Whether you borrow, secure backers, or tap into your personal savings, there are different types of funding with their own pros and cons. Below are some pointers to help you determine which funding option is the best fit for you and your business. There are three primary methods to finance your business:
- Bootstrapping, which involves using your own funds.
- Borrowing, such as acquiring loans from a bank.
- Seeking equity capital, which entails offering a stake in your business to investors. This includes crowdfunding and other investment opportunities.
Depending on your industry and the stage of your business, different funding sources may be more suitable for your needs.
Conducting proper business planning and accurately estimating your start-up expenses can provide insight into which options are the most viable. It may also be beneficial to seek guidance from a financial advisor or accountant.
How much money do you need to start a business?
Tips on getting financial advice
Impact on your personal finances
No matter which funding option you opt for, it is probable that you will bear some of the costs associated with starting your business. Here are some common examples:
- Personal savings.
- Personal loans.
- Pledging your personal assets, like your home or vehicle, as collateral for a loan
Using your own finances for your business has its advantages. You retain full control over your venture, unlike when involving investors.
Furthermore, if you decide to seek investors at a later stage, they are more inclined to support you if you can demonstrate your personal investment in the business.
What funding type suits your business?
The funding types you choose for your business will typically align with its stage of development. If you’re starting your second or third business, you’re likely to have more funding options compared to someone new to entrepreneurship.
It’s common to obtain funding from multiple sources, and the ones you select will depend on various factors such as:
- The stage of your business, such as if you’re in the initial stages or experiencing rapid growth.
- Your industry
- How attractive you and your business (or business concept) are to potential funders.
It’s worthwhile to explore all options available to you in order to discover funding alternatives that align with your objectives and financial situation.
Idea for a business
Good fit for: Bootstrapping, asset finance
When you have an excellent idea but limited resources, you’ll likely have to depend on your personal funds or seek investment from friends and family. Typically, new businesses require around $50,000 to $100,000 to establish themselves.
Obtaining a loan can be challenging for individuals who are new to the business world. If you manage to secure a loan, you may be required to provide personal assets, such as your house, as collateral. Even unsecured loans are difficult to obtain since lenders will scrutinise your cash flow, which may be minimal or non-existent.
Bootstrapping
This approach entails starting a business using your own funds. By minimising start-up costs and relying on profits as the primary source of funding, you can bootstrap your new business without depending on bank loans or investors.
Although bootstrapping may seem like an ideal and straightforward way to launch your business, it is not always the optimal choice.
Bootstrapping is most suitable for business models that do not require significant upfront expenditures and have the potential to generate revenue quickly. However, if your business is expected to take a while to recover costs, it’s advisable to explore alternative options. Bootstrapping might exert excessive pressure on your savings or credit card.
If you believe that bootstrapping could be a viable approach for your business, it’s wise to consult a financial advisor or accountant before proceeding.
Asset finance
Asset finance refers to a loan designed to cover the cost of a specific asset, such as a delivery van. The lender purchases the asset on your behalf, and you repay them in monthly instalments. The loan is secured against the new asset or your existing assets. Typically, these loans have a shorter repayment term, ranging from six months to five years.
It is critical to comprehend the terms and conditions before signing any agreement.
Bootstrapping and Asset finance – upsides and downsides
Fact
You may be qualified for government grants or other assistance to subsidise training expenses and business operations.
Explore available options for new businesses and established businesses, including tech start-ups and Māori businesses.
Early days — testing the market
Good fit for: Reward-based crowdfunding, peer-to-peer lending, family and friends.
These funding options are all sourced from individuals – strangers, acquaintances, and individuals with businesses similar to yours – rather than from banks and financial institutions.
Peer-to-peer lending
Peer-to-peer lending, also referred to as social lending or crowd lending, is a method by which you can obtain a loan from an individual rather than a traditional bank or financial institution. Websites such as Harmoney and Lending Crowd facilitate this process by connecting borrowers directly with lenders or investors who are willing to provide the funds.
Crowdfunding
Crowdfunding is a popular way to secure funding for creative work, and it’s increasingly being used to raise capital for entrepreneurial projects as well.
It’s similar to charity fundraising, where you create an online campaign showcasing your business, product, or idea, and set a target amount to raise. People can then support your project by contributing funds. In exchange for their money, you can offer incentives such as gifts or company shares.
It’s important to research and choose a credible crowdfunding website, as there are many options available, including those based in New Zealand. However, keep in mind that by revealing your ideas to the public, there are some risks to your intellectual property (IP).
Types of IP and how to protect them
Friends, family and fools
Your personal network is generally more inclined to trust you and support your business proposition compared to other types of lenders or investors.
However, mixing money with personal relationships can put pressure on the bond and undermine trust. Additionally, you might miss out on the valuable business expertise provided by a professional investor.
Be cautious about who you approach for funding and ensure you have a formal agreement with a written contract that outlines the terms and conditions. This can help avoid misunderstandings and disputes.
Crowdfunding, Peer-to-peer lending, Friends, family and fools – upsides and downsides
Launching your business
Good fit for: Cash flow loans, credit cards, and angel investors.
