I'm often asked: what is the best way to finance a new business venture. This question is usually followed by "So, do you ever invest in new business ventures?"
The answers are 1. there is no "best" way to fund a new business; and 2. I invest in new business ventures, but I can't today because I left my checkbook in my other suit.
The truth is there are various ways to finance a new business, and which is best depends totally on your product, your market, your financial requirements, your burn rate, and most importantly, your personal and financial situation.
So with that in mind, here are a few of the most common ways to finance a new business without hitting old Tim up for a loan. Remember that all methods have pros and cons, and some (or most) may not work for your specific situation. No matter what financing method you choose, thoroughly investigate the ups and downs, and don't jump in with both feet until you're sure you'll land on solid ground.
Savings and Investments
The first source you should consider tapping is your savings and investments. I'm a huge fan of self-financing when it comes to business because it doesn't make you responsible to others should the business fail. The bad thing is that if things go under, your money will go down with the ship. If you're not willing to risk your capital, you shouldn't be willing to risk anyone else's.
Friends and Family
After tapping their savings and investments, many entrepreneurs turn to friends and family for help. This works well for some, but here's the creed I live by NEVER borrow money from anyone you have to eat Thanksgiving dinner with. Nothing causes tension in a family like lending money that is never paid back. And notice I say "lending money" rather than investing money. Venture capitalists invest money. Your relatives lend you money, and they will expect it back someday, even if they say they won't. Remember, when a loved one invests in your business, they emotionally invest in you. It would be tough to tell mom and dad that their favorite son lost their life savings because his business went down the drain.
Credit Cards
I financed my first business on credit cards, which was an incredibly stupid thing to do given that my business could have failed and left me with thousands of dollars in credit card debt that would have taken until the year 2099 to pay off. It worked out in the end for me, but if you decide to finance your business on plastic, keep in mind that you will be paying extremely high-interest rates on the money you've borrowed, and unless you hit it big, you will be paying for that money for many years to come.
Mortgage The Farm
Bank loans are next to impossible to get if you don't have collateral and a track record of business success, which is why many entrepreneurs use the equity in their homes to finance their business after being turned down for a bank loan. While this makes more sense than building a business on a deck of credit cards, the financial risks are no less abundant. You must pay this money back whether your business succeeds or not, but it is a good source of low-interest funds to get you started, and the interest may be tax deductible (check with your accountant to make sure).
Angel Investors
An angel investor is typically a wealthy individual who invests in start-up ventures for a share of the ownership. Angel investors are usually the first formal investors in a business and provide the seed money to get the business up and running. Some angel investors will write you a check and leave you alone to run your business, while others consider their investment a license to "help you" manage and make decisions. If you accept angel money, ensure the terms are clearly defined on both sides. Angel money always comes with strings. Make sure you know whether those strings come from a bow or a noose before you accept an angel's cheek.
Venture Capitalists
Venture capitalists are to angel investors as pit bulls are to Chihuahuas. That's not to say all VCs are big, bad dogs, but they have powerful jaws that can chew up your business and spit it out if things don't go their way. VC money doesn't come with strings; it comes with chains, locks, and many legal documents. VC always have the upper hand in any deal they invest in. That's how it works, and that's the price you pay to get access to VC money.
If your business gets to the level that VC money becomes a viable option, don't jump at the first bone a VC dangles before your eyes. If one VC likes your idea, others will, too. Present to multiple VCs and consider each offer before accepting the check.
Remember, use the money wisely no matter how you finance your business. Don't buy $1,500 plasma monitors and $1,000 Hermann Miller chairs.
Have a very clear plan of how the money will be used and how it will be paid back.
And remember this, the more you can shoestring the business, but more of the business you will own in the end.