Bootstrapping: Is Startup Funding Oxymoronic?

bootstrapping a startup

Startup experts call it bootstrapping when an entrepreneur starts a new business without outside investment. This is the norm, not the exception.

But, you wouldn’t get that idea from the relative abundance of online startup information focused on getting outside investment, and seeming scarcity of information about starting without the investment. Statistics are spotty, but I’m pretty sure that more than 90 percent of business startups are bootstrapped.

Bootstrapping definition

What is bootstrapping?

Entrepreneur defines bootstrapping as “to finance your company’s startup and growth with the assistance of or input from others.” Investopedia says it means “to build a company from personal finances or from the operating revenues of the new company.”

Some experts say it’s still bootstrapping when somebody uses borrowed money (loans) backed by their own personal assets, so they keep the entire risk and the entire ownership.

The bootstrapping founder takes all the risk

If you’re self-funding your business, you take all the risk. If your business goes under, you lose your personal investments in the business. But, if you succeed, you also take all the reward.

In contrast, when you take investment from venture capitalists or angel investors, you’re reducing some of your personal risk, because you’re financing your business growth with someone else’s cash. But you’re also usually giving up some equity in your company.

Giving up equity or some percentage of ownership generally means that someone else shares the payout if your business scales successfully and is then acquired. Keep in mind that venture capitalists and angel investors are usually only looking to invest in businesses that have built in an exit strategy—they get paid when you sell your high-valuation business. So do you, but not as much as if you owned 100 percent of your company.

That’s one of the things that makes the personal risk of bootstrapping so appealing. You retain complete ownership and decision-making power within your business. If you want to own and run a healthy business for the next 50 years—you can do that.

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Most startups don’t actually receive outside funding

In the real world, the vast majority of U.S. new businesses are bootstrapped.

Statistics are sketchy, but experts generally agree that about 6 million new businesses start up in the U.S. in an average year. Of those, only about 70,000 startups get angel investment, and fewer than 5,000 get venture capital. And banks lend SBA-guaranteed loans to fewer than 100,000 startups per year, often requiring things like your house as collateral.

These relatively low numbers support the general idea that in reality, most startups and small businesses don’t get outside funding—the vast majority are bootstrapped. Some would say that the common phrase “startup funding” is an oxymoron, since so few startups actually get outside funding.  

So, where does the money come from?

Bootstrapping doesn’t necessarily mean starting from nothingwith no money whatsoever. Although definitions vary, most people call it bootstrapping when a founder uses credit cards, or mortgages a home, or pledges some other personal assets as collateral to borrow the money.

That was my case, in the early years of Palo Alto Software. As we grew to revenues greater than $5 million in the early days, we had no outside investment, but my wife and I had three mortgages along the way and $65,000 in credit card debt at one point. I call that bootstrapping because the risk was all on us (and do as I say, not as we did—see the final point below).

How to make bootstrapping work for your business

The best way to bootstrap is to lever up from early sales, or even promises of early sales. Kickstarter is a mecca for bootstrappers because they can use it to get pledges or promises to buy, with pre-orders, before they finish the product.

Many consulting businesses start with a big engagement from a first client, which is essentially a promise to pay. We did one product at Palo Alto Software that was funded by a letter of intent from a big distributor, promising to buy 1,000 copies as soon as we finished.

And I know people who have funded a startup with prepayments from enterprise clients for a service business. It happens. Actually, it happens way more often than you’d think if you guessed from reading all the blog posts about getting investors.

While we’re on that subject, consider this: Read my post on 10 Good Reasons Not to Seek Investors for Your Startup. Not that I’m against angel investors—I’ve done more than a dozen angel investments as a member of a local angel group—but there are a lot of good reasons to bootstrap.

How much money does it take?

The bootstrapper is spending her or his own money. So, we tend to spend less than when we’re funded by investors. We tend to add value through work, often for free, instead of paying salaries.

We also tend to spend less—and spend what we do more carefully—when we’re bootstrapping.

Here are some points from my article 10 Lessons Learned in 22 Years of Bootstrapping (without the explanations that followed):

  • We spent our own money. We never spent money we didn’t have.
  • We used service revenues to invest in products.
  • We minded cash flow first, before growth.
  • We put growth ahead of profits.
  • We hired people slowly and carefully.

And that’s pretty much how it goes.

The bootstrapper gets all the reward

It’s only fair, after all. The bootstrapper takes all the risk, so she or he gets all the reward, too.

