Innovative products and business models are the foundations of a promising startup. However, you’ll also need a steady flow of funds, especially in the early stages, to turn those ideas into reality.
Funding is crucial for improving technology, hiring the right people, and launching a comprehensive marketing strategy to get a foothold in the market. However, sourcing enough money to start your new venture can be difficult.
From jewelry to dog food to SaaS (software as a service) products, startups are popping up in virtually every field around the world, despite the risks. As an entrepreneur, you will face several challenges while seeking the funds, in part because you’ll have to convince others that your idea is a solid investment.
1. Creating a scalable business model
Whether you are hoping to expand a small business with a loan or going for a round of venture capital, you will need a scalable business model. Investors in particular want to fund only scalable or ready to scale businesses. Your business model must show the potential to increase the revenue with minimal expenditure in the coming months or years.
Your business idea itself needs to be scalable
This means being able to increase profits without increasing costs at an equal (or higher) rate. Sure, it should be unique. But without scalability, it is less likely to be investable.
Usually, scalable business models have higher profit margin and lower infrastructure and marketing investment. While expanding, your business model needs to remain aligned with the company’s core offerings.
In other words, if your business model is likely to result in the overextension of time, money, and resources, investors will be hesitant to welcome you with open arms.
Build a business model that works; don’t rely on using your competitor’s model
Your business model should support your growth goals. Staying competitive might require you to approach from a different angle.
For example, Bluestone, an online jewelry startup from India, was trying to compete with the traditional brick and mortar jewelry business market. So, they decided to focus on a made to order business model so that they didn’t have to maintain a very costly inventory. They sought investment to develop a state of the art manufacturing facility and supply chain so they could manufacture online orders in real-time.
Try to outsource non-strategic aspects of your business to minimize expenses
For example, for a restaurant, having a stylish interior is a strategic aspect of your business. However, having an in-house accountant may not be the best use of funds.
Use a billing software to record the sales and invest in a relationship with a tax professional only when needed. Make sure to use the latest automation and software technologies wherever makes sense. All of these factors contribute to a scalable business model, which in turn, helps attract investors.
2. Determining how much money to ask for
Whether you are asking angel investors to fund your expansion or seeking a bank loan, you must know how much money you need. Most people would say you should raise as much money as you can. However, in many cases, more isn’t always better.
Write a business plan
It is not possible to chalk out how you are going to spend the money without having a business plan. In fact, most investors (and zero banks) will fund your venture without a complete business plan.
Your business plan also needs to have a realistic financial forecast. You should forecast the expected cost the investment or loan will cover, and the returns it will generate in future. The projected statistics, facts, and figures must have a justification.
Be specific and concrete
When investors pay you, they expect to see how you plan to spend their money. They will expect you to spend the funds to grow your business to its next milestone.
In other words, they wouldn’t be impressed if you intend to invest in fancy furniture or unnecessary automation. Milestones need to be measurable achievements such as launching a new product or reaching a specific market share.
Every business will have a few rollercoaster moments. However, your business should be able to show consistent achievements.
Demonstrate that your company has positive cash flow
Showing that you are cash flow positive is key, especially for small startups and small businesses looking for expansion. There is no single approach here. Usually, better cash flow increases the chances of receiving desired funding.
Calculate how much money you will need to for the necessary production, training, hiring, marketing, and automation to create a viable financial model. Figure out where your cash flow bottoms out and add appropriate buffer accordingly. Make sure your funding request is in-line with your financial projections.
More investment isn’t always better
More funding can equate to increased pressure to scale up your business quickly. Although it can be helpful for healthy growth, sometimes it can prove detrimental—companies that have received huge amounts of investment fail every day because they couldn’t manage the rapid expansion.
The bottom line is to ask for the amount of money your business needs and can handle.
3. Finding the right funding option
As mentioned in the beginning, many new startup funding options are available today. To increase your chances of getting the funds, you need to choose the most suitable funding alternative. Sometimes, you may also need to use more than one option to fund your startup.
Bootstrapping or self-funding
The best (and the cheapest) option for funding your business is using your own savings or borrow from your family and friends. Flexible investment terms and quick availability makes it an attractive funding source.
Your own savings and income
Tapping into your 401(k) or personal savings may seem tempting. However, if things don’t pan out, you lose your business and also your nest egg. Many entrepreneurs choose to both run their startup and work a day job until their startup is profitable.
