It takes money to make money! We’ve all heard that adage yet when you need capital to grow your business, how can you secure it? We’ll take a look at different options and requirements for entrepreneurs including bank loans, nontraditional funding sources, venture capital and angel investors.
Show me the money! As an entrepreneur, there will come a time when you need capital to keep your operations humming. In many cases, this means that you will need to take on a debt position to infuse cash into your business as a cashflow stop gap to grow or fill large orders.
This month, our conversation centers on ways to raise capital for your business enterprise. There are several options which include bank loans, nontraditional funding sources, venture capital and angel investors.
Bank Loans
This is by far the most popular method of securing access to cash for businesses. They come in different forms such as:
- Installment Loans – these loans have a predetermined time period to repay the loan, the monthly payment is fixed and so is the interest rate.
- Lines of Credit – a LOC is revolving debt like a credit card. You can withdraw money up to your limit and make monthly payments. LOCs have a variable interest rate; so it can increase or decrease with changes in the Fed Rate or other factors, and most LOCs carry an annual fee.
Bank loans and LOCs may require collateral and/or a signature guarantee. Loan terms can differ based on the amount of debt or credit line, cashflow, profit and losses, balance sheets, tax returns, and credit for your business (i.e., Dun & Bradstreet) or your personal credit score and tax return if you are required to signature guarantee.
That said, if you wish to apply for a line of credit, do so when you don’t need the money! That’s right. Most companies apply for a line of credit when they really need it (e.g., cashflow is tight, sales are slow, etc.). The best time to apply is when your business is rocking and performing at its best. You will most likely get a larger line of credit and more favorable loan terms.
Remember that the SBA (Small Business Association) works with financial institutions to extend loans and credit to small businesses. The interest rates can be lower than traditional bank loans and the underwriting and approval processes can be less arduous.
Nontraditional Funding Sources
Sometimes, and for various reasons, companies can’t go the traditional route to raise capital. So, there are other options to consider.
- Factoring
Factoring is a method of securing an injection of cash by selling invoices or account receivables to a “factor” that will in turn collect the receivables from the customer. The factor will pay the business 70 percent-85 percent of the invoiced or collected amount. This is commonly used to collect cash sooner on long-term invoice agreements.
Factoring is used to raise cash more quickly than the banking route or traditional methods. The two most popular factoring options are recourse and non- recourse.- Recourse factoring requires that the business pay the invoice if the factor can’t collect from the customer. This is the most common option.
- Non-recourse is different in that the factor assumes the risk of non- payment of the invoice, not the business.
- Crowdfunding
Crowdfunding is done by allowing individuals to invest in your company. This is a quick way to raise money from a huge amount of people via the internet. In 2015, over $34 billion was raised around the globe using this funding option. - Peer to Peer (P2P)
P2P funding is a bankless way of lending money to each other. There are online platforms that manage the process of matching lenders to businesses.
Sometimes, the platform allocates the money to companies without input from the lender. Others allow that lender to choose who receives loans. Funding is quick and can happen in as little as three business days. Potential borrowers must authorize a credit check, verify employment and income, and provide personal identification.
Venture Capital
Venture capital (VC) is a source of funding mainly for start-ups or companies with high growth potential over the short- or long-term. The venture capital firm will advance funds in two ways…
- Debt Position – some VCs will take a debt position, which is like a bank loan, and they make money on the interest charged.
- Equity Position – this option involves the VC taking an ownership position in the company by buying company shares. This often requires that the VC has a seat on the board of directors and/or a major management role in the company.
Some VCs have an “in and out” approach which means that they want to be out of their debt or equity position within a certain amount of time. Their model is to make money and use the same money (plus gains) to invest in the next great idea. They like to keep their money moving. On the other hand, some are long-term investors if they see the potential for substantial long-term growth.
VCs are formed by individuals, investment management firms or financial institutions and often specialize in a particular sector or industry. They often use their network and affiliations to help the business succeed.
Angel Investors
Angel Investors (AI) are typically individuals who invest in start-up or infant companies in exchange for stock or ownership. Following are a few characteristics…
- They are wealthy individuals
- Will use their connections and network to grow profits
- Look for a target ROI of 20 percent
- Will take 25 percent or less ownership or stock
- The investment is typically a onetime injection vs. ongoing
- The goal is to be “in and out” in a predetermined timeframe
- The AI gets paid when they cashout the stock or sell their ownership in the business
Angel investors can be less structured when determining whether to invest in businesses. They may ask for less information than required by traditional lenders.
If you are in the market for funding, be sure to methodically research each option before choosing the best source of funding for you and your company. Don’t take this decision lightly. It can have a lasting impact on your ability to grow and succeed. Last, at the first sign of anticipating the need for additional capital, take action. The sooner, the better. You never want to put yourself in a position of no return. Keep as much leverage as you can during your negotiations.
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