Is your business a hungry monster or a little gremlin? In either case, how are you going to feed it?
Those are the key questions at the heart of the most important aspect of your business: cash.
Cash (formally called “capital” in business terms) is the energy source all businesses need to enter the world, operate, and (hopefully) grow and mature into strong, vibrant companies. Without initial cash, your business may likely never get off the ground. Without generating cash, your business will struggle to operate and grow. And without adequate cash for a long enough period of time, your business risks burning out and shutting down.
When it comes to discussing the cash needs for your business, let’s start at the beginning: the startup moment of your company.
In chapter 2, I emphasized that making decisions regarding startup capital is the second action all founders and entrepreneurs need to concentrate on when setting out to forge a new business from scratch. It’s too fundamental and sensitive a subject to avoid; address it early and head-on, whether you have a co-founder(s) or not.
Not all options for raising capital are appropriate for all founders and entrepreneurs. And pursuing more than one option at a time is often sensible in order to diversify risks and increase the odds that you’ll secure the amount of capital you need to begin operations.
Which capital raising options are most appropriate for your startup company situation? That’s up to you to decide. Let’s explore what’s available to you by diving deep into the three principal avenues to cash.
1. Bootstrapping from Savings and Freelance Cash Flow
Bootstrapping is defined as starting and growing your company using existing resources, such as savings and cash flow from other income sources. While the term can bean overused buzzword in the zeitgeist of modern entrepreneurialism, it’s still a viable funding strategy that is worth serious consideration.
For starters, you may have some personal savings that could be used to fund the early days of your new company. If that’s an option for you, great. However, if tapping into those funds puts severe and undue stress on you and your family, then it’s probably best to consider that cash off limits. If that’s the case, then you need to generate your upstart cash from different sources.
Side hustle cash flow is a great second option. Anything that involves you performing services for customers or clients that result in a new income stream can be earmarked to help launch your new company. You might think that freelancing is a temporary pursuit to raise just enough cash to get your new company off the ground. In many cases, that is likely true. For example, if your dream is to build the next boutique fashion brand for young professionals living in metro markets, and if your core competency is in design, then freelancing as a designer for other fashion brands could make great sense to raise cash for your own retail brand. In that scenario, freelancing isn’t directly linked to the business model you’re envisioning for your company, although the connections you may make with other fashion brands may help a lot with the launch and growth of your own.
That said, freelancing can be synonymous with starting your company even if yours isn’t envisioned to operate on a freelance model, at least not long term. In other words, it can be one and the same thing, which is a third option for starting your company through bootstrapping means. The origin story of RightMessage is a strong example of this option—and it's magic—in action.
RightMessage is an up-and-coming SaaS platform that helps brands (including SPI) personalize web experiences for their site visitors and customers. You might think that as a SaaS company, RightMessage got its startup funding through venture capital. Not entirely. While it did raise $500,000 from angel investors on a S.A.F.E. (the now famous financing model developed by the legendary startup incubator, Y Combinator), the larger and more important path it pursued was to validate (and fund) the SaaS idea through personalization consulting (e.g. freelancing), followed by selling personalization resources (e.g. online courses).
As Brennan Dunn, CEO of RightMessage, states in his origin story article, “Before creating RightMessage, a tremendous amount of experience and validation (in the form of $$$) occurred by selling personalization consulting (Done-For-You) and then, later, by selling personalization instruction (Do-It-Yourself).” Ultimately, once Dunn had a lot of consulting experience under his belt, he writes that he was able to sell his course more effectively and leverage the knowledge from selling consulting on his sales page. From those two forerunner experiences, Dunn and his team amassed “a tremendous amount of wind at [their] back” when the time came to consider whether to productize their knowhow into a SaaS platform.
The broad takeaways from this gamut of bootstrapping methods represent incredibly powerful questions to consider for your new venture:
- Can you leverage any existing cash reserves to get your business going?
- Can you augment that cash on hand with new income generated by freelancing, however temporary and unrelated to your new company’s intended market?
- Is it possible to begin in a less cash-heavy manner whereby you can validate the concept while generating direct revenues to further bootstrap its development?
Ponder these opportunities deeply before venturing into credit-based fundraising waters because those waters are almost always deeper and more turbulent.
2. Securing Credit or Loans From Financial Institutions
Most founders and entrepreneurs I know utilize various forms of credit to start and grow their companies. Few lean on credit alone due to the inherent risks involved with using credit, a course of action I agree with. So, as we delve into the credit-based opportunities that exist for founders and entrepreneurs like you, I advise caution: secure and use credit with great care.
Credit cards are likely the most obvious form of credit. Most folks have credit cards in their personal lives and know-how they generally operate.
