Let’s first explore the first area of finance encountered by a new company – funding.

Funding concerns the money that a business secures and allocates to specific projects or areas of operations.

Companies generally employ multiple sources of funding at various stages of the business’s existence. The general options available to individuals initially funding a business include:

• Business Revenue
• Personal Contributions of Founders
• Friends, Family, and Fools (Investors)
• Commercial Loans

You will likely notice that we don’t mention angel investors or venture capital in this list. Generally, this type of investment is only available to high-growth, scalable ventures. We discuss venture capital in detail in our Entrepreneurship course.

Funding a New Venture with Company Revenue

Some startup ventures are fortunate enough to fund various stages of business development and growth with funds generated by the business activity. For example, at the seed stage a services firm may be able to take on client work that provides the revenue necessary to establish the business (i.e., develop the full panoply of operations and services offered) and hire employee service providers.

A product business, on the other hand, will generally need some level of infusion of capital to develop and test the product before generating income. As such, revenue funding may not be a viable option unless the product business is combined with a service function.

How to Fund a Business with Personal Funds?

Nearly every business begins with an investment of time and personal funds by the founders.

Let’s dig deeper into how this happens.

Early funds used to start a business, also known as “seed funds” generally come from a combination of personal savings and revenue earned by the founders in other activities, known as “bootstrapping”.

Entrepreneurs may incur personal debt or commercial debt with personal guarantees of repayment to fund the early stage venture. In this section, we just focus on personal loans. Commercial debt arrangements are covered in a later section.

Common Methods of Acquiring Business Funds

Common methods of acquiring funds from personal assets include:

Cash on Hand and Savings

This includes any money in the ownership and possession of the founders that is immediately available.

Selling Personal Assets

We’ve all heard of the entrepreneur selling her car or jewelry to start her business. While not many people have an otherwise disposable asset that holds enough value to validly fund a business – it is an option for some.

Borrowing Against Retirement Accounts

Many types of retirement account allow the holder to borrow against the funds in the account. This can be beneficial, as the interest paid on the loan accumulates to the account holder.

Home Loan

A home equity loan is where you take out a loan against available equity in your home. This method generally provides a much lower interest rate than other types of commercial loans.The principal payments go back into your home and the interest is tax deductible.

Personal Credit Cards

Credit cards are good to cover startup expenses of small businesses.

Generally, they are more useful to add liquidity (cash is more easily available) in an operating business.

If you have a credit card, you have a built in line of credit. Although credit cards are one of the most costly ways to finance your company, they are routinely used as a source of funds for start-up businesses.

Who are Friends, Family and Fools as Investors?

Friends and family members may want to support your business venture by lending or gifting funds to you. In some cases friends or family may want to invest or purchase an ownership interest in the business venture. This is the most basic form of crowdsourcing the business venture. You collect funds from a larger group of people who have a vested interest in your success.

Each year between 35-40% of startup ventures receive capital from friends and family. This group is commonly called friends, family, and fools. The reason fools are grouped into this category relates to the risk associated with lending or investing in a seed venture.

Generally, these individuals are not sophisticated investors; rather, they invest in a foolish or whimsical manner. As such, it is strongly advisable that any business loan or investment follow all formalities for a typical lender or investment relationship. Loans should be made with a well-drafted promissory note, and equity investment should be pursuant to a negotiated term sheet (with all relevant provisions).

Business Loans

The following are common types of loans used to fund a business?

What are Micro-loans?

These are small seed capital loans (the average is $13,000) made to qualifying businesses by financial institutions or non-profits. Often these loans will be backed or secured by a particular state or federal government program.

What are Small Business Loans?

The US Government via the Small Business Administration (SBA) offers several small business loan programs. Under any SBA loan program, qualified financial institutions under the Small Business Investment Company (SBIC) program make loans to approved businesses. The SBA secures these loans against default, which provides the security necessary for the business to obtain the loan.

What are Non-SBA Loans? 

Private financial institutions may make any form of loan or extend lines of credit to small businesses. There are rash of startups that focus on lending to startup ventures. Banks often make private loans to businesses, but these loans generally requires proof of income history and extensive equity to secure the loan and/or a personal guarantee from the borrowers. The interest rates on non-SBA loans are generally far higher than SBA backed loans, given the higher degree of risk of such loans.