The best funding option for your business depends partly on the industry you are in. For instance, banks are usually hesitant to lend to businesses without many assets, making it challenging for those in hospitality or tech to obtain secured loans. However, some lenders take into account the cash flow, which is beneficial for businesses with high turnover but not yet making a profit.
Several banks and other lenders provide different incentives and fee structures specifically for small businesses.
Cash flow loans
These loans are secured by your projected cash flow rather than assets. They are typically used to cover a business’s operational costs for up to a year.
If you’re new to the business, loans can be a convenient source of funding. However, you’ll need to put in some effort to apply for a loan and devote time to business planning to ensure it’s the right choice for you.
Search for a loan that provides the lowest interest rates by comparing different lenders.
Banks will require evidence that you can afford to repay the loan. If you’re a novice in business, you’ll most likely need to apply for a personal loan or additional mortgage borrowing. Once your business becomes more stable, more options will become available to you.
Credit cards
Business credit cards are convenient for making smaller purchases.
Similar to bank loans, different banks offer varying rates and benefits for business credit cards. It’s important to compare the terms and conditions, such as annual fees, interest rates, finance charges, and cash advance options.
Your business credit card doesn’t have to be obtained from the same bank as your loan or personal finances. However, it can be advantageous to establish a positive history with a particular bank. Banks may be more inclined to provide better offers to clients they are familiar with and trust.
Angel investors
An angel investor is an accomplished entrepreneur who invests money in innovative new businesses, particularly those led by individuals or teams they have faith in.
These investors often choose businesses within their area of expertise so that their knowledge and experience can contribute to their success.
An angel investor might:
- Provide a loan that you will be required to repay based on their specified terms and conditions.
- Take a percentage of your profits.
- Request partial ownership of your business.
Tips to get investors on board
Cash flow loans, Credit cards and Angel investors – upsides and downsides
Tip
It’s important to keep receipts for all business-related credit card transactions.
These receipts can be claimed as expenses when it’s time to file your taxes.
18 months or more in business
Good fit for: Secured loans, lines of credit, equity crowdfunding, and funding from profits.
Raising capital becomes easier as you now have:
- A proven business model
- Income
- Financial statements demonstrating your performance over time
Even if your financial statements show losses, investors and lenders will be interested if you can present a clear plan for how your business will generate profits. Additionally, considering asset loans, as discussed in the business idea section above, can also be worthwhile.
Secured loans
Usually obtained from a bank, secured loans require you to pledge an asset as collateral in case you’re unable to repay. The loan amount is determined by the value of your assets, such as invoices, accounts receivables, and inventory. Banks calculate the loan-to-value ratio (LVR) to determine how much you can borrow. For instance, if your assets are worth $2,000 and the LVR is 60%, you can borrow up to $1,200.
Lines of credit
A line of credit refers to a predetermined amount of credit provided by a supplier or lender. It can either be a time frame for bill payment or a specific dollar amount. You have the flexibility to use only the amount you need. Think of it as an overdraft managed in a separate account or a revolving mortgage. The credit limit is determined based on your business and is typically set between 10% and 50% of your cash flow value.
Line of credit lenders, such as Spotcap, generally prefers to fund individuals with experience, even if they have encountered previous business failures. Learning from past mistakes is valued in their assessment process.
Equity crowdfunding
Equity crowdfunding is a type of crowdfunding where you offer a share of your business in exchange for funding, instead of rewards. Websites like Seed Invest and Snowball Effect connect business owners with potential investors for equity crowdfunding. Pledgeme offers both equity and reward-based crowdfunding options.
Funding from profits
This involves reinvesting any profits back into your business. It’s important to forecast future expenses and income and assess whether it is financially viable to allocate your profits towards business investments.
Secured loans, Lines of credit, Equity crowdfunding and Funding from profits — upsides and downsides
Three to five years in — settled and/or primed to grow
Good fit for: Venture capitalists, convertible notes, trade finance, secured loans, and funding from profits.
If your loans are secured using personal assets like your house, consider using business assets as security instead. Refer to the 18 months or more section for more information on secured loans and funding through profits.
Venture capitalists and private equity firms
Venture capitalists are particularly interested in rapidly growing businesses that have already achieved commercial success, with an annual turnover of at least $10 million and showing continued growth. Private equity firms, on the other hand, target businesses with an annual turnover of at least $20 million, and require proven business models and strong cash flow.
These investors typically invest significant amounts of capital, take a more involved role in the business, and expect a higher level of control and ownership in exchange.
Convertible notes
Convertible loans are a type of loan that can be converted into equity at a later stage, typically during a subsequent funding round. Investors provide the loan with the expectation that they will receive equity in the company at a cheaper rate compared to later investors.
Trade finance and letters of credit
This is for businesses that engage in international trade only and is common among importers and exporters. Trade finance is a service provided by banks where they guarantee payment to a supplier for their products. The guarantee is often referred to as a letter of credit.
Venture capital, Convertible notes and Trade finance – upsides and downsides
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