Growing your business is difficult, particularly when you need money to fund your plans. Many entrepreneurs use personal savings or the revenue from the company to “bootstrap” their way to success. But sometimes that’s not possible because either you lack the personal wealth or the company needs too much upfront investment prior to revenue generation. Traditional fundraising from professional investors can be daunting both in terms of time and money. However, over the past few years, some additional small business funding avenues have become available.
Small business funding: The basics
Before we jump into that, though, let’s define some terms.
Raising capital by selling shares or ownership in your company is considered equity fundraising. Because you’re a private company, you’re not listing your company on a public stock exchange to sell those shares. However, you are still subject to rules from the Securities and Exchange Commission (SEC). There are regulations and filing requirements when you sell ownership using shares (or interests for an LLC) and when you raise money through what is called convertible debt.
If I am loaning a company money and there is a provision for that loan to convert into shares, it is convertible debt and I still must be an accredited investor* to provide funding.
Next, let’s talk about friends and family: Early stage companies often turn to those closest to them to fund their dreams. Sometimes that can run against local state securities laws so always talk to a lawyer when you are fundraising by selling shares in your company to non-accredited investors.
On to angel investing, which means you go to accredited investors with your company documents and raise money using the SEC rules. This can be expensive because a raise includes gathering and preparing the company information, hiring lawyers and accountants, and pitching and following up — both of which often involve out-of-town travel.
In the last couple of years, many angel platforms have moved online and that can help with the logistics, but the documents and processes involved are still costly.
Debt is not traditionally used by startups for a mixture of reasons — but sometimes just a small loan can help to achieve a product launch or first customer.
In addition to bank debt, the Small Business Administration offers startup loans. Also, properly managed use of credit cards can get you over a difficult spot. Some states, like Arizona, have state-backed programs for grants and loans.
Rewards-based and equity crowdfunding
The two types of crowdfunding — rewards and equity — can both raise cash and provide market validation. Rewards-based crowdfunding is where you offer perks or products as opposed to selling actual shares in your company. The latter is the new Title III equity crowdfunding, which launched in May 2016. Depending on your rewards structure, you can validate that the market wishes to buy your product while raising the funds needed for production.
An interesting twist on rewards crowdfunding is the notion of only producing products if the pre-sales’ target is met. The clothing company Betabrand uses this technique to raise enough money to fund new items prior to accepting the funds from customers.
Equity crowdfunding has been successful for many companies to date. Companies sell shares of their business to unaccredited investors and can raise up to $1 million per year. The cost for this type of fundraising, using an online platform, is less than the traditional documents required for a private placement — plus you’re accessing a much larger pool of potential investors.
Explore your funding options
Regardless of the small business funding method, explore all your options and find the type of fundraising and investors that support your mission, values and options.
*Accredited investors currently are persons whose income is more than $200,000 (or $300,000 with a spouse) or has a net worth more than $1 million (excluding the value of the person’s primary residence).
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Also published on Medium.