Startups and small businesses often find themselves in a race to raise finance. According to a recent study, the average small business needs $10,000 of startup capital to get going. At the same time, only 0.05% of founders are able to obtain venture capital.
It's clear that financing and access to working capital are critical for startups. Whether a founder is just starting out or looking to accelerate growth, the expenses for running a successful business are high. Paying just five employees in the US averages out to over $300,000. Business equipment can range anywhere between $10,000 to $125,000, depending on the industry.
However, venture capital and angel investors aren't the only options for founders and business owners. Outside of private equity, there are small business loans, leasing options, and various other ways for startup founders to find funding.
Do I qualify?
What’s needed to obtain funding depends on the kind of financing you’re looking for. However, there are generally a few things most investors or lenders will want to see, including:
- Business incorporation information
- Balance sheets for the last six months to five years
- Current and projected cash flow
- A thorough business plan
Both bank-based and alternative lenders have specific credit score requirements. Banks may also require startup founders to describe how they will use the business loan.
Banks typically do not offer money to startups or small businesses that they deem risky. This is one of the reasons founders may turn to venture capital firms to acquire funding.
Types of financing
To raise capital, founders have several different options, each with its own pros and cons.
Obtaining working capital from a bank is often one of the most challenging methods for startup founders and small business owners, particularly if this is their first business. Business loans and debt capital often come to mind when thinking about bank funding, but founders can also use temporary overdrafts to plug holes in their cash flow until revenue evens out.
Founders typically need a comprehensive business plan and a credit score of about 700 to get a bank loan. Furthermore, they will need to be able to convince the banks that their business is low-risk, although this still does not guarantee approval.
Owners will also need to decide whether they will apply for a secured or unsecured loan. A secured loan provides collateral—such as the applicant's car or house—in case of default.
An asset-based loan is a method of debt financing. Similar to with secured loans, founders put their business equipment, property, or other assets up as collateral.
Asset-based lending is fairly flexible, but it does have its drawbacks. For example, if the property or equipment devalues over time, additional collateral may be needed to reduce risk.
This form of capital raising is ideal for improving cash flow for expansion. In a leasing model, the company provides an asset to lease to another. This can be in the form of equipment, software, or property. The asset continues to belong to the company while producing added value. As a result, the lessor can use the new funds to reinvest in their company.
Mezzanine debt is a type of fundraising that combines equity finance and loans. Founders can also find this form of startup capital through institutional investors.
A Mezzanine lender may provide a secured loan, with the collateral being stocks or warrants. However, since this form of financing is risky for the lender, they will also ask for higher interest rates on the loan.
Private equity and venture capital
In private equity, there is a wide range of potential investors. Angel investors and venture capitalists are both examples of equity financiers. Equity finance is ideal for startup capital once a business is running and looking to grow. In this form of financing, the owner dilutes their ownership of the company with the accredited investors, who become shareholders. At the same time, founders often get access to additional resources apart from financing, for example access to an investor’s network of service providers, which makes this form of fundraising attractive.
Should you get help when raising funds?
Getting access to loans or equity finance isn't easy. In many cases, founders may be overwhelmed with the number of options available. Most owners want to forgo debt, but debt is often easier than fundraising for venture capital.
Businesses and startup founders should seriously consider what their capabilities are and whether they should hire help to boost their chances of success. There are financial services firms for corporate finance or startups that provide capital raising strategies and support. If applying for capital appears daunting, it's good to get a second opinion and guidance on navigating the capital market.
Founders and tech companies looking to fund their business need a clear fundraising strategy. However, having a plan isn't enough. The core of any application is a positive cash flow statement and projections for growth. No matter which forms of financing an owner pursues, they should have a strong grasp on their company's finances and predicted revenue. From debt capital to equity capital, an investor needs to have clear numbers to justify their investment.
About the authorElena Leralta
Working as Foreworth’s Chief Financial Officer, Elena possesses a wealth of knowledge on business management and finance owing to her over 20 years of experience working in the financial sector.More info →
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