Starting Your Startup. Comparing Funding: Pros and Cons
Updated: Oct 15, 2019
Knowing your options, and some of the key characteristics revolving around the different financing opportunities available to your business can give you clarity and confidence in making the right funding decision. Weighing the pros and cons of the numerous routes to financing your business in both the Private Equity and Debt Financing worlds will expand your knowledge base to make the best possible decision.
L.A. Financial Management has outlined five common sources of funding below with a brief explanation of each, including the benefits and potential hesitations that can be associated with each source.
Small Business Administration (SBA) Loans
SBA loans are very common and is a government administration dedicated to funding small business success. The SBA has four primary objectives:
1. Help small businesses secure capital as a guarantor.
2. Educate, advice and train for entrepreneurial development.
3. Ensure the appropriation of 23% of all government contracts to small businesses.
4. Small business advocacy.
SBA Loans have a lot of weight to them when treated properly. Bank lenders pay close attention to how you handled the repayment of an SBA loan and consider it a qualifier for approval. The SBA also acts on your behalf to improve relationships between local lenders and borrowers.
SBA loans adhere to strict guidelines and rely on data from the previous 2-3 years. Underwriters commonly use data from the worst of those years to verify stability and growth. This can make it difficult for young companies to obtain an SBA loan.
Angel investors are private investors who will provide a loan to the company in exchange for a share of equity in the company. Investment sizes range, but are typically under $1 Million. Angel Investors are often times an organized group of individuals that personally screen deals, or do so through a board process to invest with one another. Angel Investors are more organized, and more deliberate in their dealings as this will typically be considered a business for the individual or group as a whole. However, they are usually less serious than a VC (Venture Capital) firm.
Angel Investors normally have acute industry experience and can offer sound consultation, as well as network introductions. And because Angel Investors tend to be less rigid than VC Firms, allowing the ability for flexible and creative business agreements.
Angel Investors rarely make follow-on investments due to the high-risk nature of their investment. Also due to the high risk nature, you can be forced to give up some degree of control of your company to the individual or group.
Friends and Family
Often acting as a seed investment to get the business to a position for larger funding from Angels or VCs, loans are typically invested based on personal relationship rather than accurate assessments of the business plan.
Funding is usually quickly obtained due to the existing relationship and investment terms are usually flexible with numerous equity payback methods.
There can be immense pressure to succeed as well as potential strain to personal relationships as a result to potential startup volatility or obstacles. You can also open yourself up to unsolicited advice from those with a monetary stake in the company, but have no operational influence or experience. And because of the tendency for this type of lender to not have business or industry experience, this funding source will not typically come with helpful guidance or mentorship.
Venture Capital (VC) Funding
VCs are professional investors who typically look for investments that can provide at least 6X the return on their investment. VCs are willing to put forward a large sum of money in exchange for equity. However, they only get their money back through the acquisition of your company or when your company goes public.
VCs can provide both funding and expertise, as well as other assistance that is helpful to your companies growth, and succession plan if desired. Also, being funded by a VC brings instant credibility to your company and opens up doors to vast networks, individuals and potential future partners and/or investors.
Venture Capitalists can be "all business" and even ruthless when planning for the return on their investment. When dealing with a VC, you are dealing with a force that can potentially steer your business in a direction you don't agree with, based on their experience and expertise.
Bank loans are the most frequently sought after funding source. Local lending institutions can be the first stop for your funding needs, but can be tricky as there are often many different types of financing packages, interest rates and terms. Educating yourself extensively on your chosen lending institutions terms will help you choose the best funding option for your company.
Banks offer a wide range of funding amounts and payback options to fit your company's needs and current position. Funding can be fairly quick once qualified. And an important pro to bank financing is that you do not have to give up equity in your company.
Bank loans are difficult to obtain and the criteria constantly changes and is wide ranging depending on the kind of financing you're choosing. Another liability to this kind of financing is that the entrepreneur owes the bank whether the company is a success or not. Bank loans often require tedious and time consuming preparation and documentation. And financing options are often confusing. By thoroughly educating yourself on the terms and options, you can avoid locking yourself into an unfavorable deal and poor payment terms or rates.
If you and your company is looking to acquire funding, it's important to know your options and have a trusted advisor to help navigate some of the complications and requirements. L.A. Financial can help your company present a solid financial outlook giving your and your potential investors a clear understanding of where your company is today, and the goals it can achieve with additional funding. Contact L.A. Financial Management today to discuss your needs and goals.