If you manage to build a company without outside investors, you end up owning it all yourself. You don’t have investors as bosses (you do have customers, but that’s a different article). You can make your own decisions. You may or may not have a board of directors, but if you do, it’s not a threat to your continued employment. You eat what you kill, so to speak. You control your own destiny.

That’s a good feeling, when it works. It can be hell when it doesn’t. I can speak from experience. I’ve had both the hell of multiple mortgages and the taste of impending doom, and the satisfaction of building a company that remains family-owned.

However, I don’t want you to underestimate what it means to take all the risk. Bootstrapping can ruin your life if it goes bad. Please do what I say here, not what I did.

Plan more carefully. Don’t get yourself into a deep hole. Don’t bet money you can’t lose. Don’t bet relationships you can’t afford to lose. In my case, my wife was with me in all the key moments and shared the risk. If I hadn’t had her on board, I wouldn’t have done it.

Do you have experience bootstrapping, or did you receive outside funding for your business? Let us know about it on Twitter @Bplans.

Editor’s note: This article was originally published in 2015. It was updated in 2019.

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5 Reasons You Might Not Qualify for an SBA Loan

SBA loan rejected

If you’re looking for funding to finance starting or growing your small business, you’ve probably heard about SBA loans. Loans that are backed by the U.S. Small Business Administration (SBA) are attractive for small business owners because they offer a range of loan sizes, long repayment terms, and most importantly, low-interest rates. While some alternative business lenders charge as high as 80 percent APR, you can get an SBA-backed bank loan for around seven percent APR, depending on the amount you’re looking to borrow and for how long.

So what’s not to like about SBA loans? Unfortunately, it can be difficult to get approved. Many businesses that want SBA loans get turned away by banks for one reason or another. Here are the five main reasons that SBA loan applicants get rejected, and a look at your alternatives.

1. Your business is brand new or hasn’t launched yet

Most banks will not issue SBA loans to brand new businesses. They often require you have a couple of years in business, or, when do they lend to new companies or startups, they generally expect the owners to have experience in the industry.

As a new business, it can be hard to raise funding. The news makes it seem like every startup has access to millions in dollars of funding by venture capitalists or angel investors.

Many startups are small, local businesses with hopes of eventually rapidly scaling—but they’re still establishing a track record. Both banks and investors are going to want some evidence that you’re going to be able to repay them. If your business—whether it’s a startup or a small business—is brand new, you will likely get rejected for an SBA loan, but you do have options.

Solution: Borrow from other lenders that loan to early-stage businesses

You can borrow from a nonprofit such as Accion, a popular nationwide loan provider that specializes in lending to brand new businesses. You won’t be able to borrow too much money from such sources however—Accion lends a maximum of $30,000 to new businesses and startups.

Alternatively, you can borrow based on cash flow. For instance, if you have a lot of online sales and have just three months of sales history, you could borrow from PayPal Working CapitalIf you have a lot of credit or debit card sales, you could get a merchant cash advance from a provider like CAN Capital.

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2. You have a low credit score

To qualify for an SBA loan, you must have a strong credit score—at least 600 for most banks. If you fall just short—or far short—of that, that’s ok. If you don’t have great credit, you will probably be rejected for an SBA loan, but you may have better luck with lenders that care less about credit score and have a more holistic evaluation process.

Solution: Seek a lender that doesn’t check credit or requires only decent credit

Approach short-term business lenders with caution. They often approve loans to individuals with lower credit scores, but you want to be confident you can repay on time—otherwise you’ll probably find your loan subject to unusually high-interest rates. Then there are lenders that don’t check credit score at all—FundboxBehalfand PayPal Working Capital are examples. Those companies emphasize other criteria.

For instance, Fundbox lends money based on unpaid invoices and will look at how likely it is that someone who owes you money will actually pay you. Behalf does purchase financing and mines the internet for social media and other data about your business to assess your creditworthiness. PayPal, mentioned above, looks at your PayPal sales history and volume in deciding whether to lend you money.

3. You don’t have enough collateral for a loan

Since the economic downturn, banks are especially risk-averse and want to protect themselves in the event that a business owner cannot pay back a loan. They’re looking for you to put up some collateral as assurance that they can recover their money, even if your business folds. Even though the SBA backs up to 75 percent of SBA loans, the bank is still on the hook for the other 25 percent.

Moreover, the collateral that you provide is split between the SBA and the bank. So if you cannot collateralize a large part of the loan amount, there’s a good chance that your application will be rejected.

