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How to Finance a Business: 4 Options to Consider
- 04 Aug 2020
In entrepreneurship, the old adage “you must spend money to make money” often rings true.
Once you’ve developed an innovative business idea , identified a market need, and created a value proposition , you need to acquire funding to get your company up and running.
The key to financing a business is keeping expenses as low as possible. You also want to ensure invested money is used to gain insight into how to proceed.
In the online course Entrepreneurship Essentials , taught by Harvard Business School Professor William Sahlman, entrepreneurship is described as the process of "spending money to produce information about future possibilities."
For instance, using funds to rent a beautiful office may be tempting, but leveraging it to run tests, conduct market research, or identify more efficient means of production can help you learn about your product, pivot accordingly, and expand your company’s growth potential.
Here’s a guide for assessing startup costs and expenses, along with four business financing options to consider.
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How Difficult Is It to Fund a Startup Business?
Securing adequate funding for your business can be challenging. However, it’s important to remember that starting your own business is a large investment that should be given an appropriate period of time to succeed.
Often, new businesses need to raise funding quickly and efficiently to properly grow and thrive in their given market, but it can be difficult to adhere to various lending requirements without existing financial information. In spite of these challenges, there are various financial resources that can help you get your business off the ground.
Evaluate Startup Costs and Expenses
Before deciding how to finance your business, determine how much money you anticipate needing for startup costs and regular expenses. Whether you run a brick-and-mortar or online business, consider the following when taking stock of expenses:
- Licenses and permits
- Trademarks, copyrights, or patents for your brand and products
- Business insurance
- Legal or accounting assistance
- Rent and utilities (for brick-and-mortar businesses)
- Equipment required for production
- Website platforms
- Marketing materials (both print and digital)
- Shipping supplies
- Subscriptions to content management systems and sales or marketing platforms
- Market research
As your business scales , you may need to expand your expense list to include:
- Employee salaries
- Rent and utilities for office space
- Travel expenses
- Conferences, conventions, and networking events
These lists aren’t exhaustive—every business’s needs are different—but they provide a starting point for you to brainstorm all possible expenses for your startup. When your list is complete, calculate your total estimated startup cost. This number is the amount of funding you’ll need to invest when starting your company.
Before raising capital, it’s also wise to familiarize yourself with how to read and create a balance sheet, income statement, and statement of cash flows. Financial literacy is a critical skill for entrepreneurs , and being aware of these financial statements will ensure you’re taking the necessary steps to become a responsible business owner.
Now, how do you obtain this necessary capital? Here are four sources of funding for your business’s launch.
Related: 6 Questions to Ask Before Starting a Business
How to Finance a Business
1. self-funding.
If your projected expenses add up to a manageable amount, you may be able to fund the business yourself. This can involve taking money from your personal savings account, dipping into your retirement funds, using credit cards and paying back the debt, or asking for donations from friends and family.
Self-funding comes with the risk of long-term debt or losing personal savings and, potentially, money from loved ones. However, it’s a financing option that allows you to retain full ownership over your business, which is often seen as a downside of raising venture capital from investors.
2. Crowdfunding
If you believe your business can garner a fan base, crowdfunding could be a good option. Crowdfunding platforms, such as Kickstarter, Indiegogo, and Patreon enable entrepreneurs to pitch their products and request financial backing.
If people are intrigued and support your product, they can donate to your company in exchange for a free item, discount code, or acknowledgment once your business is up and running. For this reason, crowdfunding is typically a good fit for business-to-consumer startup companies with physical products, although there are exceptions. Each platform has its own terms and conditions, which you should read before selecting one.
Like self-funding, crowdfunding allows you to maintain full ownership of your company, as long as you’re willing to thank your donors with free or discounted products. A few brands that got their start using crowdfunding are Oculus, PopSockets, and Allbirds.
3. Taking Out a Small Business Loan
Applying for a small business loan is another way to secure necessary startup funds. Before applying to banks and credit unions, prepare a business plan, value proposition, expense report, and financial projections for the next five years. Most banks or credit unions will ask to see some combination of these documents when considering your application.
Be sure to weigh the pros and cons of every bank loan offer you receive. Which gives you the lowest interest rate? What are the terms and conditions?
As Sahlman says in Entrepreneurship Essentials , “The terms of financing have a major impact on the success or failure of a venture.”
Related: What Does It Take to Be a Successful Entrepreneur?
4. Raising Venture Capital from Investors
Another avenue for funding your business is raising venture capital from investors.
“Successful companies are always forming hypotheses and testing all aspects of their business,” Sahlman explains in Entrepreneurship Essentials . “Ventures typically need outside investors to run experiments.”
Before reaching out to investors, prepare a business plan, value proposition, financial projections, and a tight, effective pitch deck.
The process of obtaining venture capital has been likened to dating —investors typically want to get to know you and your business before they commit.
One way to start this process is by asking a mutual connection to introduce you to investors. Your contact can serve as a character reference, if needed.
This process can take a while. If you’re looking for quick, easy money to start your business, raising venture capital may not be the right choice. Investors often want to see how you run your company before deciding to invest. Even after they supply funding, they may bide their time to see what you do with the money before investing more.
“Sensible investors stage their commitment to a company—they give enough money to conduct a value-changing test,” Sahlman says. “They preserve the right to abandon the venture by refusing to invest more money. They also design contracts that give them the right to invest more if the test yields encouraging results.”
There’s one factor that sets this option apart: Investors want to own a large, valuable share of your company in return for their investment. This allows them to sell their share in the future, when they predict your company will be worth a lot of money.
In Entrepreneurship Essentials , Sahlman shares Facebook’s journey with various investors and notes that it received $500,000 from angel investor Peter Thiel in its first round of funding in 2004. Just one year later, Facebook received a $12.7 million investment from prominent venture capitalist Jim Breyer.
