Last month, we detailed the entity types you may select for your new business venture. Now, we turn our attention to financing. Once you have selected your entity type, officially organized your new entity, and started gaining customers, how are you going to fund your new venture?
There are two primary categories of funding: through debt, and through equity. In order to pursue the option that is best for your business, it is important to carefully consider the pros and cons of each.
Financing through Equity
Equity financing involves selling an investor a share of your business in exchange for money, connections, or industry knowledge. The two primary types of equity financing are angel investors and venture capital firms.
In order to select the option that is best for your particular business goals, do your homework: There is no easy way to score financing, and seeking the support of an angel investor or venture capital firm is not a get-rich-quick scheme. There are strings attached in both options, so carefully consider whether – and how – you want to cede control of your day-to-day business operations to investors.
In particular, there are three considerations you should weigh when deciding to finance your business by offering equity to an investor:
- What is the investor’s industry? In other words, what are the types of companies in which this investor typically invests?
- Based on their investment portfolios, how much cash are these investors likely to give you?
- What investment strategies will the investors employ for companies like yours?
Carefully considering the answers to these questions will help you ensure that you are choosing a partner who is suited to help your business grow and thrive.
If you have ever seen the hit show Shark Tank, you are likely familiar with how angel investors work. However, contrary to what popular media may suggest, this financing scheme is rare and patently unsuitable for many businesses.
In short, an angel investor is a wealthy individual, entity, or network that supports new businesses by investing cash, providing connections with other investors or experts in the industry, or by sharing technical knowledge. As such, angels provide value beyond the initial financing.
However, it is a two-way street: In exchange for their investment, angels will seek a share in your business. In negotiating an amount with your investor, be wary of offering too much control in exchange for too small an investment. While it may be tempting to accept a large amount of cash upfront, giving up a large share of your fledgling business means losing control – something a new business owner may want to keep.
People tend to confuse and conflate angels and venture capital, but in reality, the two financing schemes are distinct: While angels will invest in young companies, venture capital firms are typically hesitant to give cash to new ventures or lifestyle companies without immediate growth potential.
As with angel investors, venture capital funds will seek a share in your business in exchange for their investment of cash, industry knowledge, and network connections. In many cases, the firm will place someone on your board and will demand preferred stock. For this reason, many smaller companies or single-member LLCs are generally not attractive to venture capital firms.
Financing through Debt
Debt may sound like a dreaded four-letter word, but it is a legitimate and viable way to fund a new business – so long as you have a solid, short-term payoff plan. Funding a business through debt involves seeking loans, lines of credit, or convertible debt to use as seed money. For a lifestyle business or a founder who opts not to pursue outside funding, debt financing can prove a quick way to get some cash upfront.
There are several types of loans available to businesses, from simple business bank loans to seeking a loan from a colleague or family member. Some founders use low-interest loans from the Small Business Administration (SBA Loans) to fund their new entities. Also, founders who need just a small amount of startup capital can take out a very small loan – an option that is not available with VC funding, which generally occurs on a much larger scale. If you would like to learn more about how to apply for an SBA loan, check out the SBA website.
Considerations in Financing Your Entity:
- What type of entity have you set up? Remember, if you are an LLC, you are unlikely to attract angel investors or VC funds.
- How do you plan to pay your employees? If you are funding your enterprise through equity, consider that this will affect the way you compensate your co-founders and employees. Conversely, if you are funding through debt or you are bootstrapping your entity, you will have more leeway in determining how to use your capital.
- How do you plan to use the funding? Are you more interested in quick cash to purchase inventory? Or, are you diving into unfamiliar territory and would benefit from the industry knowledge and connections an angel investor or VC firm would offer you?
- How much control do you want to keep? Many founders are protective of their new businesses. Are you setting up a family business that you want to run and control yourself? Or, are you looking to quickly scale and eventually exit?
Choosing the Option that is Right for Your Business
No matter which option you pursue, remember that there is no quick solution when it comes to building a successful business. Do your homework, understand the territory, and be honest about your growth goals. At Wilson Ratledge, we assist our clients in pursuing the financing scheme that is best for their business goals. Contact one of our experienced North Carolina startup attorneys today at 919-787-7711 or via our contact form below.