Solution: Go with a lender that doesn’t require collateral

There is good news and bad news in response to this problem. Some short-term lenders like don’t require a specific amount of collateral for a loan. It’s O.K. if you don’t have expensive equipment or real estate to collateralize the loan.

The bad news is that they will place a lien on your general business assets, whether your assets add up to the value of the loan or not. This means that they can sell off your business assets if you don’t pay back the loan. Plus, if you’re looking at high-interest rates and penalties if you can’t pay your loan back according to the schedule you agree to.

But some lenders that loan smaller amounts of money don’t require collateral or a lien. They usually base their lending decisions on your business’s cash flow and they don’t care much about the assets that you own. Examples include Accion, PayPal Working Capital, Fundbox, and Behalf.

4. You don’t want to personally guarantee the loan

When you personally guarantee a loan, you are personally responsible for paying the loan back, even if the business doesn’t do well or closes down. If you don’t pay back the loan, a personal guarantee allows the lender to sell off your personal assets (e.g. your home and car) to satisfy the loan.

Banks will require personal guarantees for SBA loans, but even sincere borrowers may not want a personal guarantee hanging over their head. If you don’t want to personally guarantee an SBA loan, then you won’t qualify.

Solution: Choose a lender that doesn’t require personal guarantees

Some alternative lenders such as PayPal Working Capital, Fundbox, and Behalf don’t require a personal guarantee.

If you choose a lender that doesn’t require a personal guarantee, however, you will have to make some sacrifices. Primary among these are size and cost. If you’re not willing or able to personally guarantee a loan, you cannot borrow a lot of money, and you should be prepared to pay a higher interest rate.

5. You’re in an excluded industry

You might look like the picture perfect applicant: high credit score, several years in business, and enough collateral. Even if you have all that, you will still get rejected if you’re in an industry that is ineligible for SBA loans.

Excluded business types include life insurance companies, lobbying organizations, certain types of franchises, cannabis-based businesses, certain types of health businesses, and more.

Solution: Look for another lender or funding option

If you’re in an excluded industry, there are lenders that are more liberal in the types of businesses they lend to than the SBA. Look into other lending options, but don’t be afraid to seek other forms of funding too.

SBA loans are great low-interest rate loans for your business. But if a bank rejects your application for one of the reasons above, there are other lenders that may be willing to work with you. You might find that seeking funding from venture capitalists or angel investors makes more sense. Or maybe you’ll have better luck accessing the resources you need through crowdfunding or even keeping your day job for a while to finance your businesses’s growth in the short term.

We encourage business owners to learn about all their options and choose the best one that is open to them. Check out the Bplans guide to finding funding your business for more ideas.

This article is part of our Small Business Loan Guide, check out this page for expert tips and advice on loans.

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Marc Prosser
Marc Prosser

Marc Prosser is the publisher and co-founder of Fit Small Business, a “how to” publication for small business owners. Prior to starting Fit Small Business, Marc Prosser served as the Chief Marketing Officer of FXCM (NYSE:FXCM). During his eleven year tenure as CMO, the company grew from under 10 people to over 500 employees located throughout the globe.



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How to Ask Family and Friends to Fund Your Business

asking friends and family for money

This article is part of our Business Startup Guide, a curated list of our articles that will get you up and running in no time!

Asking for help is one thing; asking for financial help is another beast all its own. Yet many small businesses and startups turn to family and friends to help fund their company.

Many entrepreneurs bootstrap or self-finance their business. But that doesn’t mean every founder saves up their own money, opens a line of credit, or seeks a bank loan. For some, it makes sense to ask friends and family for financial support.

Tom Scarda, a business consultant who helps prospective entrepreneurs find the right franchise through FranChoice, says a lot of entrepreneurs hit up friends and family for capital.

“Most friends and family say yes to a person asking to finance a business,” he says. That is, “until it comes time to write a check.”

If you want your loved ones to buy into the business, you need to get over the awkward feelings of asking for help and convince them that you’re serious about this business and have a plan to make it successful, Scarda says.

To do so, you’ll want to follow these tips to ask friends and family for startup cash.

1. Have a solid business plan

Whether you’re asking your best friend or going to the Bank of Mom and Dad, you need to treat the discussion like you would with a banker. You wouldn’t get a bank loan without a business plan, and you shouldn’t expect your family and friends to invest in your company without one either. Your business plan should include your financials, milestones, and metrics that make it clear how you plan to make your venture profitable.

Need a little help creating a solid business plan? No problem. Check out these business plan samples, or try LivePlan, our business planning software.

