Module 1: Financial Management
Financing a Start-up
Getting a loan for a start-up is far more complicated, mainly because there is no history to gauge risk by. Projections of what may happen aren’t good enough, and many businesses – some 80% – fail in their first five years. So, you can readily understand why a lender isn’t willing to lend money based on an idea or promise alone.
Equity is the usual way to finance a new business. You may have a day job while building your business or sell off an asset, such as a second house or some real estate to fund your business. The proceeds from the sale are plowed back into building your business.
A similar strategy for financing a start-up is known as sweat equity. Instead of money, you’re putting in time. Rather than buying equipment to automate processes or hire others to do specific work, you do it all yourself to build your business and save money at the same time.
Of course, you can also turn to family and friends. It can be in the form of a gift, investment or loan in exchange for payments with interest. Or you may pay it back in the form of equity (stock or ownership) in your business.
Crowdfunding is another possible route. There have been some highly visible success stories for business owners who had a great idea, knew how to market it on a site like Kickstarter, Start Engine and Fundable, and raised the cash necessary to realize their dream of starting a business.
Personal lines of credit in the form of an individual’s credit cards or a home equity line of credit can also be used in financing a start-up, but you run the risk of not being able to keep up with the payments, especially if the interest rates are high. You may be able to get a business credit card to cover some of the start-up costs. Don’t get a higher limit than you need, and don’t get more than one card. Never use credit cards to prop up a failing business. It will only put you deeper in debt.
If you have a relationship with a bank, they may be willing to offer you a business line of credit to cover gaps in your cash flow, such as when payroll is due and a big client hasn’t paid its bill yet. This carries risk as well, especially if the outstanding invoice remains unpaid. You not only end up with a revenue shortage but increased debt too. Business term loans are another form of credit used to secure a set amount of funds for a specific purchase, such as equipment or a vehicle. Security for the loans is the asset you’re purchasing, so if you can’t keep up with the payments or pay the loan in full at the designated time, the asset is repossessed.