Plan Your Funding

We’ve all heard the saying, “It takes money to make money.” And in the case of most startups and small businesses, it’s true. You are going to need some amount of money to start your business. Initial startup costs can range from a couple of hundred dollars for single-person businesses, to hundreds of thousands of dollars for big tech startups and brick and mortar stores.

“Initial startup costs can range from a couple of hundred dollars for single-person businesses, to hundreds of thousands of dollars for big tech startups and brick and mortar stores.” 

In this section of the Legal Checklist for Startups, we’re going to walk through the various methods you can use to fund your business, plus provide some insights into the potential pros and cons of each.

The three main ways to fund a new business are:

1. Self-Funding
2. Loans
3. Outside Investors

Let’s look at each one individually.

SELF-FUNDING

Self-funding is the simplest and cleanest way to fund a new business venture. When self-funding, you don’t have to pay any interest (like you would with a loan) and you don’t have to hand over any control or ownership (like you would with outside investors).

As a self-funding business, you are in the driver’s seat.

The biggest obstacle to self-funding is, obviously, having the available capital. Another issue is that self-funding could limit how quickly you expand, which could lead to missed opportunities.

If you have enough cash on hand to avoid these pitfalls, self-funding is the smoothest path forward.

When it comes to self-funding (and all other forms of funding), it is imperative that you separate your personal and business expenses. We’ll talk more about that in Step 11: Create a Separate Bank Account. Also, it may be helpful to consult with an accountant to determine the best ways to use your own funds.

SMALL BUSINESS LOANS

The second way to fund your business is through a loan.

There are several different types of loans for small businesses. The most well-known is an SBA loan, which stands for Small Business Administration loan.

SBA loans are guaranteed up to a certain point by the federal government. This means that lenders can give them out with good interest rates because they have a high level of confidence that they will be paid back. If the lender can’t get the money back from you, they can get a certain amount back from the government.

One common and very dangerous misconception about SBA loans is that if you are not able to pay it back, you will get off scot-free because the government will cover you. This is not the case, the bank will still come after you. Only after the lender exhausts all collection efforts will the government step in. The banks will get their money, and they will most likely get it from you.

The major downside of SBA loans is that they are very hard to qualify for. You have to have excellent financials, excellent credit, and you might even have to put up collateral (such as your home) as part of the loan.

If you don’t qualify for an SBA loan, there are many different types of private loans to fund your business that are not backed by the government. Since they do not have a government guarantee, they usually have higher interest rates.

The downside of any loan (personal or professional) is that you have to pay it back (with interest). That means that your business will owe monthly, quarterly, or annual payments to the lender. Repayment schedules for small business loans vary. Repayment typically starts one or more years after the start of the loan and can last a few years or a few decades depending on the loan amount.

If you’re unable to pay back a loan, the lender can attempt to collect on the debt that you owe. Collection methods vary from state to state, so consult with a professional in your state and make sure you understand the consequences of delinquent payments. Also, make sure you understand who is liable to make those payments. Depending on your business entity type, your personal assets could be at stake (we’ll talk more about that in the next section).

OUTSIDE INVESTORS

The third way to fund your business is through outside investors. It’s important to make this decision early because if you use outside investors, you should consider forming your business as a subchapter C corporation, also known as a C corp.

There are a lot of factors to think about when considering outside investors.

First, how many investors do you want? With every new investor comes a new chef in the kitchen. For instance, venture capital investors often want a seat on your board of directors, meaning they’ll oversee your job and essential be your boss.

Think long and hard about whether those investment funds are worth giving up control over your business.

The flip side of that argument is that having a sophisticated member of your board of directors could be a great mentorship opportunity for you. It can be a great way to learn from their experiences and to seek guidance for your business.

Also, if you bring on investors, it typically means handing over shares of your business in exchange for capital, making the investors partial owners of your business.

There are also a host of laws and regulations governing outside investments in your business. If you go this route, do your homework and consult with a securities lawyer licensed in your state.

Now that we’ve talked about the three main ways to fund a business, remember that you can do some combination of all three. You can self-fund a portion of your business and make up the remainder through loans and investors.