Popular media would have small business owners believe that money from a private investor or an equity firm is the way to capitalize a business for success. Unfortunately, that option is not realistic for every small business owner. Many small business owners opt instead to finance growth initiatives or new projects with debt. Which approach makes the most sense for your situation will depend upon weighing the pros and cons of capitalizing your business by selling equity or assuming debt. And, as an alternative to both options, some business owners prefer to bootstrap their business, avoiding both the challenges of working with an investor or the added costs associated with debt-financing.
How do you know which of these funding options might make the most sense for your business? Here are the details of each type.
The business owners that prefer to bootstrap their businesses are typically more content with slow and methodical growth, although this is not always the case. What’s more, John Sperry, CEO of InMoment, suggests bootstrapping compels business owners to look for more creative ways of addressing challenges. “We did a lot of things … to make it less expensive for us to do business,” he says. “Some of those things even helped improve our ability to build the best product in the end.”
Sperry bootstrapped his business to get started and 12 years later has a multi-million dollar company with offices in the U.S., Canada, and Great Britain.
1. Your business isn’t burdened with debt: There are costs associated with any type of financing, which you will avoid by self-financing or bootstrapping.
2. You don’t have to share decision-making with an investor: When an investor gives you capital, they typically expect a seat at the table to participate in making the big decisions that will impact the business. If you don’t take the investor’s money, you can make your own decisions.
3. It’s not necessary to plan for an exit: Most investors are looking for a business to be sold (or other liquidity event like an IPO) to make their return on investment. This doesn’t work for a business owner that intends to create a legacy business to turn over to their children or make his or her life’s work.
1. You may be committing to slow and organic growth: While this might be a plus for some business owners, bootstrapping a business and funding growth initiatives with cash flow, may mean slower growth.
2. You may need to turn away some business opportunities: Unless your business is cash-rich, there may be opportunities or contracts you’ll be required to turn down without the funds to execute.
In reality, only a very small percentage of businesses will be a good fit for an investor. According to Brian Cohen and John Kador, authors of the book, What Every Angel Investor Wants You to Know, “An angel investor is an individual who, using his or her own money, provides early-stage startup capital to a new business and expects a percentage of ownership in return with the expectation of a sale or ‘exit.’”
Both angel investors and other venture capitalists are looking for a payday down the road. The businesses that have a model that would be interesting to an equity investor are really very few—the numbers show as few as two percent. Nevertheless, millions of dollars are invested every year in new companies an investor believes has the potential to quickly grow and increase in value with the addition of capital.
1. You access capital now, without a periodic payment: Unlike borrowing money, the payday for an equity investor comes down the road, so you typically don’t need to make periodic loan payments and aren’t burdened with the debt that would be associated with a business loan.
2. You potentially gain expertise you might not have: You have the opportunity to work with someone who has done this before, maybe even in your industry. Someone who can help you build a successful business that will either go public or be sold for a substantial profit to you and the investor.
3. You gain important connections and insight into building a business: Your personal network increases with the addition of connections your investor(s) have to help your business grow.
1. You need to find the right investor: Finding an investor who wants to accomplish the same objectives as you, can be a challenge. You’ll find yourself spending a lot of time away from running your business courting investors and pitching your business ideas. Some investors might have different goals than yours and finding out after they assume an ownership position can be problematic.
2. You will need to share some of the decision-making: Most investors want a seat at the table and want to be part of making big decisions. Particularly those that impact how the business grows. Some of those decisions can be problematic if you and the investor disagree.
3. Depending upon how much equity you give up to investors, you can even be replaced: It’s not uncommon for investor-backed companies to go through more than one round of funding which may further dilute your ownership position. Some founders can even find themselves replaced if the majority of shareholders don’t believe he or she has the ability to take the business to the next level.
Many small business owners turn to borrowed capital to fund expansion initiatives or meet other cash flow needs. Some borrow from friends and family, others from the local bank, and a growing number are finding greater access to capital online. There are probably more options for borrowing today than ever before—even for business owners with a less-than-perfect credit profile. If you have a healthy business with the cash flow to support the periodic payments, borrowing could be an option for your business.
1. Capital is available quicker than ever before: Although it can take weeks or months to go through the application process with a traditional bank (or find an investor), many online lenders offer a very simple application, an answer in possibly just a few minutes, and funds in your account as quickly as within 24 to 48 hours.
2. In some cases, even less-than-perfect borrowers can still get a loan: Borrowers who might not meet more rigid credit criteria at the local bank can often still qualify for a loan with online lenders provided they have a healthy business with good cash flow.
3. You don’t need to give up any decision-making control to an outside investor: Although you will pay for the privilege by making regular and timely periodic payments, you don’t have to share the right to make decisions that impact your business with anyone—your decisions are your own.
1. There are costs associated with borrowing money: Lenders charge interest, and depending upon the lender and your situation, some lenders charge more than others. Riskier businesses should generally expect to pay more, and the payback of borrowed capital may be relatively short-term: meaning the business owner should have a clear sense that the ROI on an investment opportunity exceeds the cost.
2. Accessing borrowed capital isn’t easy: While there are more options available today than ever before, finding the right loan for your situation isn’t as easy as you might think. And, even though you might not need to become a small business-financing expert to find success, you will need to become very savvy regarding the financing needs of your particular business.
3. The world of small business financing has changed: The bank around the corner is only one of many options available and knowing where to look can be a challenge. The Federal Reserve Bank of New York recently reported the average small business owner spends roughly 33 hours seeking financing. Narrowing down your search to those lenders where you have better odds of success has the potential to save your business many hours of wasted time going from lender to lender.
Whether you decide to seek investors, bootstrap, or turn to a small business loan, there are many options available to small business owners today. Deciding which options best fit your business needs requires some thoughtful consideration, honest evaluation, and an informed decision.