Resist the urge to go big right away. Perhaps raising venture capital from investors is a second or third step for the funding of your business.
What's the Best Way to Finance Your Business?
Keep in mind that no two businesses are the same—only you know the ins and outs of your company’s needs. By weighing the risks and rewards of each funding option, along with your personal finances, predicted startup costs, and business expenses, you can select the best option for financing your business.
Are you looking to learn more about financing your venture? Explore our four-week online course Entrepreneurship Essentials and our other entrepreneurship and innovation courses to learn to speak the language of the startup world. If you aren't sure which course is the right fit, download our free course flowchart to determine which best aligns with your goals.
This post was updated on June 3, 2022. It was originally published on August 4, 2020.
About the Author
5 Common Funding Sources For Start-Ups & Business Growth
Written by Dave Lavinsky
If you want to be successful in business, it is crucial to determine when, where, and how to obtain the funding you need. Whether you’re launching a startup or expanding operations, understanding your options is key to success. In this article, we’ll explore five key funding options, helping you find the one that best suits your needs and sets your business up for long-term success.
Before You Look For Funding
Before you look for funding, you need to create a solid business plan. In addition to explaining your business and your strategy for success, your plan must determine how much money you need and how it will be used.
Also, it’s very important for you to understand the timing of the funding. For example, do you need all the funding now (e.g., to build out a location), or can you receive your funding in stages or “tranches.”
The amount of funding you seek will affect the source of funding you approach. For example, if you require $250,000 in funding, angel investors are more applicable than venture capitalists. If you need $5 million, the opposite is true.
Secure Funding Quickly!
The key to securing funding for your business is having the right business plan. With Growthink’s Ultimate Business Plan Template you can complete your plan in just hours and secure funding quickly!
What is The Most Common Source of Funding for Entrepreneurs?
Personal financing is the most common funding source for entrepreneurs. This includes using both your personal savings and personal credit cards to initially fund your business. Other key funding sources, as discussed below, include business loans, friends & family, angel investors and venture capitalists.
What Are the 5 Sources of Funding for Startups and Growing Businesses?
While I have identified 41 sources of funding for your business , below are the 5 most common.
1. Funding from Personal Savings
Funding from your own savings is the most common type of funding for small businesses. The two issues with this type of funding are 1) how much savings you have and 2) how much personal savings are you willing to risk.
In many cases, entrepreneurs and business owners prefer OPM, or “other people’s money.” The four funding sources below are all OPM sources.
2. Business Loans
Debt financing is a fancy way of saying “loan.” Simply put, debt financing is a way to borrow money and pay it back over time, along with interest. It’s a common way for businesses to raise capital.
Credit unions and banks offer funding that you must repay over time with interest. This can come in the form of a personal loan, a traditional business loan, or different loans based on the type of asset you need to purchase (e.g., for equipment, land, or vehicles).
You must prove to the lender that the likelihood of you paying back the bank loans is high, and meet any requirements they have (e.g., having collateral in some cases). With a bank loan, you do not need to give up equity. However, once again, you will have to interest payments along with the principal.
3. Friends & Family
A big source of funding for entrepreneurs is friends and family. They can provide funding in the form of debt financing (you must pay it back), equity financing (they get shares in your company), or even a hybrid (e.g., a royalty whereby they get paid back via a percentage of your sales).
Friends and family are a great source of funding since they generally trust you and are easier to convince than strangers. However, there is the risk of losing their money. And you must consider how your relationship with them might suffer if this happens.
4. Angel Investors
Angel investors are generally wealthy individuals like friends and family members; you just don’t know them (yet). At present, there are about 250,000 private angel investors in the United States that fund more than 30,000 small businesses each year.
Most of these angel investors are not members of angel groups. Rather they are business owners, executives and/or other successful individuals that have the means and ability to fund deals that are presented to them and which they find interesting.
Networking is a great way to find an angel investor for your business.
5. Venture Capital
Venture capital funding is a suitable option for businesses that are beyond the startup period, as well as those who need a larger amount of venture capital for expansion and increasing market share. Venture capitalists and VC firms are professional investors that are more involved with business management, and they play a significant role in setting milestones, targets, and giving advice on how to ensure greater success.
Venture capitalists invest in new businesses and medium-sized businesses they believe are likely to go public or be sold for massive future business profits. Specifically, they want to fund companies that have the ability to be valued at $100 million or more within five years. They also go through an expensive and lengthy process of deciding on the best business to invest their venture funds. Hence, the application process and approval usually takes several months.
What Are the Three Major Sources of Funding for New Businesses?
The three major sources of funding for new businesses are personal funds, loans and credit, and venture capital. Personal funds involve using one’s own savings or assets to finance the startup. Loans and credit options are sought from banks, credit unions, or online lenders to obtain the necessary capital. For high-growth potential startups, venture capital firms and angel investors can provide funding in exchange for equity. Other funding options like crowdfunding, grants, or government assistance may also be explored based on the specific business and its needs.
The Bottom Line
As you search for the best funding options for your start-up business or to expand your existing business, you will discover that some sources are more complicated and time-consuming while others may offer a very small amount. While the five sources mentioned above are the most common, there are other ways of obtaining the financing you need including government programs including grants , crowdfunding sites, business credit cards, or a line of credit from a bank just to name a few.
Choosing an inappropriate type of funding can lead to unfavorable outcomes such as feuds between the lender and business owner, shift of control, waste of resources and other negative consequences.
With this in mind, you should study the benefits and drawbacks of each financing option and select the ideal one that will help you meet your business goals. With the right sources of money, the sky’s the limit for your business.
Other Helpful Funding & Business Plan Articles
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