No matter what kind of business you own, ideally, your products and customers should provide all the funding that it needs. But, reaching that can be tricky and often takes time. Choosing the right way to fund your business as your customer base and revenue grows is critical. There are a number of different ways to get the funding you need it your company grows. Here are some of the considerations to keep in mind when choosing your funding sources.
Since the goal is to have your customers provide all the funding for your business, why not try that from the beginning. Nationally, as funding markets are "correcting for years of overly exuberant startup funding," or in states like Vermont where startup capital has always been difficult to find, bootstrapping your company can be an attractive option.
With bootstrapping, you create a profitable product from the beginning and then reinvest the early revenue to improve the product, expand your customer base, and grow your profits. The process strongly aligns with the principles of the Lean Startup methodology, which emphasizes continuous validated learning. Bootstrapping requires a strong internal drive, a willingness to build sweat equity, and a lifestyle that gives you the flexibility roll with the inevitable ups and downs of income.
It also requires that you develop and sell a good product quickly. When your only source of cash is revenue from the products you sell, you must have a product that people want to buy from the start. With outside funding, poor product performance can be masked. When funding runs out for these products, they fail in the marketplace.
Without external investors, you continue to own and control your entire company and you can grow and learn at your pace without answering to anyone else.
Crowdfunding has become a popular mechanism for bootstrapping a new product. Platforms like Kickstarter and IndieGoGo allow businesses to offer the public early access to a product, typically for a reduced price. This allows you to test the demand for a product before it is produced and to collect the funds needed to make a product before you deliver it. Crowdfunding allows you to make larger jumps in scale than would otherwise be possible if you had to make the product before you sold it.
Not every business is suited for bootstrapping. Businesses that are very capital intensive will likely need outside funding since it will take a lot of money before they are able to generate revenue. Similarly, businesses that are looking to quickly grow to massive scale (hundreds of thousands of customers and up) can benefit from outside investment to power the rapid development and scale up needed.
Additionally, not every business owner is well suited for bootstrapping. If you benefit from having a strong outside source of motivation and direction, bringing in an outside investor may increase your chances of growing your business successfully.
If bootstrapping isn't the right fit for you or your company, you will need external funding. Choosing the right type is extremely important. Should you take a loan from a bank? Should the business take an investment in exchange for equity? Read below to learn more about options for external financing.
Equity financing is the umbrella term for investments in which the investor takes an ownership stake in the company in exchange for providing funding. There are many different types of investors who do equity investments and each is suited for particular types and/or stages of a business's growth.
Angel investors are typically "wealthy individuals who like to invest their personal funds in startups." They tend to be less formal than venture capitalists, and while they typically take an ownership stake some look for a percentage return on their investment instead. Their informality and generally smaller investment size makes them well suited for early investment rounds before other investors would be interested.
Angel investors are also typically people that you already have a trusting relationship with, which makes networking and relationship building vital to securing this type of funding. Additionally, since angel investors often have entrepreneurial backgrounds, they may be able to provide expertise and access to networks beyond their financial investment. However, as with any investor, it is important that you can work well with an angel investor long term.
Family and friends may also invest in companies in a similar manner. Depending on their background, they might act like an angel investor or they may invest based on their faith in you rather than on a deep understanding of your business. Either way, they are often one of the earliest sources of funding that a company is able to access.
Venture capitalists (VCs) are organizations of investors. Run by professional investors, they use funds raised from partners "partners such as pension funds, endowments, and wealthy individuals." In general, VCs are interested in later stage companies that have already shown potential for long-term growth. VCs also typically look for more control in the company than angel investors do. Their investments will often require seats on the company's board and sometimes even the ability to replace you as CEO the company.
Even more so than angel investors, VCs bring business expertise and access to networks to help companies grow. This, coupled with their ability to make large investments, makes them a powerful partner for companies that are looking to quickly grow to massive scale. In exchange, they look for much greater control over the company. This increased control makes it vital for you, as a business owner, to carefully choose which VCs you take investments from.
Strategic investors are similar to VCs, but are typically corporations making investments instead of funds. For example, when Coca Cola invests in an up and coming beverage company or Budweiser invests in a craft brewer, these are strategic investments. The level of funding can vary greatly depending on the stage of the company. These company's investment styles are similar to VCs and many of the same benefits and drawbacks still apply. They often have deep knowledge and experience in the market and can provide expertise that may be impossible to find anywhere else. In exchange, they are also likely to require high levels of control over the company.
Finally, debt financing is an option for some companies that do not want to give up ownership or control of the company. Typically, debt financing comes in the form of loans from banks, though sometimes angel investors will provide funding with a fixed return. The benefit of debt financing is that you, as the business owner, retain control over your company. However, banks are also often less likely to lend to businesses with significant risks. Thus, if your business has high capital requirements but relies on relatively proven technologies you are more likely to be able to secure debt financing. Keep in mind that debt financing usually gets paid back before any return is given to equity holders. So, a business with a lot of debt will be less attractive to VCs and strategic partners.