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2. Ask for enough money

When you’re asking friends and family to part with their hard-earned cash, your instinct is probably to ask for as little as possible, but Scarda says this is the wrong approach. If you don’t have enough money to start the business, it won’t succeed. Scarda says you need to consider three pools of money:

  • Initial investment: Money needed to get the business ready for customers, also called startup costs.
  • Working capital: Money needed to keep the business going until you hit your break-even point.
  • Home capital: Money needed to personally survive while the business is launched. You need money to pay your own bills—don’t forget this piece! A six-month reserve is a good rule of thumb, Scarda says.

3. Make a payment plan

How do you plan to repay your family of investors? If you’re not planning to offer equity in your company in exchange for cash (a typical scenario with angel investors and venture capitalists), you’ll need to figure out a plan to pay everyone back, with interest, just like a business loan. Scarda suggests scheduling the first payment six months after the business opens.

The plan should also include “what ifs”: What if you can’t make a payment one month? What’s the plan then? By having these issues worked out ahead of time, you’ll save problems down the road. Put it all in writing, too. A legal document is best.

4. Expect investors to take an active role

The friends members and family that invest in your business may want a say in how things are done. It’s something you should discuss before raising money from people you’re close to. Investors, even if they are your parents, will want to protect their investment. Expect them to check in, ask questions about the business, and give you unsolicited advice. Don’t take it personally, Scarda says—it’s a business relationship, and you should treat it as such.

Above all else, you want to show your family that you are professional and prepared. Show them you’re ready for the big time by having all the necessary documents and by answering any questions they have. Practice your pitch beforehand, and think through your answers to any potential objections.

All that said, there are all kinds of reasons to avoid mixing business and family as you consider your business funding options. There are plenty of pitfalls—the Young Entrepreneurs Council shared a few considerations in this article.

Tim Berry, founder of Palo Alto Software (makers of Bplans) cautions that it can be hard to get out when it’s time to walk away from a business if you’ve involved family and friends in your funding plan.

Susan Solvic says it’s important to remember that challenging personal relationships won’t magically become less complicated when you add on a new type of business relationship. However you decide to fund your business, just think through the long term consequences—both of your success, and of the potential of slower growth than you hoped.

This article is part of our Business Funding Guide: Fund your business today, with Bplans.

Need help finding a loan? Check out the Bplans Loan Finder.

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Lisa Furgison
Lisa Furgison

Lisa Furgison is a journalist with a decade of experience in all facets of media.

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How to Start a Digital Marketing Agency Without Outside Funding

how to start a digital marketing agency

It’s easier to start a digital marketing agency without funding than people might think.

In this post, I will cover starting your business on your own—with aspirations of becoming an agency. I will look at how to get your first clients and how to balance your time when finding them—when you start on your own, that is one of the toughest balancing acts.

Setting up

The beauty of setting up a digital marketing agency is that you can start from virtually nothing. I know this from personal experience because my business partner and I did just that with our company, Louder.Online. If you have the expertise, then all you need to get started is a computer and a home office (or at least a space to work). There are not many businesses where that’s all you need.

You don’t need to put it all on a credit card, you don’t need to get a bank loan, you don’t need startup capital—you can just build a website, and you can be on your way. That’s what we did, and we now have a successful digital marketing agency with clients around the world.

Taking on your first employees

Many businesses will hire recruiting and onboarding agencies to find employees for their burgeoning digital marketing agency, but if you’re going to build an agency without funding then you need to be doing this yourself.

Beyond the fact that you won’t need the extra cash from the start to make hires, it will mean that you have control over the kind of employees that you take on. When you’re ready, you can hire the right people for the culture that you create around your business.

Training your team

Training your employees can be a costly business if you are not wise. When building a digital marketing agency without outside funding, you need to make sure you have a plan in place to be able to train people as and when they join you without incurring additional cost to the business.

Something we found invaluable when building our agency was to train the first few staff ourselves and educate them on everything we could. Sure, it meant that we put in some long hours at the start, but it paid off in the long run.

Training our first employees in every area we could think of prepared them to be able to train the next wave of staff. In turn, those staff members were able to teach the team members that joined after them.

As people moved up the ladder in our business, the staff that joined early on were able to train up the juniors that came in after them. Higher paid employees were able to use their time to liaise with clients and strategize rather than spending their time on training—making the business more successful and profitable, while not losing any of the vision that we had for the company or how our digital marketing client work was undertaken.

