Starting a business is an invigorating, fun, scary, inspirational challenge. It also costs money.
When you are starting out, all you've got is yourself. You might have a partner or two. You may have seen other entrepreneurs getting venture capital (VC) funding. If you don't have a groundbreaking product or service, VC funding is likely off the table.
Other startups might be getting angel funding. Even your mom might offer a little something to get you started.
But all those things come with a price: equity. VCs won't rain money on you unless they can get a part of your business in return. The same is true of angels you don't know well.
Your mom might consider it a gift and not want anything in return. But if her gift to you goes beyond the IRS annual exclusion, the gift tax could apply. Your mom could keep her gift under $15,000, or she could pay the tax, or you could give her consideration for her cash. Again, this is equity most of the time.
But what if you want to keep 100% of your business? There are options out there.
What is equity?
Equity is a percentage or share of ownership in your company. It is what VCs, angel investors and other sources of capital require in return for funding or cash.
You may not want to give up control of your business. It's possible that an equity partner or partners – the parties that provide the funds you need – may agree with the way you run your company and the decisions you make. However, if disagreements occur, trouble – from management snafus to lost revenues or worse – may follow. In some cases, disagreements between equity partners escalate and the entrepreneur is pushed out of the business. It's rare, but it happens.
Funding for brand-new startups
Funding a new startup without forgoing equity requires perseverance and creativity. For new ventures, many forms of funding, including bank loans, won't work, because many lenders require you to submit proof of an operating history (e.g., one to two years or more in business). Instead, try these five options:
1. Bootstrapping
Bootstrapping involves building your business using only the revenues it brings in. It is typically feasible only if you have a startup with low capital expenditures.
2. Using personal credit
Options here include personal unsecured term loans (loans that don't require collateral), secured term loans (loans that require collateral), traditional lines of credit (which provide access to funds on an as-needed basis, up to a credit limit set by the credit issuer) and revolving credit card accounts.
If your FICO score is good (670 or above), you have a higher chance of being approved, plus you may have a lower interest rate. Lenders, including many online lenders, require the business owner to meet a minimum FICO score threshold.
What if you don't have great personal credit? You may need to sign a personal guaranty, which is a legally binding agreement in which you pledge to pay the loan in full if your business defaults. Another option is to offer collateral, or personal assets that will be forfeited if you are unable to repay the loan. You can use your inventory, accounts receivable or a 401(k) as collateral. You can also work with a credit partner and tap into their stocks or 401(k) for collateral.
When using your personal credit to fund a startup, pay your company's bills on time and in full. You never want to borrow beyond what you can pay back, because your personal credit – and assets – are on the line if you pay late.
3. Friends and family
If you don't have personal funds to contribute, family and friends may be willing to loan you money to help you with your venture. If, despite your best efforts, the company never makes a profit and you can't repay them, you may irreparably damage relationships. That's why you must give them a clear picture of the business you are starting and let them know upfront that there is a risk that the business may not succeed.
3. Crowdfunding donations
Crowdfunding, obtaining funds from multiple sources, in this case, on a donation basis, could work. If you pursue this option, here are some quick tips. Your funding pitch will make or break your campaign. Make it as well written, informative and eye-catching as you can. You'll do better by reaching out to bigger investors beforehand. Get them to donate on the first or last days of the campaign. Big donations on the first day get the ball rolling and serve as an impressive reminder to potential donors on the last day.
4. Federal grants
For urban projects, try HUD grants (the Department of Housing and Urban Development). For rural projects, check with the U.S. Department of Agriculture. Make sure to follow the application requirements to the letter.
5. State and local grants
Local governments also provide grants. You can find a list at GrantWatch. You can also try searching online for grants targeting businesses in your state or city.
Entrepreneurs who are veterans can try the Department of Veterans Affairs.
Start earning business credit
Business credit is credit in a business's name. It isn't directly linked to your personal credit, even if the owner is a sole proprietor or the only employee of the business. Your business credit score is largely influenced by whether your business pays its debts on time. An entrepreneur's business and personal credit scores could be very different.
You don't automatically establish business credit. You've got to build it, and this happens over time as you work with vendors and companies to pay your bills on time, establish an employer identification number (EIN) with the IRS, and as you apply for a business credit card (and pay the balance in full and on time monthly, too).
Monitor your business credit, and update data that is incorrect or incomplete. Mistakes happen with business credit reports all the time.
The more quickly you work to build up your business credit score, the better position you are in when trying to raise capital from sources other than your friends, family or via crowdsourcing platforms.
Funding for startups with a more established operating history
Have you been in business for a year or more? Does the company own equipment or have inventory? If so, your venture may qualify for other types of financing, including the following:
1. Loans
There are loans entrepreneurs can get to fund a startup, and some don't come directly or entirely from banks. For example, the U.S. Small Business Administration (SBA) loan program offers small businesses, including startups, the opportunity to obtain funds for a variety of purposes.
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2. Private investors
You may be able to get a loan from a private investor or an alternative lender.
The qualification requirements from alternative lenders may be less stringent than, say, conventional lenders. Private investors and alternative lenders will likely want to see your financials, such as profit and loss statements, balance sheets and income statements. However, be aware that interest rates from alternative lenders can be high. [Looking for a business loan? Check out our reviews and best picks.]
3. Credit lines
A line of credit (LOC), or credit line, is a preset amount of money that a bank agrees to lend to a borrower. As the borrower, you can access funds from the LOC at any time, as long as you don't exceed the preset amount. To be approved for a LOC, you must have good credit, a demonstrated operating history for a certain period of time and good financials.
LOCs are revolving accounts, like credit cards. You can run up a balance on your LOC, pay it off, and then use the available credit again. Often, LOCs are not secured, much like credit cards.
4. Invoice financing
Invoice financing lets you "sell" an invoice to a lender, which advances you a certain amount or percentage of the amount due on it. The remaining balance is held until the invoice has been paid in full.
Fees for invoice financing are typically higher compared to traditional types of financing. Additionally, the amount you end up paying depends on when your client pays the invoice. However, because the invoice itself serves as collateral, you don't need to lay out money to secure the loan. What's more, funds are usually available quickly – sometimes within one day – and the qualifying requirements are not as stringent as with traditional financing options.
5. Equipment financing
When you need money to buy equipment, consider equipment financing. The benefits are that you get fast access to cash, and there is no collateral, other than the equipment that is being purchased.
The drawbacks of this financing option, though, are that interest rates can be higher, and the lender may seize your equipment if you stop making payments on the loan.
Increasing your business's fundability quotient
No matter how you fund a startup in a move to maintain 100% equity, it's important to ensure that your business is run professionally. If or when you do need to apply for financing, these four elements are what lenders will check when they evaluate your application:
- Online presence. Lenders and credit providers will search for your business online – and it's not good if they can't find it. Even if you sell nothing online and your clientele isn't internet savvy, you need a professional-looking website and an email address. You can buy the domain from a web hosting provider.
- Business communications. Business phone and fax numbers must have a 411 listing. Your main business phone number should be toll-free. You also need a business bank account.
- Business licenses. Besides a license from the state you operate your business in, you may need to secure a city or county license.
- Business ID numbers. Visit the IRS website to get a free EIN. You should also get a DUNS number from the Dun & Bradstreet website. It's free, although it takes longer to get than the EIN.
You want to keep 100% of your business, and you can. Funding a startup without losing equity does not have to be challenging if you know where to look.
Additional reporting by Julie Ritzer Ross.