savings or equity. This proves to investors and bankers that you have a long-term commitment to your business and that you are ready to take risks. The investor likes to see that a business owner has invested personally in their business—it usually correlates with things going well when the owner has a significant personal stake in its success.
Personal resources can include your savings accounts, profit sharing or early retirement funds, real estate loans, or cash value insurance policies. These options have the advantage of being simple, No hidden fees, no fancy formulas, just basic personal resources.
With self-funding, you retain complete control over the business, but you also take on all the risk yourself.
Home equity loans – A home equity loan is a type of loan in which the borrower uses the equity of his or her home as collateral. The loan amount is determined by the value of the property.
If your home is paid for, it can be used to generate funds from the entire value of your home. If your home has an existing mortgage, it can provide funds on the difference between the value of the house and the unpaid mortgage amount. Some home equity loans are set up as a revolving credit line from which you can draw the amount needed at any time. The interest on a home equity loan is tax deductible.
Life insurance policies – A life insurance policy refers to the contract between an insurance provider and an individual. A standard feature of many life insurance policies is the owner’s ability to borrow against the cash value of the policy.
The money can be used for business needs. It takes a few years for a policy to accumulate sufficient cash value for borrowing. You may borrow most of the cash value of the policy. The loan will reduce the face value of the policy and, in the case of death, the loan has to be repaid before the beneficiaries of the policy receive any payment.
Equity Funding
Equity financing involves selling a portion of a company’s equity for a financial investment in the business. Companies raise money because they might have a short-term need to pay bills or have a long-term goal and require funds to invest in their growth.
The ownership stake resulting from an equity investment allows the investor to share in the company’s profits. Equity involves a permanent investment in a company and is not repaid by the company at a later date.
The investment should be properly defined in a formally created business entity. An equity stake in a company can be in the form of membership units, as in the case of a limited liability company or in the form of common or preferred stock as in a corporation.
Companies may establish different classes of stock to control voting rights among shareholders. Similarly, companies may use different types of preferred stock. For example, common stockholders can vote while preferred stockholders generally cannot. But common stockholders are last in line for the company’s assets in case of default or bankruptcy. Preferred stockholders receive a predetermined dividend before common stockholders receive a dividend.
Personal Loans for Business
For entrepreneurs with very strong personal credit and a new business idea that you feel really good putting your own finances on the line for, a personal loan for business might be worth considering.
Generally, a personal loan will tend to have lower interest rates as well as easier repayment terms than its business counterpart—and it can also be used for nearly any purpose.
However, here is the disadvantage—and this is important: When you take one of these loans out for your business, the lender is entering into a contract with you as an individual—not with your business. This means that if bad fortune strikes and the business fails, you are still fully and personally responsible for the repayment of the outstanding balance.
Friends and Family
Founders of a start-up business may look to consider going to friends and family to fund their startup. It may be in the form of equity financing in which the friend or relative receives an ownership interest in the business or it will be repaid later as your business profits increase.
However, these investments should be made with the same formality that would be used with outside investors. This means creating and executing a formal loan document that includes the amount borrowed, the interest rate, specific repayment terms based on the projected cash flow of the start-up business, and collateral in case of default.
When borrowing money from friends and relatives, you should be aware that:
Venture capital funding
Investors can give you funding to start your business in the form of venture capital investments. Venture capital is normally offered in exchange for an ownership share and active role in the company.
Venture capital firms usually don’t want to participate in the initial financing of a business unless the company has management with a proven track record. Generally, they prefer to invest in companies that have received significant equity investments from the founders and are already profitable.
Venture capital typically:
They also prefer businesses that have a competitive advantage or a strong value proposition in the form of a patent, a proven demand for the product, or a very special and protectable idea. Venture capital investors often take a hands-on approach to their investments, requiring representation on the board of directors and sometimes the hiring of managers.
Venture capital investors can provide valuable guidance and business advice. However, they are looking for substantial returns on their investments and their objectives may be at cross purposes with those of the founders. They are often focused on short-term gain.
Venture capital firms are usually focused on creating an investment portfolio of businesses with high growth potential resulting in high rates of returns. These businesses are often high-risk investments.
How to get venture capital funding? There’s no guaranteed way to get venture capital, but the process generally follows a standard order of basic steps including finding an investor, sharing your business plan, going through due diligence review, working out the terms, and finally getting the Investment.
Angel Investors
Looking for angel investors is also another excellent source for startup or early business funding. They are individuals and businesses that are interested in helping small businesses survive and grow. So, their objective may be more than just focusing on economic returns. Although angel investors often have somewhat of a mission focus, they are still interested in profitability and security for their investment. So, they may still make many of the same demands as a venture capitalist.
Not only will they provide the funds, they will usually guide you and assist you along the way.
Angel investors may be interested in the economic development of a specific geographic area in which they are located. Angel investors may focus on earlier stage financing and smaller financing amounts than venture capitalists.
Government grants and subsidies
Grants for small businesses are a form of startup funding that require no repayment, unlike debt, and no trade of equity, unlike venture capital.
Federal and state governments often have financial assistance in the form of grants and/or tax credits for start-up or expanding businesses.
Government agencies provide financing such as grants and subsidies that may be available to your business. The Canada Business Network website provides a comprehensive listing of various government programs at the federal and provincial level.
Equity Offerings
In this situation, the business sells stock directly to the public. Depending on the circumstances, equity offerings can raise significant amounts of funds. The structure of the offering can take many forms and requires careful oversight by the company’s legal representative.
