Businesses exist to earn money, but many have to spend quite a lot to start earning even a little before they eventually move toward profitability. However, that money doesn’t just appear out of nowhere.
Someone has to spend it and bet on that business surviving long enough to become profitable, and that is where most start up business funding ventures come in. Most business owners do not completely ‘own’ their business either, at least at the start, and that has a lot to do with how that business is funded.
Raising Capital
Businesses need money to set things up, from buying materials to making a product to sell in the first place. Before the money is raised, they need a plan to get things started because, more often than not, someone starting a business won’t have much cash to spend. They need some startup capital to set up first.
The costs are often projected and calculated well before any investor is approached for startup capital. Any business owner or entrepreneur needs a solid plan with risk assessment, growth, averting current and future risks, a plan to break even, profitability, and much more.
You can have the best business idea, but unless you have a business plan–or partner with someone who can plan it for your business–investors would not want to inject their money into your project. If you have an idea for a prototype and need money to make it, you won’t be funded unless you have a plan to monetize your idea. The business plan is often more important than the idea itself because there are usually very, very few people who have ideas big enough that investors can afford them to be loss leaders for a while.
Seed Capital
Sometimes, investors are people you know and, more importantly, people who have just enough money to get you started rather than millions of dollars. A few hundred thousand is more than enough if a business does not require too much innovation in terms of building a product or when it can simply start off small and grow over time.
It’s important to know that seed capital is very different from venture capital because seed capital is much lower in amount and is less transformative. While they are certainly interchangeable in some ways, one easy way to differentiate them is this: venture capital is used for innovative startups, whereas seed funding is for regular businesses.
Funding Options for Business Owners
There are several types of start up business funding options available for aspiring businesspersons,, each with its own characteristics and requirements. The choice of funding depends on factors such as the stage of your business, your industry, your growth plans, and your willingness to give up equity or take on debt. Some startups might be willing to rack up millions in debt, whereas others might prefer to break even in a year or two.
Bootstrapping and Using Your Finances
A business owner who already has a job and is slowly growing their business bit by bit until they can afford to focus on it full-time follows the bootstrapping method. Using their job, they raise personal funds or even have the capital available. This simply means they are self-funding the business.
Seeking Seed Funding
As mentioned above, seed capital is typically raised through friends, family, and acquaintances. Of course, this means you most likely won’t be able to raise too much, and depending on the type of idea someone has, they would need to ensure they have their planning air-tight before actually seeking or spending any of those funds. Even if the agreement is informal–which these funding rounds usually are–there is still a fiduciary duty owed to investors by the owner in paying back their dividends.
Angel Rounds and Entrepreneurship
Most angel investors are very smart, very well-learned people who have plenty of information and knowledge of the industry they’re working in. Angel investors typically scrutinize a business and are on the hunt for startups with great ideas or even great potential. Uber, for example, was started with angel investors, and it only recently began turning a profit.
Some angel investors will also focus on the tech industry as it is a high-risk, high-rewards industry. They will have tens or even hundreds of businesses they’ve invested in, and even one working for them can net them a healthy profit. They can even provide mentorship in some cases.
Venture Capital and the Business of Investing
If you’ve heard of Silicon Valley, you’ve probably heard of Venture Capitalist (VC) firms. These firms typically invest money into a promising startup that has the potential for growth in exchange for equity. They might sound like angel investors in some cases, but there are significant differences.
For one, VC firms typically look for investments that have the potential for return. A VC firm will invest in a business for a few years and strive to make it grow to the point that they can potentially sell their shares for a profit. Any expert capital group will want to invest in a business that can grow and increase in value over being a cashflow-positive business, so they can let it be a loss leader investment if it means a higher return when they sell their shares.Of course, that can vary by VCs and businesses, but VCs typically make money this way.
Taking on Debt for a Business
One very common method to find cash is to use debt to fund your business yourself, called debt financing. This includes traditional bank loans, business lines of credit, and other forms of debt where you borrow money and repay it over time with interest. Debt financing doesn’t involve giving up equity but requires regular repayments, almost similar to dividends–almost.
The problem here is that it often depends on the current debt and risk the person is taking on, and this is limited to regular businesses that can turn a profit quickly after getting enough clients and making enough sales. If you are someone who a lender considers a high-risk individual, you might get a higher interest rate, and effectively pay much more over time.
How Investors Find a Return
Of course, the money provided to a business isn’t all free. It has to be paid back at some point, and there is more than one way to make that happen.
Equities and Shares
Equity investment is one of the most common ways startup investors seek a return. When investors buy equity, such as common stock or preferred stock, in a startup, they essentially own a portion or percentage of the company. If the startup succeeds and its valuation increases, the value of the investor’s equity stake also increases. Investors can realize a return by selling their equity stake at a higher valuation through secondary sales or when the company goes public.
VCs are a great example of equity investment as they often rely on selling their stake after a growth period that provides an acceptable return. This can also be combined with exit strategy returns. Larger companies acquire some startups as part of their growth strategy, and they need to give their investors some return.
Similarly, investors can ‘exit’ through an acquisition by selling their shares, giving them to the new buyer or back to the business owner, depending on how the deal goes through.
Dividends & Repayments
Dividends are more commonly associated with established, profit-generating companies because you need to make money to be able to distribute it. Companies distribute profits to their investors in the form of dividends. This is less common in early-stage startups, as they typically reinvest their earnings to fuel growth. However, in some cases, startups with a steady stream of revenue may pay dividends to their investors to provide a return on their investment earlier than usual.
Initial Public Offerings (IPOs)
Going public is the point of an IPO, but from a business perspective, it means that their shares get listed on the stock exchange, allowing the company to sell their shares to the public. As more people buy the stock, the price goes up, and investors can get a return by selling their shares at a higher price. Some expert capital groups also give a company looking to raise money advice that IPOs are a great way to raise capital without relying on investors, though that is usually for businesses already set up.
Overall, this is about new companies and businesses raising money and investors making a return. That return comes at its own time, and it isn’t always successful either. More companies fail than succeed, but those that do usually make it big.