NerdWallet is a phenomenal resource to investigate on all matters related to credit cards. The site is more geared toward personal credit card use cases as compared to small business ones. Still, since a lot of the terms and usage behaviors pertaining to small business credit cards are similar—if not identical—to personal credit cards, it’s a quality resource for founders and entrepreneurs. As a starting point for researching a possible small business credit card that may be best for your circumstances, read their How to Pick the Best Credit Card for You: 4 Easy Steps article as well as research specific card options using their business credit cards ratings and rankings tool.
It’s highly unlikely you will be able to secure a business credit card unless you have already properly incorporated your business. Why? Because financial institutions usually require that a business credit card (and checking account, for that matter) be linked to the company’s federal employer identification number (EIN). It is also likely that they will ask for the company’s Articles of Incorporation, operating agreement, or other seminal founding documents to prove the duly formed existence of the company.
That said, don’t think that you as the founder are off the hook personally for any debts that your company may incur with respect to your usage of a business credit card(s). For first-time founders and small business owners, financial institutions will almost certainly insist as part of their underwriting process that the individual opening the account personally guarantee it, meaning that if your business folds the financial lender can recoup its debts from the individual. That’s a serious decision for many entrepreneurs, especially those that may be pursuing high credit card limits because of the cash demands for their startup company.
A business line of credit is another common form of raising working capital either for immediate upstart needs or growth and development investments. All banks will offer different terms, so it’s important to sit down with a business banker at your local branch and talk through options and details should you have an interest in adding a line of credit to your startup fundraising strategy.
With a business line of credit, you don’t actually receive that cash like you would a loan. In other words, you do not receive that cash directly into your business checking account. Instead, the business line of credit sits outside your business checking account as a separate account. You can then draw cash from this line of credit account into your checking account when you need it. Applicable interest rates are only applied to the amount of cash you draw out and have not repaid to the line within a reporting period. During one of my former companies, we used a business line of credit regularly, and especially during growth periods, in part to build a good credit history in the name of the company, which helps with securing greater amounts of business credit in the future.
Specifically, we pulled on the line of credit to offset certain operating expenses (e.g. payroll, credit card balances), then repaid that draw to the line of credit as soon as possible to showcase that we were responsible with our use of working capital.
One final option here is a small business loan, which is similar to a business line of credit but functions differently. A seminal difference is that with a loan, you do receive the entirety of those funds directly into your checking account. Small Business Administration (SBA) loans are perhaps the most common and popular type of business loan for founders and entrepreneurs, which you can learn more about directly from the United States SBA program webpage.
If you’re struggling with the question “Should I get a loan or a line of credit?” you can use an online calculator like this one from Huntington Bank to evaluate the two options in terms of the cash amount you need, applicable interest rate, any other fees (like an annual fee), and other assumptions like tax rates that are applicable to your circumstances.
If you need a quick guide to further inform your thinking between these two, CreditKarma.com states that a line of credit may be best when (a) “you need ongoing access to cash, and (b) “you need payment flexibility,” versus a loan, which may be best when (a) “you know how much you need to borrow,” and (b) “you want set repayment costs.”
Credit and loan options may sound pretty dull. Don’t discount them, especially if you’re like one of my entrepreneurial friends who is the CEO of a founder team building their own microbrewery here in Columbus, Ohio. A microbrewery business has very different capital needs than, say, an internet-based retail brand, which itself will have very different capital needs from a professional services company like a digital agency.
Regardless of your business, the bottom-line calculus is the same: First, evaluate your company’s specific capital needs in correlation with your company’s business model. Then align specific capital raising strategies to hopefully achieve those funding goals.
To achieve those goals, you may need to venture into the third category of fundraising options: raising capital from investors.
3. Raising Capital from Others, Including Big League Investors
If you aren’t going to bootstrap your new startup company yourself, and if securing credit lines and debt financing don’t sound like a good fit for you—or won’t get you all the way to fulfilling your upstart capital needs—then the third arena to explore for financing your company is direct investments from others.
“Others” can take on a variety of forms. Here are the most notable:
- Friends and family
- Fans and supporters
- Private equity firms
- Angel investors
- Venture capitalists
Friends and Family
This group is precisely that—your family members or friends whom you have personal relationships with and who may be in a position to write checks to you as part of a “friends and family round” of fundraising. Now, although you may be tempted to think that fundraising from such personal contacts is an informal act, it’s not. Any investment dollars you raise for your company should be treated seriously and managed in writing.
Specifically, investment dollars from family and friends don’t always take the same form. As explained in this article from Entrepreneur.com, money raised from such contacts “could be a gift, a loan or an equity investment in the business. Each have pluses and minuses, and each should be recorded in writing, in many cases a legal document.” Different friends and family members will likely have different financial interests in mind, so consider these various forms and align the right one with the individual person. It’s okay to have some take the form of gifts while others take the form of equity investments, so long as those conditions are mutually understood and accepted by the respective parties involved.