Documenting your processes and making life easier

If you want to start an agency without having outside funding, you need to find ways to do things in a non-traditional manner.

If your business takes off straight away, then it is likely that you are going to be taking on staff fairly quickly to cope with demand. When you have new staff starting regularly, you need two things in place—process documentation and basic HR functions—preferably avoiding having to hire an HR person too early.

At Louder.Online we made sure that we concentrated on these very early on. We documented our processes from day one in some software called Process Street. The software lets you create checklists and workflows that any of your staff can run at any time.

We use Process Street to document things like:

  • How to answer the phone
  • What to do when you are sick
  • How to put in an expenses report
  • How to book a holiday
  • What is needed before a new employee starts
  • What is required when an employee leaves

Having these processes documented means that everyone knows what they need to do and can follow a standard protocol. They don’t have to ask their manager or other staff.

This saves time and means that the employees that you have at your agency can actually spend more time on billable work for the clients. That, in turn, makes you more profitable. You are saving money that might otherwise have had to have come from outside funding.

We also didn’t want to have to hire an HR person until we really needed to and we certainly didn’t want to outsource that to a third party. They both cost a lot of money, and we didn’t want to have to use outside funding to do that.

After some searching around in the early days, we found some software called AppogeeHR.

The software boasts:

  • Centralized employee information
  • Leave and sickness management
  • Performance and learning tracking
  • Reporting
  • OKR management

It is simple to use, and it means that my business partner and I were able to act as HR without having to spend a lot of time on it. As earlier employees moved up, they were able to take on some of the work as well—and of course, this was all documented in a subsection of Process Street for when they needed it.

There is a saying that “necessity is the mother of invention,” and when we knew we didn’t want to use outside funding we looked for ways that we could make sure we didn’t have to.

Bootstrapping

If you don’t have that cash injection at the start of your businesses life, then you need to be bootstrapping.

A dictionary definition will tell you that it’s to get oneself into or out of a situation using existing resources. When you read other articles, they will talk about relying on personal income or savings, and they talk about sweat equity.

We think the definition can be a little broader than that—essentially optimizing your current situation. We did this through an intelligent choice of clients and being smart with our cash. We found these to be essential to avoid that outside funding.

Getting good clients

Bad clients bring you down. Bad clients cost you money. Bad clients suck up your time.

If you don’t want to be spending money on additional staff to cover those losses, then you need to know how to spot a good client. Taking on every client that comes your way was never an option for us.

So how do you spot a good client? Here are my tips:

  • Choose clients that will let you do your best work—stay away from the clients that overly worry about cost, because they will cost you in the long run.
  • Choose clients whose business you believe in—the synergy between your agency and their business will lead to a healthy and respectful relationship.
  • Work with clients who understand what you do—if they have some knowledge of the digital marketing landscape then they will be interested in what you do and don’t expect the world.

Being smart with your cash

This one sounds kind of obvious, right? But how many stories in the last few years have you read about businesses going under because of the inordinate amount of cash they spent on offices and perks to try and attract staff?

The employees that join your company are likely to know about these perks and want to see some of them. This is where you have to try and resist. Sure they are fun, but if you don’t want that outside funding, then you need to be sensible.

Company culture is not about the arcade machines and novelty slides from one floor to another. Company culture is about the bonds you create, the work that you do and how comfortable people feel at work.

People want to enjoy their work. When people enjoy their day to day life they produce better work, and they stay with a company longer. Combine these two together, and it cuts down the money you need to spend on recruitment and training—another way to avoid using outside funding.

Financial goal and milestone setting

Being smarter with your cash and spending less is one thing; financial goal and milestone setting is another. We knew we would have to create something scalable from the start and also be able to predict with some degree of accuracy what our potential revenue might be.

As we were starting a digital agency, we knew we were going to be selling hours from the very start. We knew that tracking employee time and client budgets were the way we wanted to head in. Using a project management tool like Liquid Planner or a Harvest/Basecamp combination can really help with this.

We set prices for staff, created client folders and subprojects early on. Every member of staff had tasks assigned that they accurately track time against. This allowed us to make sure we didn’t go over or under for clients and the tools turn the hours into dollars in detailed reports.

We started in a very granular way and had activities set for the different types of work that we were doing. This allowed us to accurately predict how long specific tasks would take and we could pitch accordingly—there was no finger in the air guesswork.

After we had started to collect this data we could predict how much revenue we might bring in per client. From there we created financial milestones based on the close rate of proposals and how much similar projects had cost—and whether they had come under or gone over. We found this to be an accurate way of getting solid estimates on where the business would be in six months, a year, five years and beyond. It’s strategic planning or Lean Business Planning.

