One of the most critical skills any business owner should master is that of financing the venture. If you are starting out with a new business, this skill is even more important. Whether you plan to fund the new business with your own funds or you plan to ask family or outside investors for money, you need to know what are the financing alternatives and how the law affects your strategy for sourcing capital.
Today, unlike any time in recent memory, the traditional sources of financing one’s business are becoming increasingly difficult to reach. For many startup owners it is no longer feasible to refinance their house to tap equity and banks have ever tougher loan underwriting standards that eliminate them as sources of capital. Even if the business owner is able to access home equity or obtain a commercial loan, these sources of capital may not be sufficient or may offer terms that are unattractive. Accordingly, the business owner must understand all available sources of capital and be comfortable using one or many sources at a given time.
Bootstrapping and Family
A basic component of your capital sourcing strategy is “bootstrapping.” Bootstrapping usually means using personal savings or income from a full-time job as well as revenue earned by the business. Bootstrapping may also include obtaining seed capital from friends and family. If your business is not in need of significant capital, then bootstrapping might be enough. On the other hand, if you need significant capital for your business, bootstrap financing can serve as a bridge until you obtain larger amounts of financing by other means.
The advantages to using bootstrap financing are many. First, not only will you avoid having to bring in outside investors who may require you to dilute your ownership interest significantly in exchange for financing, but you will obtain financing that is somewhat inexpensive and quick. For example, you will likely have an easier time convincing friends and family to invest in your startup than you would third party investors and the funds would therefore be more readily available in a shorter amount of time. Finally, friends and family may exert less control and influence over your business than would an outside investor.
One of the main disadvantages to bootstrapping is that you may have to use your own personal net worth. Also, you may not be able to raise enough capital in a timely fashion. This in turn may affect how successful your business can be because you may not be able to reach critical points (e.g. time to market) that are vital to your business not only surviving but thriving. Another downside to bootstrapping is that you will not have access to the resources that outside investors might bring with them. Such resources include mentoring and professional contacts that friends and family may not be able to provide. From a legal perspective, soliciting and selling investments in your business to friends or family may run afoul of securities laws so the advice of a qualified attorney is important. Despite these disadvantages, bootstrapping may give you your best chance to start and grow your business depending on your circumstances.
If you have done some research into sources of startup funding you have probably heard of “Angel” investors. These investors are individuals with high net worth and/or income. They are usually successful businesspeople, professionals or from wealthy families. Angels can often contribute to your business valuable connections and resources beyond their investment. Finding Angel investors can be tricky because these individuals do not advertise the fact that they are Angels. Even though there are Angel investing networks and groups that can be found without too much difficulty, attorneys, accountants and similar professionals can provide a valuable personal connection to key Angel investor contacts. You should never make a general solicitation for Angel, or any other, investors without first consulting an attorney because such solicitations can violate securities laws.
Angel investors are looking for high returns on their investments as quickly as possible. Because of this Angels generally will not be interested in businesses that provide a lower return on investment (such as restaurants, car repair shops, etc.). Because Angels are looking for high returns they will typically consider high risk investments so long as the company meets their rigorous standards for such things as business model, management team and intellectual property portfolio.
Angels are preferred over friends and family because they tend to provide greater amounts of capital without as much concern over securities laws requirements. An advantage of Angels over venture capital funds (which I’ll discuss in a later post) is that the Angels are willing to take on more risk by investing earlier in a startup’s lifecycle and can act more quickly. But if your business is at a point where it needs a greater infusion of capital than Angels can contribute, you would need to consider venture capital sources. So one can think of the Angel investor as a source of capital that slots between the bootstrapping phase and venture capital fund phase of your startup’s growth path.
As you can see there are alternatives to going to your bank and asking for a loan to finance your business. In the next post I will discuss further alternatives like venture capital funds, government grants, and partnering with a corporation. There are of course other funding sources, such as project funding platforms and microfinance. But such sources tend to be very limited or serve a particular niche so I will discuss those at a later time.
This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.
This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation. If you need legal advice, consult a qualified attorney.
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