Why do you need funding to start or grow your business? Seriously, why do you??
Nobody seems to ask this question, but I think it’s the most important question to start with!
Why is “Why” the most important question?
Because if you don’t know why you need money, you’ll probably waste way too much time looking for it in the wrong places.
And why will you waste time?
Because many sources of startup and growth funding are specialized by why you need it. And those specialized funding sources (such as equipment leasing) are sometimes available to you when more generalized funding sources (like bank loans) are not.
And because some of the most successful entrepreneurs know that Bootstrapping is Plan A. But since nobody but you will make money off of your bootstrap funding, nobody is advertising it as a funding option. You’ll need to figure that out on your own. (With our help, of course!)
Why Do You Need Startup Funding?
Let’s start with the Why of Startup Funding. And to be clear, I’m asking the question “Why do you need cash in the first year of starting your business?” If you make it through year one, the questions and answers start to change.
Why This, Now?
The first question to help guide your startup funding thoughts is actually:
Why do I need to start this business right now?
In the US alone more than 500,000 businesses start every year. How many need to start right now? Some, but not all!
Startup urgency (need to start now) can come from:
- The need to generate income because you are unemployable, you’ve been laid off, your current salary sucks, you’ve moved to a new location
- The need to leave your current job because your boss is horrible, or the company is corrupt, and that kills the ability to be hired by some other company
- The need to pursue this idea now because it will drive you or your partner crazy if you don’t
- The need to pursue this idea or opportunity before others do it, or before the window of opportunity closes.
If you don’t need to start a business right now, keep an open mind about whether you should take some time to improve your chances of getting the best sources of funding.
At how many of the 500,000 new businesses that start this year can the founders say “we know this business is exactly what we should start”? Some examples in which this is it:
- The founders know from their deep industry experience that this opportunity is real, and they know how to operate this kind of business
- The founders have a big customer (or lots of small ones) anxious to pay for this product or service
- The founders have specific technical expertise or specialized knowledge that gives them a competitive advantage in this business
- The founders have looked at lots of different businesses and concluded that this business is the best fit.
If you aren’t 100% convinced that this business is right, keep an open mind as you’re looking at funding options. Some businesses require almost no cash to start – consulting, cleaning, dog walking, personal chef, software. Some businesses require tens of millions to start – launching rockets, cancer drugs, self-driving cars.
In other words, your choice of which business to start has a huge impact on why you might need money for startup and growth.
And some entrepreneurs determined to do it on their own figure out that if they start this business now, they can generate enough cash to start that business later.
For example, there are lots of companies that launch as tech services businesses that later develop tech products. “Services now, products later” is a time-honored bootstrapping strategy.
Or, “one big customer now, many customers later.” Or, “imitate now, innovate later.”
These are bootstrap startup strategies that don’t cut off other possible funding sources in the future, like angel investment, or bank financing.
Why? Expensive Extended Product Development
If you need a long time and a lot of funding to develop your products, you may be pushed into grants or equity funding. New drugs and medical devices, new nanomaterials, and large scale alternative energy systems are just a few examples of businesses that tend to need lots of money and time for product development.
For some consumer-facing products that require tens of thousands rather than millions to develop, Kickstarter and other rewards based crowdfunding is an option for the final stages of product development.
Why? Founders’ Salaries
If you and your co-founders need the business to generate money to live on and “pay the mortgage” (or the rent), focus first on customer cash (i.e., bootstrapping). Or follow another time-honored bootstrapping strategy and keep your day job while building your side project until you know you can afford to make the big leap.
If you just need a crash pad and ramen noodles to live on, equity funding from an accelerator may be enough to get you started.
Don’t use debt to pay the rent.
Why? Buying A Business or a Franchise
On the other hand, if your “startup” is in fact an existing business or a franchise, debt is absolutely a viable funding option. Do your research, though, to make sure that positive cash flow after servicing that debt happens quickly.
Why? Acquiring Buildings, Vehicles, Equipment
Some businesses need hard assets to launch: Main Street retail, manufacturing, construction. Much of the time these assets can be funded with debt, including SBA loans.
It’s also common for startups to take a bootstrapping, “virtual” approach of using assets without owning them. For example, renting an office (duh). Leasing equipment (half debt, half “virtual). Using an incubator that has specialty equipment. Outsourcing manufacturing.
Why? Initial Inventory
Retailers and manufacturers can struggle to fund initial inventory. Vendor credit can be helpful, but hard to obtain upfront. Microloans are sometimes available but can be expensive if they aren’t from CDFIs. If you are figuring out where to invest your own cash in your retailing startup, this is a good place to focus.
Again, in some cases Kickstarter and other rewards based crowdfunding is an option for funding initial inventory. This is another example of how your “why” leads to a specialized type of funding.
