by Rob Cordasco, author of “A Framework for Growth: Smart Financial & Tax Planning Strategies throughout the Entrepreneurial Life Cycle“
Not every would-be entrepreneur was discouraged when the COVID-19 pandemic began to cause headaches for businesses across the country.
The number of startups surged at a time when opening a new business looked like a questionable move. Now, with things looking up in the economy and in the battle against the virus, even more people may take the plunge and launch their own businesses.
But as they do, they face a crucial question every entrepreneur must address, pandemic or no pandemic: How do you gather the capital to pay for such an endeavor?
When you are trying to get started, every nickel and dime counts. Many entrepreneurs have a great idea for a business and an eagerness to move forward, but they have few funds, so that’s the first obstacle to overcome. You’ll want to plan carefully because, while there are several options available for funding a new business, each comes with its own pros and cons.
Here are some options to consider include:
Personal savings.
This is the cheapest option for funding, but comes with obvious drawbacks. The upside is you won’t have to make payments to a bank every month, regardless of your sales level. The downside is that if you dip too far into your personal funds, you could put yourself – and your family – at risk. If you choose to self-fund the business, map out a plan before transferring or withdrawing any funds. That gives you time to think through what you want to do and evaluate how to make the most of each dollar.
Debt.
If you choose to borrow money to launch the business, you can seek a loan from a bank, an online lender, a family member or even a friend. When you’re low on funds – or reluctant to dip too far into your savings – this is a viable option. But debt has its downsides as well.
As soon as you take the money, you’ll be held accountable for paying it back. In the startup phase, your personal assets will likely be used to guarantee the loan. This means if the product doesn’t sell, your savings, house, or car could potentially be lost, as they may have been used as collateral when the loan was first established. On top of that, your startup will feel the pressure of having to sell enough to cover the debt and the interest owed.
Equity.
This is by far the most expensive option. Essentially, through equity, you sell part of the company to an outsider. This outsider will gain some ownership in the company in return. They’ll also take some of the profits. You could think of this situation as “forced sharing.” Through equity, you’ll receive funds to help start the company, but you’ll also have other owners involved and will have to think about earnings, profits, and distributions right from the beginning. During the early stages of your business, its value is low, and you will give up more ownership than if you wait until later in your business life cycle to take on partners.
Before starting a business and making any decisions about funding, I recommend sitting down with a CPA so you can make sure your financial footing is solid.
The two of you should evaluate the funding options together. Look at your personal finances as well. You’ll be able to see risks to be aware of, such as payments that must be made every month and the particular income needs that you have.
Starting a business can be an exciting time, but if you aren’t careful and intentional with your planning, your dream of successful entrepreneurship can turn into an overwhelming financial ordeal.
Rob Cordasco, author of “A Framework for Growth: Smart Financial & Tax Planning Strategies throughout the Entrepreneurial Life Cycle” is the founder of Cordasco & Company, P.C., a boutique Certified Public Accounting firm. Cordasco is a CPA with more than three decades of experience. He holds a bachelor’s degree in accounting from Spring Hill College in Alabama.