Family and friends
Asking your family and friends to invest in your startup also comes with considerable risks. You are not only risking their financial future but also potentially jeopardizing personal relationships.
You can, however, readily overcome these risks by writing a formal business plan just like the one you would use to attract professional investors. Then, handle the loan with professionalism. Document the terms (particularly what will happen if you can’t pay back the money) and stick to your agreement.
Your bank may offer special credit cards for individual entrepreneurs and small business owners. If you have good credit, it can be a simple option. It is also the most expensive option, as credit card debt comes with high-interest rates.
Most credit cards are also personal, meaning that if your business goes bankrupt, you are still personally liable for any debt. Plus, your credit score will take a hit the moment you miss a payment—this can affect your ability to secure funding in the future.
A bank loan is also a reliable funding option for a small business or startup. You may also be able to apply for government-subsidized bank loans or soft loans.
Small Business Administration (SBA) loans can be a good option. The SBA doesn’t actually administer loans, but when you apply for an SBA backed loan from your bank, the SBA promises to pay back a portion of the loan to the lender if you default. Basically, this makes it possible for banks to take a risk on granting a loan to a small business that might not otherwise qualify.
Most traditional bank loans require at least two years tax returns showing gross and net profits. In other words, you need a good credit history. Banks will also ask for collateral such as equipment or real estate. They will always ask you for your full, traditional business plan. Make sure it includes financial statements or projections, personal and business credit reports, tax returns, bank statements, and growth projections.
Angel investors may offer more flexible investment terms compared to the venture capital firms. They tend to invest large sums of money (but no more than $1 million) in exchange for equity in the startup.
Angel investment may not be the right option for a small shop owner, but small plant owners, tech startups, or firms can take advantage of this source.
The significant disadvantage of using angel investors is losing the ownership of a part of your company in exchange for the money. They will also have a say in how the business is run, and they’ll be highly interested in your exit strategy, as they will make the majority of their money when your business is sold.
Venture capitalists are similar to angel investors. However, they tend to invest upwards of $2 million. Being professional investors, they can provide guidance in growing your business, they’ll also probably be interested in having a say in how your business operates.
Most VC firms will rarely invest in small businesses such as coffee shops, bars, and proprietary stores because they’re not built on business models that are designed for rapid growth and huge expansion. But, if your coffee brand is trying to expand into a super chain like Starbucks, for example, they might be keenly interested in investing.
Keep in mind that venture capital firms will invest at a point when injecting more capital into your business will result in further growth and more profit.
Crowdfunding can help you to reach a broad group of potential investors and possibly generate publicity for your startup. However, crowdfunding campaigns require a significant amount of time and planning, and your ability to achieve funding often rests on whether you already have a wide network that you can access to ask for support. Plus, some platforms mandate that if your campaign fails to raise the target amount, you don’t receive any funding at all.
To succeed, you must keep your make your campaign visible, measurable, and understandable. Having a well-established network of friends and professional contacts can increase the chances of a successful campaign.
Each option comes with a distinct set of advantages and disadvantages. You will have to make your decision based on your particular situation—and you might seek several different types of funding.
4. Spending wisely once you’re funded
Stick to your plan
If you took investment, you’re accountable to your investors to do what you said you would do with their funds and to be transparent if you’re thinking of changing course.
Avoid going on a spending spree. Don’t spend the money on overly expensive furniture, workspace, infrastructure, equipment, business trips, and lunches. Save the splurge for when you’re bringing in more revenue.
Spend wisely on tech
If you haven’t assessed your technology needs already, you need to do it before spending the funds.
Find out what type of software and hardware upgrades are available for your business and choose the most affordable yet feature-rich options. Technology spending should always focus on future marketing and branding successes.
Keep your investors in the loop
Chances are you decided to seek outside investment, your contract requires you to give investors their proper return in due time. However, showing them that their money is being put to good use will help forge a bond of trust.
Funding your startup or business idea is a tough nut to crack. Whether you are approaching a venture capital firm or trying your luck on a crowdfunding site, you will come across multiple hurdles while in search of funds.
The above tips will help you overcome the most common startup funding challenges and secure capital for your business in due time. How did you manage to secure funds for your startup idea? Share your experiences on Twitter @Bplans.