An aspiring small business CEO asked me this week to expand on my examples of ideas for funding a business to include using personal and family loans as well as crowd funding. This is the third in a series of columns on funding your small business. This topic is covered in depth in one of SCORE’s projects that was developed with the help of and in partnership with FedEx. This project is called “Startup Roadmap” and outlines every step in starting a business. In this column I will focus on the topics requested by the reader and build on and incorporate content from the Startup Roadmap project. I encourage CEOs to ask their SCORE mentor how to access this free course.
Personal loans
- Description: Credit unions, online lenders, and some banks will lend you money for personal use based on your personal financial information, income and credit score.
- Advantages: Personal loans can be the answer if you need less money than a bank will lend, but more than a microlender can offer. Many personal loans are unsecured, so they don’t require collateral. Unlike business loans, you don’t have to specify what the money will be used for, which can give you greater flexibility if your needs change during the startup process. Loans typically fund quickly—in some cases, within a few days.
- Disadvantages: Personal loans tend to have higher interest rates than business loans. By using a personal loan to start a business, you’re mingling business and personal finances, which can cause tax and legal problems later on.
- When used: Best if you need a small amount of money and are confident you can pay it back quickly.
- Examples: An entrepreneur gets a personal loan for $20,000 to buy inventory to sell online, planning to pay it back with the profits from the sales.
Friends and family
- Description: Getting money from friends and family is a common method of startup financing. You can either get a loan (debt financing) or investment (equity financing).
- Advantages: Your friends or family members are more likely than outside investors to trust you, so there are fewer hoops to jump through. You won’t need to complete a loan application or prove your creditworthiness to someone who knows you.
- Disadvantages: If you can’t pay back the loan, if the person doesn’t recoup a profit on their investment, or if the person wants too much say in your business, it can harm your relationship.
- When used: Best for entrepreneurs who are very confident in their relationship and investors or lenders who can afford to lose the money.
- Examples: You need $500,000 to start a restaurant and your uncle, who has run several successful restaurants himself, offers to invest $100,000 in return for 20% ownership in the business.
Equipment financing
- Description: If you need to buy equipment, vehicles or machinery for your startup, you can get an equipment loan to finance the purchase or lease the equipment (similar to buying or leasing a car). An equipment loan generally requires a down payment of 20% of the equipment’s value.
- Advantages: Equipment financing lets you get the equipment you need to launch your business without a major cash outlay, so you can conserve capital for your other expenses. Because an equipment loan is collateralized by the equipment itself, the interest rates are lower than many other types of startup financing. Fixed monthly payments make it easy to budget.
- Disadvantages: This money can only be used for equipment. If you don’t make your payments, the lender will repossess your essential business equipment.
- When used: Loans are best for equipment that has a long life. For equipment that quickly becomes outdated, leasing is usually a better option.
- Examples: A startup entrepreneur who needs an expensive pizza oven and commercial dishwasher uses an equipment loan to finance the purchase.
Crowdfunding
- Description: Crowdfunding is a type of equity financing done through crowdfunding websites, where small business owners post their ideas and solicit capital from individuals. There are two types of crowdfunding. In donation or purchase-based crowdfunding, individuals donate money to a company or small business owner in exchange for receiving products, perks or rewards. In investment crowdfunding, businesses sell equity stakes in their companies in exchange for infusions of capital from individuals. Investment crowdfunding is regulated by the federal government, which requires investors to be accredited investors; your state may have additional requirements to meet. Donation-based crowdfunding is preferable for most startups because it is simpler to administer.
- Advantages: Crowdfunding lets you get in front of potential investors and get financing very quickly. Obtaining financing through crowdfunding also serves as market validation of your ideas, which can help you get other types of financing down the road.
- Disadvantages: “Selling” your idea to the crowd takes a lot of time, energy and commitment. Many projects don’t get funding, and some sites don’t give you any of the funds you raised unless you fully meet your funding goals. Investment crowdfunding requires complying with lots of regulations and giving up equity to investors. Crowdfunding sites may charge fees for use.
- When used: Best for new inventions, tech products, or niche products that inspire excitement and passion among the target market
- Examples: A startup business owner with a prototype for a new type of video gaming accessory raises $15,000 through crowdfunding to manufacture the first 5,000 units.
Dean Swanson is a volunteer Certified SCORE Mentor and former SCORE chapter chairman, district director and regional vice president for the North West Region.
