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Start up Financing: What it is & How to Get It?

August 16, 2022

Start up Financing: What it is & How to Get It?

There’s no shortage of options if you’re looking for money to start a business. Startup financing ranges from news-worthy venture capital rounds to credit cards, angel investors, grants, and small business loans.

All entrepreneurs need to raise capital at some point, whether to get their business up and running or accelerate growth. But every lending choice comes with advantages and disadvantages. Some have long repayment terms and others require you to give partial ownership to investors.

What is Startup Financing?

Startup financing is the capital that’s used to fund a business venture. It’s used for a variety of reasons, such as launching a company, buying real estate, hiring a team, purchasing necessary tools, developing a website, launching an IT product, or growing the business.

Small business financing comes in many forms, but it all falls into two main categories: dilutive and non-dilutive financing. Dilutive financing requires an exchange of equity, or ownership, in the company, while non-dilutive financing allows founders to retain full ownership.

For instance, an investor who gives money to a startup and gets shares in that company is considered dilutive financing. But a loan is non-dilutive because it doesn’t require giving ownership in exchange for capital.

When choosing a financing option, you need to consider whether or not it will dilute your ownership and what kind of repayment plan is in place. Small business grants, for example, don’t have to be repaid. But certain business loans require lenders to start payments as soon as they receive the money.

Startup Financing Options

Entrepreneurs can take advantage of dozens of types of small business and startup financing models, but all these options boil down to three main ways to raise capital: by borrowing capital, issuing equity, or from net earnings.

1. Debt Financing

Companies can take on debt to finance their operations, just like people can take on debt to buy a house or pay for school. This can be done publicly through a debt issue or privately through an institution, such as a bank. Debt issues include credit cards, corporate bonds, mortgages, leases, or notes. Private debt financing mainly involves taking out a loan.

Companies that borrow money are responsible for paying the principal and interest to the lenders. They have to repay the creditors at a chosen point in the future, which could be within weeks or even years.

While interest is typically tax-deductible for companies, failing to repay lenders can result in bankruptcy or default. If this happens, it negatively impacts the borrower’s credit rating and can make it difficult to raise capital in the future. That said, debt financing can be less expensive than net earnings or equity financing.

2. Equity Financing

Equity is the sum of shareholders’ stake in a startup and represents the value of the business if all assets were liquidated and all debt paid off. Business owners can use this equity for financing by selling shares to outside investors in exchange for capital.

The investors become partial owners in the company and obtain voting rights, which allows them to weigh in on business decisions. The most common kind of equity financing comes from investor seed rounds, venture capitalists and private equity firms.

Since all shareholders own equity, they get a slice of future profits. This dilutes the ownership and overall control of the company, but that ownership also means you’re not required to pay back investors’ money.

You have time to build your business without the pressure of monthly payments. If your company goes bankrupt, investors lose out too. Just keep in mind that equity doesn’t come with tax benefits and takes away part of your ownership, so it can be a more expensive form of financing.

3. Net Earnings Financing

The goal of every company is to make a profit. If a startup makes more money than it costs to run the company, it can use its earnings to fund other business activities.

Net earnings financing allows founders to grow a business or fund a new project without issuing equity or taking out debt. They can also use this money to reward investors and shareholders with dividend payments or even buy back shares to regain ownership control.

In an ideal world, a startup would be able to use its revenue to invest in itself. The truth is most companies first need to determine a market need and create a product or service satisfying that client/customer need.

While the net earnings model is the most cost-effective way to finance, it’s usually not accessible to startups until they have a minimum viable product to sell or ready service. So, let’s look at how to get the funding you need to build a customer base, increase revenue, and become a financially independent business.

How to Get Financing for a Startup Business

Some startups need more financial help than others, so take the time to figure out what’s best for your business. If you only need $50,000, don’t take out a $100,000 loan and get stuck with excess interest and payments. Here are a few options for financing:

  1. Business term loan– A sum of cash that small business owners can borrow from banks, online lenders, or financial institutions. These loans come with fixed repayment terms, and 95% have fixed interest rates.
  1. SBA (Small Business Administration) loana S. government-backed loan with low-interest rates and variable funding amounts. In 2020, 30% of SBA microloans were issued to startups. All SBA loans have eligibility requirements, so make sure to check the organization’s website to find the right option for your business.
  1. Business line of credit- A short-term loan that business owners can obtain without fixed repayment terms. It can range from $1,000-$250,000 and be used for rent, machinery, inventory, hiring, or other business expenses. In 2021, the Federal Reserve Bank delivered $44.8 billion in funding to small businesses through more than 61,000 loans.
  1. Business credit card- Similar to a personal credit card, a business card can be used to make everyday purchases for your company. The credit limit is based on your financial history, as well as the company’s financials, so you may have to work your way to a higher limit if you’re just starting out. A major perk of a business card is getting points and rewards for business travel and expenses, which you can reinvest in your company.
  1. Personal loan: A personal loan can be used to finance a business, but it’s based on an individual’s personal credit history and often requires securitization such as an individual’s home. These loans range from $1,000 to $50,000 and are available from banks and credit unions. Keep in mind, a personal loan for business still impacts your personal credit score and savings, so make sure you can make payments on time.

 

About CMR | PolicySmart®

PolicySmart’s risk management consultants provide independent group benefit, retirement and commercial insurance advice by reviewing your current portfolio of policies to improve coverage and reduce cost. By using our proprietary database – The CMR Database® (comprising some 13,000 brokers and specialists globally), we maximize access to the insurance and retirement industry providing greater options that will translate to better coverage and lower cost.

Please email croche@policysmart.com or call 888-873-1982 or 212-447-4300 for more information.  www.policysmart.com

 

 

 

About CMR | PolicySmart®

CMR & Associates’ risk management consultants provide independent group benefits, retirement and insurance advice by reviewing your current plans to improve coverage and reduce cost. Through CMR’s proprietary database – The CMR Database® (comprised of some 13,000 brokers and specialists globally), we maximize access to the insurance and retirement industry for greater options that will translate to better coverage and lower cost.