Why? Initial Supplies
A handful of online office supply companies extend credit to young companies – if you have taken the steps to set up your company correctly. See “The Secret Path to Business Credit” for details. This can delay the need for cash for a little while, but not for an extended business launch.
Credit cards can also be used, both personal and business. But this is a slippery slope. I personally know a few people who got into serious financial trouble because of misuse of credit cards. If you are planning to use credit cards in part to fund the startup, they should be used for smaller purchases that can be paid off promptly.
Why? Setting Up Your Company
In many cases it’s a good idea to be a corporation. In the US, the do-it-yourself approach to setting up a corporation can minimize but not eliminate all of the legal and licensing costs. Make sure you use the free mentoring and advisory services of SCORE or SBDC to ensure that you get the details right.
In addition, some law firms extend free assistance to startups, or extended credit for legal assistance if companies are on a path to raise equity. Do your research and ask around.
Why? Initial Marketing
Don’t forget about the need for marketing and sales early on in your startup’s life! Revenue doesn’t happen magically.
The DIY bootstrapping strategy for marketing is common. But if you don’t have a strong marketing and sales background, plan on a major investment of your time. And be open to investing some scarce cash here.
Grants usually don’t cover marketing, which is an oversight for grant-making organizations that try to encourage technology commercialization. Marketing is a common use of proceeds for equity, less so for debt because the assets involved (customer lists, goodwill, brand equity) can’t be resold like hard assets such as buildings and equipment that are more frequently used as collateral.
Why? Initial Employees
If your initial employees fit into some special disadvantaged categories (women, below poverty, veterans) you may be able to find modest grants to help.
Bootstrapping techniques include using 1099 contractors, hiring consultants, virtual assistants, enlisting retired parents or your kids, finding interns, using 100% commission salespeople, and paying equity instead of cash.
Sometimes angel investors can help pay for building needed capacity. Debt is probably the least appropriate funding option for meeting early payroll.
That’s a whole bunch of different “why’s” for startup funding, that lead to a whole bunch of different “how’s!”
Why Do You Need Growth Funding?
If your business is more than a year old and growing, congratulations!
Lots of the cash needs listed above keep going as you gain customers and grow revenue. And many of the funding options listed above remain on the table as you grow.
In addition, some new needs emerge from another set of “why’s, along with a different set of funding options. Here are three big “why’s.”
Do You Need Working Capital?
The most common form of funding need for revenue generating companies is called working capital. Normally as your top line revenue grows, your monthly inventory and accounts receivable from customers also grow. Not all businesses have inventory, and not all have accounts receivable, but most have one or the other.
For example: a retailer that does $10,000/month in revenue and turns over inventory 6 times per year requires $20,000 of inventory on hand. If the business grows by 50%, they’ll need 50% more inventory on average, or another $10,000 of inventory that’s sitting on the shelf.
Similarly, a B2B company that is billing $40,000/month and has 45 days average collection on its customer bills has a $60,000 accounts receivable. That company can expect to “invest” an additional $15,000 in its receivables if it grows by 25%.
Even companies that aren’t growing, but have big seasonal fluctuations in revenue, will need extra working capital from time to time. Growing inventory for holiday sales requires additional working capital ahead of customer revenue.
Balancing revenue coming in from customers with checks to suppliers (accounts payable) can be an ongoing struggle for many businesses.
Once you have at least six months of revenue, new working capital funding options open up. Even more open up the longer you’ve been in business. These include:
- Lines of credit from online and bank lenders, including SBA loans
- Factoring and merchant cash advances (expensive but sometimes necessary)
- Supplier credit improvements.
While these new funding sources can seem like a welcome relief, they are often not a long-term solution. Many of these are short-term; the debt must be repaid within months. Meanwhile, if your business is experiencing long term growth, the need for more working capital is long term. Permanent, in fact.
Longer-term funding options for a sustained higher level of working capital include:
- Retaining business earnings – “putting profits back into the business”
- Long term SBA loans
- Equity from angels
- Revenue sharing loans
Do You Need a Big Lumpy Investment in Growth?
Some businesses can grow smoothly (consulting), while others like manufacturing can require big, “lumpy” investments to get to the next level of revenue. Breweries add more, big equipment. Retailers and restaurants add a new location.
Once you’ve been in business for a while, you may start qualifying for SBA guaranteed bank loans to help with the next big lumpy leap to growth. Specialized equipment loans or leasing may also be an option. Otherwise, equity (angel, crowdfunding) or equity-like debt such as revenue sharing loans may be an option.
Do You Need to Disrupt, Dominate, Change the World?
If you’ve made it through initial product launch, customers love what you do, and there’s a mad rush to beat competitors in your new, rapidly growing market, there’s really just one funding choice.
Venture capital. Big bucks, high risk, roll the dice.