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Start small but plan for growth

That’s how we did it at Louder Online, we took a no outside funding stance from the start and made sure we looked for alternative solutions to cut costs. We started small and made sure that there was a culture in place from day one.

We made sure that we documented everything so that new employees would know what they had to do and when.

We enabled the staff to train each other as the agency grew, creating last bonds and teamwork.  

It isn’t for everyone and it was definitely hard for us at the start, but it has made us the profitable digital marketing agency that we are today and we wouldn’t change that for the world.

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Aaron Agius
Aaron Agius

Aaron Agius, CEO of worldwide digital agency Louder Online is, according to Forbes, among the world’s leading digital marketers. Working with clients such as Salesforce, Coca-Cola, IBM, Intel, and scores of stellar brands, Aaron is a growth marketer—a fusion between search, content, social, and PR.

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How to Get Funding for a Business

how to fund a business

Most healthy businesses need business financing at some point. Startups have to deal with starting costs and ongoing businesses have to finance growth and working capital.

Deciding to take on some kind of debt is quite common. In this article, we’ll take a quick look at the big picture, and then talk through options for funding.

Financing options depend on what kind of business you have. Its age, position, performance, market opportunities, team, and so forth are very important. So you should tailor your funding search and your approach. Don’t waste your time looking for the wrong kind of financing.

Understand the general realities of getting funded

Let’s start with a quick reality check. Like so many things in business, a lot about business financing depends on your specific details. Realities go case by case, depending on the growth stage, resources, and other factors.  

Are you a startup or ongoing business?

The outlook for funding depends a great deal on the specifics of the business.

For example, many ongoing businesses have access to standard business loans from a traditional bank that would not be available to startups. Also, high-tech high-growth startups have access to investment funding that would not be available to stable, established businesses that show only slow growth.

Small business financing myths

Before we get into the most viable options for start-ups and established businesses, let’s dispel some popular funding myths, just so we can get them out of the way. Don’t get discouraged at this point. Better to deal with realities that you can work with rather than myths you can’t.

Myth #1: Venture capital is a growing opportunity for funding businesses

Actually, venture capital financing is very rare. I’ll explain this more later, but assume that only a very few high-growth companies with high-power management teams are venture opportunities.

Myth #2: Bank loans are the most likely option for funding a new business

Actually, banks don’t finance business startups. I’ll have more on that later, too. Banks aren’t supposed to invest depositors’ money in new businesses.

Myth #3: Business plans sell investors

Actually, they don’t.

A well-written and convincing business plan (and pitch) presents your business to investors in detail; but they are investing in your business, not just a plan.

Normally you have to have a team in place, have made progress toward idea validation, or—better still—traction (paying customers). So you do a lot of work before you get investors.

Nobody invests in ideas or plans. The rare exception is a special case, in which investors know an entrepreneur well and are ready to invest in them at an early stage. In that case, they are investing in the entrepreneur, not the plan.  

The role of the business plan

I’m not saying you shouldn’t have a business plan. You should.

Your business plan is an essential piece of the funding puzzle, explaining exactly how much money you need, and where it’s going to go, and how long it will take you to earn it back.

Investors will look first to a summary, and then a pitch; but if you get through that screening, they’ll want to see a business plan for the process of due diligence. And even before that, during the early stages, they’ll expect you to have a business plan in the background, for your own use.

Most commercial banks require a business plan as part of a loan application. A plan is also required for applying for a business loan guaranteed by the Small Business Administration (SBA).

Everyone you talk to is going to expect you to have a business plan available. They may not start their discussions with you by looking at the plan, but don’t get caught without one when they ask to see it.

Where to look for money

The process of looking for money must match the needs of the company. Where you look for money, and how you look for money, depends on your company and the kind of money you need. There is an enormous difference, for example, between a high-growth internet-related company looking for second-round venture funding and a local retail store looking to finance a second location.

In the following sections of this article, I’ll talk more specifically about six different types of investment and lending available, to help you get your business funded.

1. Venture capital

The business of venture capital is frequently misunderstood. Many startup companies complain about venture capital companies for failing to invest in new ventures or risky ventures.

People talk about venture capitalists as sharks, because of their supposedly predatory business practices, or sheep, because they supposedly think like a flock, all wanting the same kinds of deals.

