One of the most important tasks of a small business owner is finding capital for their business. However, most business owners have no idea about where to start when it comes to finding money. This is crucial to understand because your business needs capital. Your capital needs will change over time, which is why you need to build a strategy for capitalizing your business from the beginning. This is where most business owners fail. They come up with great concepts, good marketing, hire the right people but they fail because they never planned for the capital their business needs.
Begin with digging your well
Capitalizing your business is like digging a financial well. A wise business owner will not dig a well that only satisfies short-term needs. There is some groundwork that must be done still.
There are five layers of your financial well. The first is the personal assets of the principles. It is the most commonly used of all but it is mostly recommended that you use other people’s money to build your business.
The following layer is friends and family who you can ask to help you get the funds you need for your business. After that layer you have the credit, loans, and investors. The biggest problems is when business owners wait until it is too late to get capital because they end up out of luck. The reality is no one wants to give your money if they know you need it.
Not all money is created equal
The most important lesson to understand is that all money is NOT created equal. Consider the following as you look at sources of capital for your business.
- Debt vs. equity - Any capital that you receive is either going to be debt or equity. Equity requires you to surrender some of your ownership. You need to be clear on what type of money you are getting. Equity might feel like free money but actually it is the most expensive capital you can get for your business if you are successful.
- Control – does the money reduce your control? Brining on investors will lessen the control you have. You need to be aware of that you are giving up.
- Security – how is the lender or investor securing the money? If you default, who will they go after for repayment?
- Transferability - Can you transfer the capital to the next business owner? In other words, is the capital for you or is it for the business? It will not do you much good to sell a business if all the working capital is still tied to you.
- Ease of attainment – how easy is it to get? How much time do you need to invest in order to obtain the capital you need? Are you adding people to your team that are invested in your success?
Build a foundation
You need to start building a foundation for your business, regardless of the capital you are seeking. Always separate your personal activities from your business activities as much as you can.
The process of building business credit will help to ensure that you have the fundamentals in place. The fundamentals include operating in a manner that lends legitimacy to your corporation.
The four tiers of financing
It is important to be familiar with the four tiers of financing so you can develop a strategy for your business that uses these tiers. The following are the four tiers of financing:
Tier 1: Basic trade credit. Trade credit is the largest source of capital in the world. These are companies granting business credit without the need for a personal or business credit check and rarely require a personal guarantee. Tier 1 is the most basic trade credit and when a corporation is rightly prepared, it will serve as a building block for establishing credit for that corporation.
Tier 2: Advanced trade credit. This is capital extended by businesses to businesses like tier 1. With tier 1, this includes larger credit lines, longer terms, and some cases can be used for equipment financing.
Tier 3: Bank lending. This is the best-known type of business financing. Typically, banks offering unsecured business lines of credit. A personal and business credit check and personal guarantees are required. The most basic level of bank financing, for the most part, is score and business history driven.
Tier 4: Investors. Tier 4 involves venture capitalists, angel investors, and other private investors. These investors want businesses that have been around a couple of years and can provide detailed financials and growth strategies.