Today I want to talk with you about four different ways that you can get the initial capital you need to fund your startup.
When considering how to fund your startup, give careful consideration to your financial situation, business plan, and willingness to give up equity or take on debt. Evaluate each method based on your circumstances and risk tolerance to determine the best approach for your startup.
So let's just jump into it.
Method #1 to Fund Your Startup: Use Your Own Money
This is what I would say most entrepreneurs do.
There's a stat from the Chamber of Commerce that says 75 to 80 percent of businesses are self-funded. I think the actual number is much higher than that. If I had to guess, I'd say it's probably somewhere in the 80 to 90 percent (if not higher) range. There are all sorts of self-funded small businesses that are not being reported because they haven't registered with the Chamber of Commerce. Since it’s likely the official statistic refers to companies that are members of the Chamber of Commerce who have filled out some sort of survey that they gave out, the actual number is apt to be much higher.
Now, there are Pros and Cons to self-funding your business.
Pros:
- You have total control. If you have money and assets to put into a business, you control how you're going to grow that business and the people who are going to work for you.
- You are going to keep all ownership equity in your business. When the business becomes successful, you receive all the rewards without incurring debt.
Cons:
- You may not have the funds to self-fund your business. Continue reading for other means to do that.
- You're basically on an island. If you don't already have a network of people that you can rely on for assistance, guidance, and all these things that are necessary when you're just starting your business, you're going to need to go out and proactively seek those relationships. Find people including mentors, legal counsel, and accountants who can help you to build and grow your business.
There are three types of self-funding that you can use for your business.
Type 1: Your job
This is the most common way that most people start a business. They're working someplace to receive a paycheck, and they're using that income to help fund their business and to work on their business on the side.
The biggest issue that I see is you just need to make sure you're not in any way infringing on your employer. You might have an employment contract or some sort of non-compete that says you can't do something that is going to harm their business. As long as you stay in your lane and your employer stays in their lane and they don't really overlap, then you shouldn't have too many problems. But, if you do have a situation where you're trying to start a competing business, I would first talk to a lawyer before you go that route.
Type 2: Savings
Typically, I would recommend that you have at least six to 12 months of savings in the bank to pay for your normal, ordinary living expenses in addition to the money you're going to need to fund your business. I made another video about exactly what it costs to start a business and how much money you're going to need in the bank to start that business.
Type 3: Spouse or partner support
Another great way to fund a startup is if you have a spouse, significant other, or partner who is willing to support you while you're building the business. They believe in what you're doing and they think it's going to be successful. I've seen a lot of businesses built and grown on the backs of an income from another spouse. The nice thing is you don't have to continue working in a job and you can devote 100 percent of your time to the business. As soon as people start devoting 100 percent of their time to their business, those businesses really start to take off.
Method #2 to Fund Your Startup: Apply to an Incubator
This is an interesting idea, though it's not going to work for a lot of people.
For the right person, the right entrepreneur, and the right startup, to avail yourself of an incubator where you live could be the ticket to really building and growing your business.
The most famous incubator out there is Y Combinator. Y Combinator has produced such companies as Stripe, DoorDash, Coinbase, Instacart, and more. It's one of the more famous incubators out there. It's got a very low acceptance rate – somewhere around one percent of companies that apply to Y Combinator get accepted, and that's pretty common for most incubator companies.
A lot of you are probably wondering, “What is an incubator anyway? How would that help me as I'm starting out my business?”
In basic terms, an incubator is an organization, usually of angel investors, who try to identify talent in businesses and ideas that have a really strong potential to grow on a massive scale. They may give you access to office space, mentorship, networking opportunities, and maybe even business education classes. It's an opportunity to jump in, learn from other people, and intensely focus on your business for a very short period of time – usually around three months.
At the end of those three months, typically, you'll make a pitch to the organizers of your cohort, and they will decide as to whether or not they want to invest in you.
There might be a small fee or no fee to be a part of an incubator program. But, the real price is the fact that, at the end of the program, if they believe in your business, they're going to invest in you and they're going to take equity in your company. So, that's what you need to be aware of.
It's not like thousands of dollars; it's usually tens of thousands of dollars.
They're going generously invest in your idea and continue to build and grow with it, but you need to put the work in upfront to show them that you have what it takes to be a successful company.
Pros:
- It's a great opportunity to learn and to connect with other people.
- It's a great opportunity for substantial funding.
Cons:
- You are going to give up equity in your business.
- The acceptance rate for these programs is very, very low – usually, one to two percent of applicants. They're looking for the best and the brightest, and the best business ideas to potentially want to invest in. Because they're going to be putting a lot of money in you over the course of the program and potentially beyond, they want to make sure they get a return on their investment.
- Access may not be easy for everyone. Y Combinator is in San Francisco. There are a handful of incubators directly in and around Raleigh, North Carolina, where I'm from. There are incubators connected to the universities in the area, too, so chances are that there's going to be at least one incubator where you live. If you're a couple of hours away from a large metropolitan area, find a program that is hybrid online. Options exist. Just Google to see what options are available in your general area. You never know – there might be a really good incubator that's right for you and what you're doing with your business.
