Paging first-time, early-stage entrepreneurs. It’s time to think strategically about how you want to fund your business. How you bring money into your business affects basically every important aspect of your startup experience:
- Ownership of your company
- Power and control within your business
- Who will be willing to give you money, and on what terms
- The money you raise
- Your potential payoff if you sell your company
- Your ability to pay business expenses
- Your ability to pay for your life
Understanding the universe of funding options gives you more flexibility and control over what happens to you and your company. There are still many things that will always be out of your control such as economic forces, systemic bias, and competition, but you’ll be a step ahead if you understand the options available to you and how they can fit together.
5 Methods of Bringing Money Into Your Business
Roughly speaking, there are five main ways entrepreneurs fund their companies. Each has its own upsides and downsides.
Sell Part of Your Business to Investors
This is the most talked-about way to bring in money. You slice your business up into shares that you sell to investors for a certain amount of money. Sometimes, investors give you an amount of money with an agreement that their money will convert into a certain number of shares later (via a SAFE agreement or a convertible note). Regardless of how the legalities are structured, the basic idea is that investors believe the value of your company—and their shares—will grow. Eventually, those shares can ideally be turned into cash at a multiple of their investment.
A major pro of selling equity to raise funds is usually neither the company nor the founders have to pay back investors. Some cons include:
- Giving up some control over your business, often with intense pressure to scale and sell
- Raising investor dollars can become a full-time, often-demoralizing job where you’ll get 99 rejections for each yes
- Difficulty finding investors who will fund you at the idea stage, meaning you have to figure out how to create your first product MVP without investor dollars
- Reticence of investors invest in companies led by CEOs who identify as women and people of color
- The tendency for many service-based companies and companies that have the potential to be very successful but not billion-dollar unicorns to be overlooked by investors
Some investors do play in the middle market and are willing to provide patient capital. They are usually harder to find but do exist!
Take on Debt
Debt can include private loans from friends and family, bank loans, credit cards, and lines of credit. Although debt is seen as less sexy than investment in the startup world, getting a loan means you get to keep ownership and control of your business. However, you do need to pay back debt plus interest. Furthermore, you may have to personally guarantee the debt, meaning the founders might have to pay back loans out of personal assets by means of selling a house or a car.
In addition to having to pay back any debt you take on, some major downsides of debt financing include:
- The difficulty (or impossibility) of getting a loan or line of credit if the lender thinks you don’t have enough business or personal assets or good enough credit;
- Needing to show how the loan will create the ability to repay the loan with interest (you likely won’t get loan financing without this)
- The incompatibility of many banks and small businesses or startups (finding a startup or small business-focused bank or credit card provider is key)
Founders should think about if makes sense to combine debt financing with investor financing. You can start with debt and then add investor funds or start with investor funds and then add debt, but it’s hard or impossible to go down the investor path and then switch to debt only. Investors are unlikely to want to just be paid back with interest like a lender would because they typically seek the upside potential associated with your company growing in value.
Bring in (Enough) Revenue
This one is self-explanatory. If you can sell goods or services that bring in more money than those goods or services cost to create, you have profit that you can re-invest into the business. If you can bring in enough sales revenue, you can keep control over your business and not incur debt. For many types of startups, however, it’s not possible in the early years to bring in enough money to cover salaries, the cost of producing and distributing products, and other business expenses without bringing in other sources of funds.
Founders often work toward supplementing revenue with grants and prizes, but those sources of funding are time-consuming and uncertain.
Although having healthy revenue is a fantastic achievement, growing only as fast as profits allow means you might not have enough revenue to grow as fast as you’d like. At that point, you might decide to take on debt capital or investor financing.
Leverage your day job or other personal money
Keeping your day job is a classic way to start a business while still paying for your life. Some founders also invest personal savings into their startups if they’re available. Keeping your day job is usually a smart call as you take the first steps into setting up a new and risky business venture, especially one that won’t generate revenue for some time.
However, there comes a point at which the time constraint—not to mention the physical and mental health constraints—makes it too difficult to successfully work a full-time job and build a new company. Ideally, there would be an obvious point at which you would jump from one to the other. That’s rarely the case, though. More often, founders supplement with contract work related to their existing expertise while building their startup or entrepreneurs go all in for little or no pay if privileged with the support network to do so.
Besides capacity constraints, keeping a day job can also become a source of conflict between co-founders if one has taken the leap and others have not, especially without an equity adjustment amongst co-founders. Additionally, it’s a good idea to think about if intellectual property issues might arise particularly if you are a full-time employee creating a business in a field related to your job. Talk to an employment lawyer if this could be you.
Work for 'Free' or Find Free Services
This final category is probably the most frequently used and can be the most taken for granted—the ability to be fully focused on your business as an unpaid founder because of financial privilege. Working for free isn’t free; it comes with an opportunity cost (giving up the ability to make money in another way) and relies on you being able to support yourself with existing wealth or a supportive breadwinner. A change in circumstances such as a spouse losing a job or a large emergency expenditure can require an unpaid founder to suddenly need outside work, so having a backup source of funding is critical.
You also might be able to find free assistance if you have the privilege of access to a highly educated and/or experienced social network. For example, you might have a lawyer friend from college who is willing to help you out or a CFO neighbor who will sit down with you to work on your financial projections. You’ll still want to plan for a way to pay your service providers as it’s usually hard to find longer-term, dependable expertise for free.
Founders can find free support services such as business incubators and accelerators, although many accelerators also take equity or charge a fee. You can also sometimes can also find service providers willing to trade up-front work at no charge in exchange for equity in the company.
Weaving it All Together
Your funding mix is likely going to look more like a patchwork quilt than a straight line, and that’s okay. Remember that all these funding mechanisms can be used together, and don’t forget to build in plans for a sustainable wage for yourself and your co-founders.
Be thoughtful about how and when to use each way of bringing money into your business, and be mindful of the pros and cons. There’s no perfect balance. There’s just the next right step for you and your company.
Lastly, don’t be afraid to ask for help! The universe of business financing isn’t something most of us learned in school. There are plenty of resources online and in the local startup ecosystem to help you figure out a strategic plan. Use them well and often.