Which Financing Option is Best for Your Business
A lot of entrepreneurs ask themselves: “What is the best way to finance my business?”
In this article I will show you which financing option is best for your business given your capital needs, networking needs and stage.
I will discuss (1) the business model specific factors such as capital needed and network needed, (2) the stages your company can be in, and (3) the financing options that fit best given your unique circumstances.
BUSINESS MODEL SPECIFIC FACTORS
The two most important factors that distinguish business models are capital intensity (low versus high capital need) and importance of relationships (low versus high need of relationships to key decision makers).
Some business models require you to invest a large amount upfront in order to enter the market. This costs can include product development, creating brand awareness or setting up a sales force. Business models with low capital needs include SaaS and consultancy services. Business models with high capital requirements encompass a shoe manufacturer or chemical factory. By intelligently testing your business model assumptions via a minimum viable product you can significantly lower your capital needs.
Some business models heavily require you to have a strong network to key decision makers in order for you to make sales. Business models with high importance of a good network include consulting services (e.g. management consulting, mergers & acquisitions) and other business models where the purchase decision is made on executive level of your client.
The business stages must be considered when choosing the right financing option for your business. Let’s have a look at the major business stages.
In this stage you have a basic idea of which product or service you would like to provide which customers, but you still have to think through the whole business model and define the assumptions to be tested. Brainstorming with friends about business ideas is fun and helps you clarify your rough business model.
Your basic idea has developed and you have a good grasp how you want to enter the market (which marketing channels, sales channels, budgets), what are the product requirements, and how you will make a profit on selling your products and services. In addition, you may have developed a financial model as well as a first version of your product for testing under market conditions.
FIRST MARKET VALIDATION
Great! You’ve build your product and you make your first customers happy. Congratulations! This is what we love about being entrepreneurs 🙂 You learn from your customers’ feedback and iterate on your business model in order to optimize your product market fit.
SINGLE MARKET VALIDATION, EXPANSION AHEAD
You achieved product market fit in a single market (e.g. upper premium market for shoes in the US) and now you are keen to expand to further markets. This market extension can be geographically (= further countries) or product related (= add new product segments such as jeans or furniture). The challenge is that for the new markets you might not have enough market insights, contacts or capital.
You’ve come a long way since you started your business. You sell hundreds of products in multiple countries and are loved by your customers and feared by your competitors. But maybe it’s time to move on to a new business or retire on an island. 🙂
Now, as you understand your business model specific factors and the stage you are in, let’s find the best financing option for your business.
FINANCING OPTIONS FOR YOUR BUSINESS
The first and my favorite financing option is bootstrapping. When bootstrapping you finance your business based on internal sources: your personal assets, other parallel businesses, or the revenue of the business itself. The idea of bootstrapping is to cover the cost with the revenues of the business as fast as possible in order to achieve a continuously self-supporting business.
This option can be used generally in every stage of your company, but it suits best for the idea stage and concept stage.
When to choose: I will boostrapp my company when the capital and network requirements are very low (e.g. less than $10k) to achieve break even.
Examples of companies which grew by bootstrapping: 37signals
FAMILY & FRIENDS
The second option is using assets of your family and friends for growing your business. When you have tested your business model under market conditions and only need a little more resources (aka cash) for optimizing your business or for reaching break even, then asking your family and friends might be a good financing option for you. But be aware that investments from your closest friends and family might worsen if your business fails. Therefore, we recommend asking for a loan under friendly conditions which you will pay back to your friends and family.
When to choose: When you only need little financial resources for reaching break even and you are quite damn sure about that, then asking your family and friends might be a good financing option for your business.
Examples of companies which grew based on assets of family and friends: TBD
The third financing option is to get funded by people via crowd funding. You just register at a crowd funding website, upload your project decription and why people should finance your project, and then hope for the best. 🙂 There are different website specific types of crowd funding:
- “Thank you”-funding, if the people provide their money for a specific start-up project with no return promised (donation-like)
- “Product-Return”-funding, if the people get some product from the start-up project in return for their financing
- “Equity/Debt”-funding, if the people gets either equity stake or debt obligation from the startup company in return for their investment
When to choose: If your business has a medium need for financing (e.g. $50k to $200k) and you run a B2C business model, then crowd funding might be a good financing option; especially if you go for the “Thank you”-funding. 🙂
Examples of companies which grew based on crowd funding: Oculus
The fourth financing option is getting funded by an accelerator such as Ycombinator. A good accelerator provides funding for you to build a minimum viable product, test product market fit, get some media traction and make relevant contacts with potential partners. Ycombinator is a good example for this and giving you advice on how to iterate your business model.
After you leave the accelerator program you will either have to break even or in most cases you will have to look for follow up financing by venture capitalists.
When to choose: If you have a rough idea or concept for a business and love to build your product together with serial entrepreneurs for less than $20k, then using an accelarator program is a good financing choice.
Examples of companies funded by an accelerator: Firebase
The fifth financing option is to find a business angel. A business angel is a wealthy individual who likes being involved and invested in startups. Many business angels are corporate executives or entrepreneurs, so you can learn from them while using their network. Business angels typically invest between $50k and $250k.
When to choose: If you need a substantial amount for testing your business model assumptions or for reaching break even while having a close exchange with some experienced business angel, then this financing option should be considered.
Examples for business angel financed companies: Google
The sixth financing option is to fund your business via venture capital. Venture capitalist look for highly disruptive and hockey-stick like growing companies that they can invest in $500k to $$20m in equity.
When to choose: If your company is growing quickly and is serving an innovative solution while not being profitable yet, then venture capitalist might be a good financing solution as they will provide you with capital and contacts.
Examples of companies financed by venture capitalists: Twitter
The seventh financing option is to get bought out by private equity. Private equity investors buy your company, takeover management control and try to increase the value of your company.
When to choose: If you would like to retire from business, don’t find a successor or just want to cash in, then selling your company to a private equity investor might be a good option. This is only applicable to mature companies.
Examples of private equity financed companies: Dell