An equity offering can happen as an Initial Public Offering (IPO), or Secondary Offering if the company’s stock is already being traded.
Each offering has the potential for investors to realize a profit, and each has pitfalls that may trap the unwary. Careful attention to details can maximize your chance of earning profit.
Initial Public Offerings – Initial Public Offerings (IPOs) are used when companies have profitable operations, management stability, and strong demand for their products or services. This generally doesn’t happen until companies have been in business for several years. To get to this point, they usually will raise funds privately one or more times.
Warrants
Warrants are a special type of instrument used for long-term financing. They are useful for start-up Companies to encourage investment by minimizing downside risk while providing upside potential. For example, warrants can be issued to management in a start-up company as part of the reimbursement package. However, a warrant does not mean the actual ownership of the stocks but rather the right to purchase the company shares at a particular price in the future.
A warrant is an option issued by a company that trade on an exchange and give investors the right but not obligation to purchase company stock at a specific price within a specified time period. This involves purchasing the stock at the warrant price. So, in this situation, the warrant provides the opportunity to purchase the stock at a price below current market price.
Generally, warrants contain a specific date at which they expire if not exercised by that date.
Debt Financing
If you want to retain complete control of your business, but don’t have enough funds to start, consider debt financing.
Debt financing involves borrowing funds from creditors with the condition of repaying the borrowed funds plus interest at a specified future time. For the creditors (those lending the funds to the business), the reward for providing the debt financing is the interest on the amount lent to the borrower.
Debt financing may be secured or unsecured. Secured debt has warranty, a valuable asset which the lender can attach to satisfy the loan in case of default by the borrower. Conversely, unsecured debt does not have warranty and places the lender in a less secure position relative to repayment in case of default.
Debt financing (loans) may be short term or long term in their repayment schedules. Generally, short term debt is used to finance current activities such as operations while long-term debt is used to finance assets such as buildings and equipment.
Banks and Other Commercial Lenders
Banks and other commercial lenders are the most commonly used sources of funding for small and medium-sized businesses.
Most lenders require a solid business plan, positive track record, financial projections for the next five years and plenty of collateral such as a personal guarantee from the entrepreneurs. These are usually hard to come by for a start- up business. Once the business is underway and profit and loss statements, cash flows budgets, and net worth statements are provided, the company may be able to borrow additional funds.
Commercial Finance Companies
Commercial finance companies may be considered when the business is unable to secure financing from other commercial sources. These companies may be more willing to rely on the quality of the collateral to repay the loan than the track record or profit projections of your business.
If the business does not have substantial personal assets or collateral, a commercial finance company may not be the best place to secure financing. Also, the cost of finance company money is usually higher than other commercial lenders.
Government Programs
Federal, state, and local governments have programs designed to assist the financing of new ventures and small businesses. The assistance is often in the form of a government guarantee of the repayment of a loan from a conventional lender. The guarantee provides the lender repayment assurance for a loan to a business that may have limited assets available for collateral.
Bonds
Bonds may be used to raise financing for a specific activity. Bonds are different from other debt financing instruments because the company specifies the interest rate and when the company will pay back the principal (maturity date). Also, the company does not have to make any payments on the principal and may not make any interest payments until the specified maturity date.
The price paid for the bond at the time it is issued is called its face value. When a company issues a bond, it guarantees to pay back the principal (face value) plus interest.
From a financing perspective, issuing a bond offers the company the opportunity to access financing without having to pay it back until it has successfully applied the funds. The risk for the investor is that the company will default or go bankrupt before the maturity date. However, because bonds are a debt instrument, they are ahead of equity holders for company assets.
Lease
A lease is a method of obtaining the use of assets for the business without using debt or equity financing. It is a legal agreement between two parties that specifies the terms and conditions for the rental use of a tangible resource such as a building and equipment. Lease payments are often due annually.
The agreement is usually between the company and a leasing or financing organization and not directly between the company and the organization providing the assets. When the lease ends, the asset is returned to the owner, the lease is renewed, or the asset is purchased.
A lease may have an advantage because it does not tie up funds from purchasing an asset. It is often compared to purchasing an asset with debt financing where the debt repayment is spread over a period of years. However, lease payments often come at the beginning of the year where debt payments come at the end of the year. So, the business may have more time to generate funds for debt payments, although a down payment is usually required at the beginning of the loan period.
Which Type of Startup Funding Is Right for You?
Funding options for startups vary. When figuring out which financing option is suitable for your startup, you first need to gather important information about your business. Lenders, especially banks and venture capitalists, want to see exactly where your business is at in terms of growth and direction. Make sure you have the following information about your business:
Next, you’ll have to ask yourself: What are your goals and needs? For example, if your tech startup is in its early stages of development and requires additional working capital to continue growing, you’ll probably want to look into forms of equity financing, such as venture capital or angel investment.
On the other hand, if you’re a more established business seeking funding to maintain cash flow or keep up with payroll, getting a business loan or a credit card from a bank or alternative lender will make more sense because you’ve demonstrated that your business has longevity.
How to find business financing options
Trying to find financing for your startup can easily turn into a full-time job. From building a network of investors to connecting with other founders, financing is at the heart of any business’s success, but it can turn into a serious time commitment. However, by working with the right investors and taking the time to be purposeful in your pitch, you can take important steps toward funding your company. Make no mistake; it will be difficult, but by being precise in your search, you can position yourself for success.
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