Starting a business sometimes seems as simple as launching a website and creating a Facebook page. Without the right funding, most businesses run out of money quickly. Determining how to finance your business is an important decision with big consequences.
There are several ways to approach funding, but there are two main sources of financing: debt and equity.
Debt Financing.
Debt financing is where you borrow money from a lender that you will later pay back with interest. This is a business loan. With debt financing, you are, for the most part, in control of this extra capital. This type of financing is flexible with a variety of business loans available with wide ranges as to how much money you borrow and how long you have to pay it back.
There are a few cons to debt financing. You will have to pay the loan back with interest, so you are paying for the money you get. Optimally, you will use this money to earn more money. Depending on different factors including your credit score, it may be hard to qualify for a loan. If you fail to repay the loan, your lenders can seize your assets.
Equity Financing.
In return for capital, you trade ownership of a portion of your business to angel investors or venture capitalists. Equity is especially important for companies with global aspirations or technology startups. One of the benefits of equity financing is you don’t have to pay interest on the capital you receive. Since you don’t have to use your profits to repay your debt, you have more money available to grow your business. Many investors provide industry connections, experience, wisdom. If your business ultimately fails, you are not indebted to a lender.
But, equity financing can take a long time to obtain. With equity financing, you are relinquishing control of a portion of your business. You will need to consult with your investors before making big decisions. These investors may even be able to dictate the direction your company takes.
Angel Investors Versus Venture Capitalists.
Typically, angel investors are non-professionals investing their own money. Venture capitalists are professionals investing someone else’s money. Venture capitalists rarely provide startup funding. They tend to invest in entrepreneurs with a successful track record or invest later down the line. On the other hand, angel investors are more likely to fund new entrepreneurs at seed rounds.
This isn’t always true. For instance, venture capitalist Chris Sacca is known to invest in seed and early-stage technology companies. Sacca invested in Twitter, Instagram, and Kickstarter with great success.
Minimum angel investments start as low as $25 thousand, while venture capital investments start around $2 million. Your focus should not be strictly on the numbers. There are other important considerations you should take into account:
Business ownership – Venture capitalists tend to demand more control of your company. They want to be more heavily involved in your spending and strategic decisions. Angels tend to agree to simpler terms. They are satisfied with less restrictive terms on voting rights, executive roles, exit options, etc.
Startup opportunity – If your business plan opportunity isn’t at least $1 billion, many venture capitalists won’t be interested. Both investors are looking for scalable solutions with expected revenue growth close to $20 million by year five.
Financial return – Venture capitalists are looking for a high return on their investment. They expect ten times their return within three to five years. Although angel investors desire the same returns they are more willing to accept five times return.
Investment rounds – Most angel investors make a single investment per startup. Venture capitalists are willing to protect their initial investment and the resources to do so. They may make several rounds of high dollar investments if needed.
Experience – Angel investors tend to have an emotional interest in giving back. They are more likely to invest in new entrepreneurs and act as mentors to make up for lack of experience. Venture capitalists are rarely interested in first-time entrepreneurs. They want to see at least a couple of seasoned, successful startup success on the team.
Connections – Sending out a pitch to every VC and angel you can find on the Internet will not likely to be an effective approach to gaining funding. To get the attention of most angels, you need to do at least some local networking. Venture capitalists require more of an introduction.
Help – VCs are more likely to have dedicated individuals that can provide hands-on help where needed. Angels may act as mentors or may simply provide money alone.
Choosing the right funding source should not be taken lightly. Know your business needs. Debt financing is the best route for many small businesses. A select few entrepreneurs are able to pique the interest of equity financiers. If you do decide to seek out investors, be intentional about your process. It is important to be prepared to negotiate involvement in your business along with investment level.
