When you start a new business, you might need some funds, but you might lack the money to invest in yourself. So how do you get the funds without losing equity in your business? Start-up investment usually involves equity. Why else does somebody risk money?
In your case, the signed contracts may be a bit of an advantage. Are they “bankable” (meaning that the documentation is strong enough that you might be able to borrow off the value of the contracts)? If so, that would be very unusual, but that would also be your easiest route for financing—using the contracts as collateral.
However, bankable contracts are extremely rare. Banks need to have real collateral because it is required by law.
Start-up business owners are too quick to criticize banks for not financing new business. Banks are not supposed to invest in businesses and are strictly limited in this respect by federal banking laws. The government prevents banks from investment in businesses because society, in general, does not want banks taking savings from depositors and investing in risky business ventures; obviously, when (and if) those business ventures fail, bank depositors’ money is at risk.
Start-up businesses are not safe for banks and do not have enough collateral. However, small business owners borrow from banks. A business that has been around for a few years generates enough stability and assets to serve as collateral. Banks commonly make loans to small businesses backed by the business’ inventory or accounts receivable. Normally there are formulas that determine how much can be loaned, depending on how much is in inventory and in accounts receivable.
A great deal of small business financing is accomplished through bank loans based on the business owner’s personal collateral, such as home ownership.
Some companies are financed by smaller investors what is called “private placement”. For example, in some areas there are groups of potential investors who meet occasionally to hear proposals. There are also wealthy individuals who occasionally invest in new companies.
Sometimes you can get a private investor to give you money as a loan, but you might get a very high interest rate and a high equity if you default. This is a lot of risk they are taking, and they want to get the money back or else they will go somewhere else with the money.
You can look for people who might want to invest in your business. Look for lists, government agencies, business development centers, and similar organizations that will be tied into the investment communities in your area. Also, a great place to look is your local Small Business Administration (SBA) offices.
Always Be Careful
Some additional warning is to be careful when you are dealing with anyone who offers to help you find financing as a service for money. Never pay money in advance for investment-finding services, and a request for money in advance should be a warning signal. There are more fakes and frauds in the business of finding investment than there are legitimate finders.
Many small business owners turn to friends and family for investment. However, be wary about it because you risk losing friends, family, and your business at the same time.
Additionally, never spend someone else’s money without first doing the legal work properly. Have the paperwork done by professionals and make sure they are signed.
The Bottom Line
At the end of the day, equity financing can be a smart move for a startup business, but it is not right for every business. Determine that this approach is best for you and ensure that you understand the agreement you are making before working an investor. There can be some complex negotiations so perhaps look into working with a business attorney to help you through the process.