If you need guidance figuring out how to approach the conversation (a.k.a. the pitch) with your family and friends, Forbes has a good article to get you started with the basics. Don’t ignore your prep work before you even start that conversation. As the Forbes article mentions, honestly answer questions for yourself such as, “Am I going to give every inch of my soul to making this the biggest and best business this can be?” and, “Am I ready to speak about my business all the time?” You want to think carefully on those points before pitching those close to you because often the personal relationship is put on the line if expectations aren’t abundantly clear up front.
Fans and Supporters
This category of people is very viable for those founders and entrepreneurs who have already developed an engaged following online. Crowdfunding is the hallmark method of activating that audience to participate in a round of fundraising for your new thing—which is often a flagship product for the new company. Pat and Caleb’s Kickstarter campaign for their SwitchPod product is a strong example of involving their fans and supporters in an early-stage capital raise to advance that particular business.
Kickstarter is arguably the largest and most popular crowdfunding platform used by founders and creators, but it’s far from the only one. Other credible options include Indiegogo.com, Gofundme.com, and Patreon.com. Each one has their own unique spin on how to raise funds from fans and supporters. In Patreon’s case, their model is rooted in ongoing contributions (a la, a subscription) from those willing to back a particular creator’s project. Our very own Non Wels, our solutions expert, has a Patreon funding page set up for his personal podcast, You, Me, Empathy.
Private Equity Firms
This category is a whole different—and more serious—can of worms.
Private equity (PE) firms raise their financial capital from their limited partners and invest almost exclusively in privately held, mature, and (usually) traditional companies in exchange for equity.
As you might already be able to tell, PE isn’t usually an appropriate option for younger companies chiefly due to misaligned financial incentives between such small, early-stage companies and the investors. That said, if you have a track record of success as a startup founder and are working on your next big business idea, then that pedigree may be enough to attract some PE interest, especially if your next company promises to be the sort of high-stakes, high-reward venture that PE investors covet.
To expand your knowledge on private equity, read Entrepreneur.com’s A Beginner’s Guide to Private Equity. Even if you do not intend to pursue a PE investment now for whatever reason, I encourage you to read up on the mechanics of PE financing because it’s a good idea to educate yourself as a promising startup founder and serious businessperson.
If you’ve ever heard of an “angel” investing in a company, that’s an angel investor—an individual (usually with a high net worth) who makes a personal capital contribution into a company in exchange for an equity position. Angels can be one-and-the-same as a family member or friend.
Typically, angels invest in early-stage, high-risk companies such as tech startups. And in most cases, angels operate in stark contrast to venture capitalists because although angels care about the possible return on their investments like venture capitalists, they invest more in the individual entrepreneur (or founder team) and less in the potential viability of the business model.
If you’re considering approaching angels for investment into your company, read Investopedia’s angel investor definition as well as Forbes’ article about the twenty things all entrepreneurs should know about angel investors. And if you care to explore the mindset of a world-class angel, read up on Chris Sacca, who has made billions (yes, billions) from his investments as a super angel from investing early into companies such as Twitter, Uber, Instagram, and Kickstarter. Sacca was featured prominently in season one of Startup, Gimlet Media’s first podcast with founder Alex Blumberg that chronicled the start of their company, which—naturally—Sacca invested in.
Venture capital (VC) is private equity. That said, VC firms are historically far more willing to take bets on young entrepreneurs and their unproven companies, especially in high-stakes, high-rewards market sectors like technology. And VC money has flowed rather freely over the years, particularly in hot beds like Silicon Valley. That’s why successful tech entrepreneurs like our friends at ConvertKit, Teachable, and RightMessage are often presumed to have taken on VC money even if they actually haven’t. (For the record, Teachable is venture-backed while ConvertKit and RightMessage, as of this writing, are not.)
Venture capital—it’s a lot to get your head around. To begin to make sense of this universe, I highly recommended Brad Feld’s book, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist.
The Road Forward
Road, well, given all of the variables and options we’ve covered, it’s more like roads. You don’t need to travel the super-fast highway of complicated term sheets from aggressive VCs or excessive loan amounts from financial institutions if your business concept is a little gremlin. And never, ever, accept money from anyone unless you know how to put it to good use in your business to achieve your intended business objectives.
If you do choose the route of big-league money, those professionals and firms will almost certainly require that you develop a use of funds model for the amount of money you’re seeking to raise. So, get ready for that work. In fact, it’s a good exercise to do even if you’re staying small and only looking to raise a little bit of startup capital from family and friends. Everyone will be happier and stand a far greater chance of experiencing a positive return on their respective investments when you’re smart about your use of money.
You’ve now made it through the thicket of capital fundraising. With your newfound wisdom, let's shift to talking about business operations. The best way to illustrate and teach these important concepts is through a transparent lens on our very own company. So, if you’re up for a look inside the machine that is the SPI business, let’s move on to the next chapter.