This is not the case. The venture capital business is just that—a business. The people we call venture capitalists are business people who are charged with investing other people’s money. They have a professional responsibility to reduce risk as much as possible. They should not take more risk than is absolutely necessary to produce the risk/return ratios that the sources of their capital ask of them.

Venture capital shouldn’t be thought of as a source of funding for any but a very few exceptional startup businesses. Venture capital can’t afford to invest in startups unless there is a rare combination of product opportunity, market opportunity, and proven management.

Venture capital professionals look for businesses that they believe could produce a huge increase in business value within just a few years. They know that most of these high-risk ventures fail, so the winners have to win big enough to pay for all the losers.

They focus on newer products and markets that can reasonably project increasing sales by huge multiples over a short period of time. They try to work only with proven management teams who have dealt with successful startups in the past.

If you are a potential venture capital investment, you probably know it already. You have management team members who have been through that already. You can convince yourself and a room full of intelligent people that your company can grow ten times over in three years.

If you have to ask whether your new company is a possible venture capital opportunity, it probably isn’t. People in new growth industries, multimedia communications, biotechnology, or the far reaches of high-technology products, generally know about venture capital and venture capital opportunities.

If you are looking for names and addresses of venture capitalists, start with the internet.

The names and addresses of venture capitalists are also available in a couple of annual directories:

2. Angel investment

We started with venture capital first in this article because the phrase is more common, and some people think of all outside investment in high-growth startups as venture capital.

However, the reality is that what we call angel investment is much more common than venture capital, and usually is much more available to startups, and at earlier growth stages too.

Although angel investment is a lot like venture capital (and is often confused with it), there are important distinctions. First, angel investors are groups or individuals who invest their own money. Second, angel investors tend to invest in companies at earlier stages of growth, while venture capital typically waits until after a few years of growth, after startups have more history.

Many people use the term “venture capital” to apply to any investors who invest in high-growth startups. In fact, angel investment in startups is much more common than venture capital, especially at the earlier growth stages. Businesses that land venture capital typically do so as they grow and mature after having started with angel investment first.

Like venture capitalists, angel investors normally focus on high-growth companies at early stages of development. Don’t think of them for funding for established, stable, low-growth businesses.

Your next question, of course, is how to find the “angels” that might want to invest in your business. Some government agencies, business development centers, business incubators, and similar organizations will be tied into the investment communities in your area. Turn first to your local Small Business Development Center (SBDC), which is most likely associated with your local community college.

You can also post your business plan on websites that bring angel investors together. The two most reputable sites in this area are:

You should also be aware that angel investment was affected by the 2012 JOBS Act that loosened some restrictions and allowed what we now call crowdfunding.

Traditionally, angel investment was limited by U.S. securities and exchange regulations to individuals meeting some minimum wealth requirements, called “accredited investors” in the legal wording. Crowdfunding is the accepted term for individual investment in startups by people who don’t meet the legal wealth requirements.

Under certain conditions, startups and even non-high-growth small business can solicit investment from a wider range of investors. Details are still fuzzy on a lot of this, so, when in doubt, check with a good attorney first.  

Important: Be careful dealing with anyone or business firm offering to find you startup investment if you hire them to act as front or negotiator for you, or do your business plan, or your pitch presentations and such. These are shark-infested waters.

I am aware of some legitimate providers of business plan consulting, but legitimate providers are harder to find than the sharks. Real angel investors want to deal with the startup team founders, not brokers, or finders, or consultants. Finders’ fees had a place in startup investment a few decades ago, but have become obsolete.

Download the free Investor Pitch Deck Template Kit today!

3. Commercial lenders

Banks are even less likely than venture capitalists to invest in, or loan money to, startup businesses. They are, however, the most likely source of financing for established small businesses.

Startup entrepreneurs and small business owners are too quick to criticize banks and financial institutions for failing to finance new businesses. Banks are not supposed to invest in businesses, and are strictly limited in this respect by federal banking laws.

The government prevents banks from investment in businesses because society, in general, doesn’t want banks taking savings from depositors and investing in risky business ventures; obviously when (and if) those business ventures fail, bank depositors’ money is at risk. Would you want your bank to invest in new businesses (other than your own, of course)?

Furthermore, banks should not loan money to startup companies either, for many of the same reasons. Federal regulators want banks to keep money safe, in very conservative loans backed by solid collateral. Startup businesses are not safe enough for bank regulators and they don’t have enough collateral.

