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How to overcome the funding gap as a first-time business owner

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Thousands of people decide to start their own small business every year. They may have an excellent business plan and tons of enthusiasm but they all have one thing in common: they need funds to make their vision become reality.

In our current economic climate this is quite a daunting task, not every start-up qualifies for a traditional bank loan so they need to be aware of all the options out there. This short guide is designed to give you just that, an overview of how you can access the funds to get things off the ground.

Funding Through Venture Capitalists

This is a common choice for companies which don’t have enough collateral to secure a loan from a bank. A venture capital firm will finance your business with funds they pooled from their clients and, in exchange, you grant them partial ownership. The percentage of ownership is determined by how well you are able to negotiate with them.

Since they have to take the risk of investing in an unknown product and brand, they’ll want to lend their own expertise to increase their chances of getting a high return. You can expect them to want access to financial information and be willing to share decision power.

You can usually get in touch with a venture capital firm though bankers, lawyers, CPA’s or other financial professionals and when you manage to set up a meeting, the first thing they’ll want to see is your business plan. Make sure you also prepare a compelling presentation if you want to get them to take you seriously.

Angel Investors

Many people believe that venture capitalists and angel investors are one and the same but that’s not really the case. VCs usually work through their companies so even if you manage to convince one to take you into consideration, they still have to get their company on board. An angel investor, by contrast, tends to invest their own money and can provide more favorable terms.

These are typically wealthy individuals who dedicate about 10% of their investor’s portfolio to high risk start-ups in the hope that they’ll get a higher rate of return.

The term originated in Broadway theater, where affluent people would give money to propel a production.

Small Business Bank Loans

This strategy is already well-known: A bank will provide you with finances to run your business and you have to repay it over a certain period of years. Unfortunately, this is quite hard to do in your first years, since banks give loans to companies that have a track record of generating profit and substantial assets. There are also financial institutions that specialize in small business loans like Thinking Capital.

When you’re ready to apply for a loan, you need to consider what type of business loan is the most suitable for you, more specifically what terms you’re most comfortable with.

For example, you can take an unsecured loan, meaning you don’t have to provide any collateral. But this means that the lenders are taking a higher risk so you need to have a good personal and business credit history.

A secured loan, on the other hand, entails you put up some sort of collateral against the loan, and if you repay the amount owed in due time, the assets you provided as collateral will be released. But if you default on your payments, this gives the bank the right to sell the assets to the highest bidder in order to recover their losses.

One advantage is that secured loans don’t require you to have a perfect credit score and the interest rates tend to be lower.

CDFIs or Community Development Finance Institutions

These are non-profit financial institutions aimed at increasing the economic prosperity of low-wealth or underserved communities through investing capital in small businesses. Compared to banks, they tend to be more lenient regarding credit scores and give more favorable loan terms.

Since they deal mostly with low-income areas, they are more understanding towards the inability to provide assets as collateral and poor credit score caused by job loss or medical bills. Their main goal is to generate jobs, so if you have a viable business plan and can prove that you can help the community grow economically, you have fairly good chances of securing a loan.

Strategic Partner Financing

This tactic involves having another player from your industry provide you with the funds to get your enterprise started in exchange for a favorable future collaboration. For example, they might negotiate special access to your products or distribution rights.

This funding alternative presents several benefits. You’ll be linked with a large company from the same sector which already has a vast number of relevant customers, a good sales teams, marketing department and every interest in your success.

Crowdfunding

Platforms like Kickstarter and Indiegogo have become quite popular among entrepreneurs. You’ll have to make sure you read the fine print before committing to one platform. Some will require you to raise the full amount if you are to keep any of the money and you need to watch out for payment processing fees.

The general idea is quite simple: you have an idea for a product, project or service and if you can put together a convincing advertisement campaign, you can launch it on an online crowdfunding platform and people can show their support through small financial contributions.

It all depends on how much “buzz” you can generate but if it works you can get thousands of backers.

Factoring

This financing strategy has become more commonplace in recent years but is more suitable to solving cash-flow problems. You practically get an advance on your invoices. This presupposes you already have customers and it works best if these customers are large commercial or government institutions. The advance provides you with capital to cover your expenses and gives you the means to acquire more business opportunities.

Typically, you will get an advance of up to 80% of the invoice and the rebate is paid at delivery. Then the transaction is settled. Keep in mind that the advance rates will differ depending on the industry.

Image by Gerd Altmann