We have gotten our new business in good shape from a planning standpoint over the last few weeks. We know what we do and stand for. We have a plan to sell and market our product. We know what the numbers look like. There are some steps left to do. Formally create the business and get it started. But the one crucial step is to look where we get the money to start it from.
As we talked about last time, you need to plan to get enough money to cover that worst case in the funding that you have from your financial plan. I have also put to you that you need to have a buffer as it is likely that you have missed some things and will need some money beyond that.
You might have enough cash to fund the gap out of your own cash. If so, go forth and make your business happen. But for most people to fund this gap, there are 2 choices: Equity and Debt. Equity is the process of selling a portion of your business to investors. Debt is a loan that needs to be repaid.
Most people look to Debt first. Why is that? With a couple of exceptions, most new businesses do not fit the profile that investors want to buy a part of. The exceptions are Friend and Family, Social Investors and VC backed startups. I will cover Friends and Family later as it is possible that they are a source of Debt as well. Beyond that, you need to have a company that meets a need of the investor. VC backed startups are ones that will get at least a 10x valuation after 3 years (rule of thumb). They are generally going to be product companies that are addressing a state of the art need in a market. Retail or Professional Services generally don’t meet the outcome requirements of these kind of investors. Social Investors look at things in terms of the societal value of the outcome. Their reason for investing will not be purely financial and some kinds of startups might get funding there.
But most people have Debt in their future. I want to be quite clear right now. You are not going to walk into a Bank and get an unsecured loan for a startup business. It is just not going to happen. You may want that, but you can stop right now if that is your plan. What can happen is a secured loan. That means you have to have some form of asset to borrow against. Home Equity, 401K plans or IRAs are very typical assets used in this regard.
But many Businesses will be formed in conjunction with Friends and Family. This means you go to the folks you know and get them to give you money. This can be in the form of either Debt or Equity. But you should set up a formal agreement around this if you want your relationship to survive the business. A business failure that loses the money of the people you care about will cause a huge strain on the relationship. Taking care to have a good business plan and having a formal agreement around the financing will help greatly.
I deliberately avoided Crowdfunding here and I will talk about that and some thoughts about it next week.
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