Why then do I say that banks are the most likely source of small business financing? Because small business owners borrow from banks. A business that has been around for a few years generates enough stability and assets to serve as collateral. Banks commonly make loans to small businesses backed by the company’s inventory or accounts receivable. Normally there are formulas that determine how much can be loaned, depending on how much is in inventory and in accounts receivable.

A great deal of small business financing is accomplished through bank loans based on the business owner’s personal collateral, such as home ownership. Some would say that home equity is the greatest source of small business financing.

4. The Small Business Administration (SBA)

The SBA makes loans to small businesses and even to startup businesses. SBA loans are almost always applied for and administered by local banks. You normally deal with a local bank throughout the process of getting an SBA loan.

For startup loans, the SBA will normally require that at least one-third of the required capital be supplied by the new business owner. Furthermore, the rest of the amount must be guaranteed by reasonable business or personal assets.

The SBA works with “certified lenders,” which are banks. It takes a certified lender as little as one week to get approval from the SBA. If your own bank isn’t a certified lender, you should ask your banker to recommend a local bank that is.

Need help finding a business loan? Find available small business loan options with the Bplans Loan Finder.

5. Other lenders

Aside from standard bank loans, an established small business can also turn to accounts receivable specialists to borrow against its accounts receivables.

The most common accounts receivable financing is used to support cash flow when working capital is hung up in accounts receivable.

For example, if your business sells to distributors that take 60 days to pay, and the outstanding invoices waiting for payment (but not late) come to $100,000, your company can probably borrow more than $50,000.

Interest rates and fees may be relatively high, but this is still often a good source of small business financing. In most cases, the lender doesn’t take the risk of payment—if your customer doesn’t pay you, you have to pay the money back anyhow. These lenders will often review your debtors, and choose to finance some or all of the invoices outstanding.

Another related business practice is called factoring. So-called factors actually purchase obligations, so if a customer owes you $100,000 you can sell the related paperwork to the factor for some percentage of the total amount. In this case, the factor takes the risk of payment, so discounts are obviously quite steep. Ask your banker for additional information about factoring.

6. Friends and family funding

If I could make only one point with budding entrepreneurs, it would be that you should know what money you need, and understand that it is at risk. Know how much you are betting, and don’t bet money you can’t afford to lose.

I’ll always remember a talk I had with a man who had spent 15 years trying to make his sailboat manufacturing business work, achieving not much more than aging and more debt. “If I can tell you only one thing,” he said, “it is that you should never take money from friends and family. If you do, then you can never get out. Businesses sometimes fail, and you need to be able to close it down and walk away. I wasn’t able to do that.”

The story points out why the U.S. government securities laws discourage getting business investments from people who aren’t wealthy, sophisticated investors. They don’t fully understand how much risk there is. If your parents, siblings, good friends, cousins, and in-laws will invest in your business, they have paid you an enormous compliment. Please, in that case, make sure that you understand how easily this money can be lost, and that you make them understand as well.

Although you don’t want to rule out starting your company with investments from friends and family, don’t ignore some of the disadvantages. Go into this relationship with your eyes wide open.

Maybe, your idea and your situation is a better fit for crowdfunding—that is, creating a profile and pitching your business idea or product on a site like Kickstarter. In fact, this method of raising money has become so popular that here are dozens of crowdfunding sites to choose from, all offering different terms and benefits.

Words of warning

Sadly, financing and investment involves money; and money breeds some predatory business practices, scams and such. So here are some reminders to help you avoid the pitfalls.

  • Don’t take private placement, angels, friends, and family as good sources of investment capital just because they are described here or taken seriously in some other source of information. Some investors are a good source of capital, and some aren’t. These less established sources of investment should be handled with extreme caution.
  • Never, spend somebody else’s money without first doing the legal work properly. Have the papers done by professionals, and make sure they’re signed.
  • Never, spend money that has been promised but not delivered. Often companies get investment commitments and contract for expenses, and then the investment falls through.
  • Be aware that turning to friends and family for investment is not always a good idea. The worst possible time to not have the support of friends and family is when your business is in trouble. You risk losing friends, family, and your business at the same time.

Summary

Most businesses are financed by home equity or savings as they start—bootstrapping. Only a few high-growth startups can attract outside investment. Venture capital deals are extremely rare. Borrowing will always depend on collateral and guarantees, not on business plans or ideas. And business borrowing is normal for ongoing businesses with an established history, but not a normal option for startups.

What might be the next steps to take depends a lot on your specific business. Generally, high-tech startups might explore angel investment or friends and family first, while steady ongoing businesses should start by asking their small business banker. But always remember, your business is unique.

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