Method #3 to Fund Your Startup: Seek Private Investment
You need to be careful with this one. It is the right idea for some people. Personally, this was not something that was ever going to work for me…uh…for a variety of reasons.
For some people, you can go out and find an investor. What does that mean?
Basically, you're looking for someone – could be friends, could be family, could be some stranger you met on the street – anyone who believes in your idea and says, “You know what? I'm willing to give you five thousand…ten thousand dollars… or more…to invest in your idea and what you're trying to do with your business.”
If you have somebody like that that you know is willing to write you a check and say, “Hey, go for it! Here's some money. Pay me back when you can” or “I want a stake in your business,” great! That is an option for you. It's not an option for everybody. But, if that's something that sounds appealing, and you are an extrovert who's willing to go out and talk with people and convince people that they need to invest in what you're doing, that is a great option for you.
Even if this is an option for you, you're likely going to need some savings to at least see you through the first couple of months. It might take some time to find investors for your business. Also, chances are you're going to need a really solid business plan so that you can sell your idea to people – know what you're doing, who your customers are going to be, how you plan on generating revenue and growing your business, and all the things like that.
If you think about the show Shark Tank, this is what they do. These people come on Shark Tank and pitch to the Sharks to convince them to invest in their business. Now, that's at a much higher scale in that they're taking significant equity in the business, typically. But, it's the same general idea. You're probably going to people more familiar to you, and you're asking them if they can invest in your business. It's apt to just be on a smaller scale.
Again, you're likely going to be giving away equity in your business. You may also need to cover some startup legal expenses to draft documents that codify a percentage of the equity in your business you are offering to these investors, so you have to know what your business is worth. Is your business worth a hundred thousand dollars? Two hundred thousand dollars? Or, I should say, what is your business idea worth? And, that's kind of up in the air…who knows what that is?
If somebody's willing to give you ten thousand dollars, and you think your business is worth a hundred thousand dollars, then they're getting a ten percent equity stake in your business. Alternatively, these people could be giving you a loan, and they could ask you to pay them back with either some interest or no interest. You know, sometimes parents are willing to help out like that. In sum, there are various options for private investment, and it's something you may want to look into.
Pros:
- You will have a solid and thoughtful business plan. You will have invested considerable time and effort fleshing out your ideas for a convincing pitch.
- It may be possible to acquire a low-interest or no-interest loan.
Cons:
- Initial costs will be covered by you. You will be on your own as you seek investors and incur startup legal expenses.
- You're likely going to be giving away equity in your business. Before agreeing to terms, determine your worth, which may not be easy if it’s based on an intangible asset.
Method #4 to Fund Your Startup: Debt Financing
This is my least favorable option.
Here, you are using a credit card, a small business loan, or some other type of debt instrument to fund your business. I don't like this option because there's too much risk associated with it. I especially wouldn't mortgage your house on a business unless you have a very strong idea that your business is going somewhere. But for most people – don't you dare.
Listen to what I said: DO NOT mortgage your house.
I'm just going to go ahead and say that I think that is a stupid idea. Don't do it. Do. Not. Do. It.
Credit cards are bad enough. The only time that I would say this could be a potentially good idea would be if you've already validated the business idea. Meaning, you've gone to the marketplace and you've told them what you're selling. You've got a viable product and people are willing to invest in you. You know that you've got a good sales funnel that is driving sales to your business.
At that point, you could spend a small amount of money on some Facebook ads. If you're getting at least a 2:1 or 3:1 return on your investment from those ads, then it's possible that you could have a real winner there.
At that point, I would recommend “bootstrapping.” For example, if you went out and spent $500 on Facebook ads and you got $1000 back, take that $1000 and put it back into Facebook ads to see if you can make $2000. If you can do that, continue to scale until you don't feel comfortable scaling anymore. That would be the best option.
Alternatively, if you've already proven several times over that if you put $1000 into Facebook ads and you know within 30 days you're getting $2000-$3000 back, then you might want to use a credit card to fund that. But, I would be very careful there because you can lose your shirt on Facebook ads (or any type of ads, really) very, very fast. Ads are there for a reason. If you're not making money off the ads, then you need to cut them off.
Pros:
- For a tried and proven revenue-generating expense, controlled debt can be a useful tool. Start small and test for return on investment before making larger purchases.
Cons:
- There is too much risk involved. You can be saddled with debt that suffocates your business (or even your personal life, heaven forbid) before your idea even gets off the ground.
Bonus Option to Fund Your Startup: Pre-Sell Your Products
Last, but never least, and great for people who are developing technology or software solutions, this is probably one of the stronger ways to develop a business.
The idea here is to create a beta model of what it is you're going to be doing for your business. Go to potential customers who might be willing to invest in your business and what it is that you're selling.
Ask them, “Would you be willing to pay me X amount of money upfront? I will give you lifetime access to the product.” Or, “I'll give you a super deep discount off the monthly rate for the product if you invest in the business now.”
The actual version of the product may not be available for 3, 6, or 12 months. During that time, beta users should agree to provide feedback on the product that contributes to its final iteration. This could be a really good option for people who are in the right business space.
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