Entrepreneurial managed companies are constantly on the search for new capital and it is seldom easy to come by. Top entrepreneurs understand that raising money is a way of life.
Experienced entrepreneurs realize that the financing of companies is done in stages and that they have to be flexible in identifying the latest trends in financing. Many first-timers erroneously believe that they can successfully generate sufficient cash flow on a near-term basis, then bootstrap their way to financial success. This does not work in today’s fast-moving business climate, especially in many medium and high-tech areas. This section discusses this fact and other potential problems. The next section offers many solutions for the sourcing of financing.
There Are Several Types of Financing: Debt and Equity
Contrary to the dreams of many startup entrepreneurs, initial financing can be the hardest part of launching their new business. There are many popular misconceptions that an idea, a startup team, and a preliminary business plan will get them in the venture capitalist door. They expect to exit, happily, with the check in hand. They don’t realize that traditional venture capital-venture capital funds that are supported by institutional investors-only finance a fraction of a percent of the new companies started each year. They are not cognizant of the fact that 90 percent plus of startup money comes from private sources and its up to the individual entrepreneur to identify and sell their project to these financing sources. It’s tough, tough work!
The first thing to do is to put together a business plan to use as a fundraising tool (see Business Plans). Second is the actual raising of the financing, or financial marketing. Each alternative to raising money requires a different approach to the business plan. Financing never happens quickly; it is never simple. In fact, it is usually quite painful and exasperating. Entrepreneurs can find themselves chasing down blind alleys if they don’t prepare properly.
For any alternative business venture there are a number of sources of financing and a variety of forms of capital. Some are used to finance seed or startup companies while others are used for expansion. Start-ups are usually limited to the type of financing they can get, like personal savings used as equity or personally secured subordinated debt. It may take a few different attempts at alternative business plans to secure the funding you need. On the other hand, companies with a proven track record have a much larger choice of financing alternatives–such as banks, business loans, venture capital firms and private or public offerings.
What all entrepreneurs soon discover is that there are several factors that they must constantly reckon with, in pursuit of the elusive dollar.
- the dilution of equity ownership,
- potential restrictions on daily operating flexibility, and
- debt-imposed constraints on future growth.
- alternative business loans
These factors are touched on in this section.
Your Two Basic Choices for Financing
For all intents and purposes, the entrepreneur has two basic choices when considering financing: debt or equity, pledging a part of one’s soul or giving away a piece of it. Commonly, one does both.
In simple terms, debt is borrowed money secured in some fashion with some type of asset for collateral. Equity, on the other hand, is contributed capital, usually hard dollars. Debt may be secured by a personal signature only, and equity can also be in the form of a contributed asset.
But most often new businesses require long-term debt or permanent equity capital to support major expansion and anticipated rapid growth. The advantage of borrowing is that it is a relatively simple process to arrange. It does not take a great deal of time and does not dilute equity ownership.The disadvantages are that it is a high-risk strategy as far as company growth is concerned, in that incurring debt subjects the company to a firm obligation, usually including the principals as cosigners. A downturn in business or an increase in interest rates could result in the inability to service debt payments with the consequences being that the co-signers have to personally pay the company’s debt.