In entrepreneurship, the old adage “you must spend money to make money” often rings true.
Once you’ve developed an innovative business idea, identified a market need, and created a value proposition, you need to acquire funding to get your company up and running.
The key to financing a business is keeping expenses as low as possible. You also want to ensure invested money is used to gain insight into how to proceed.
In the online course Entrepreneurship Essentials, taught by Harvard Business School Professor William Sahlman, entrepreneurship is described as the process of "spending money to produce information about future possibilities."
For instance, using funds to rent a beautiful office may be tempting, but leveraging it to run tests, conduct market research, or identify more efficient means of production can help you learn about your product, pivot accordingly, and expand your company’s growth potential.
Here’s a guide for assessing startup costs and expenses, along with four business financing options to consider.
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Securing adequate funding for your business can be challenging. However, it’s important to remember that starting your own business is a large investment that should be given an appropriate period of time to succeed.
Often, new businesses need to raise funding quickly and efficiently to properly grow and thrive in their given market, but it can be difficult to adhere to various lending requirements without existing financial information. In spite of these challenges, there are various financial resources that can help you get your business off the ground.
Evaluate Startup Costs and Expenses
Before deciding how to finance your business, determine how much money you anticipate needing for startup costs and regular expenses. Whether you run a brick-and-mortar or online business, consider the following when taking stock of expenses:
- Licenses and permits
- Trademarks, copyrights, or patents for your brand and products
- Business insurance
- Legal or accounting assistance
- Rent and utilities (for brick-and-mortar businesses)
- Equipment required for production
- Website platforms
- Marketing materials (both print and digital)
- Shipping supplies
- Subscriptions to content management systems and sales or marketing platforms
- Market research
As your business scales, you may need to expand your expense list to include:
- Employee salaries
- Rent and utilities for office space
- Travel expenses
- Conferences, conventions, and networking events
These lists aren’t exhaustive—every business’s needs are different—but they provide a starting point for you to brainstorm all possible expenses for your startup. When your list is complete, calculate your total estimated startup cost. This number is the amount of funding you’ll need to invest when starting your company.
Before raising capital, it’s also wise to familiarize yourself with how to read and create a balance sheet, income statement, and statement of cash flows. Financial literacy is a critical skill for entrepreneurs, and being aware of these financial statements will ensure you’re taking the necessary steps to become a responsible business owner.
Now, how do you obtain this necessary capital? Here are four sources of funding for your business’s launch.
Related: 6 Questions to Ask Before Starting a Business
How to Finance a Business
1. Self-Funding
If your projected expenses add up to a manageable amount, you may be able to fund the business yourself. This can involve taking money from your personal savings account, dipping into your retirement funds, using credit cards and paying back the debt, or asking for donations from friends and family.
Self-funding comes with the risk of long-term debt or losing personal savings and, potentially, money from loved ones. However, it’s a financing option that allows you to retain full ownership over your business, which is often seen as a downside of raising venture capital from investors.
2. Crowdfunding
If you believe your business can garner a fan base, crowdfunding could be a good option. Crowdfunding platforms, such as Kickstarter, Indiegogo, and Patreon enable entrepreneurs to pitch their products and request financial backing.
If people are intrigued and support your product, they can donate to your company in exchange for a free item, discount code, or acknowledgment once your business is up and running. For this reason, crowdfunding is typically a good fit for business-to-consumer startup companies with physical products, although there are exceptions. Each platform has its own terms and conditions, which you should read before selecting one.
Like self-funding, crowdfunding allows you to maintain full ownership of your company, as long as you’re willing to thank your donors with free or discounted products. A few brands that got their start using crowdfunding are Oculus, PopSockets, and Allbirds.
3. Taking Out a Small Business Loan
Applying for a small business loan is another way to secure necessary startup funds. Before applying to banks and credit unions, prepare a business plan, value proposition, expense report, and financial projections for the next five years. Most banks or credit unions will ask to see some combination of these documents when considering your application.
Be sure to weigh the pros and cons of every bank loan offer you receive. Which gives you the lowest interest rate? What are the terms and conditions?
As Sahlman says in Entrepreneurship Essentials, “The terms of financing have a major impact on the success or failure of a venture.”
Related: What Does It Take to Be a Successful Entrepreneur?
4. Raising Venture Capital from Investors
Another avenue for funding your business is raising venture capital from investors.
“Successful companies are always forming hypotheses and testing all aspects of their business,” Sahlman explains in Entrepreneurship Essentials. “Ventures typically need outside investors to run experiments.”
Before reaching out to investors, prepare a business plan, value proposition, financial projections, and a tight, effective pitch deck.
The process of obtaining venture capital has been likened to dating—investors typically want to get to know you and your business before they commit.
One way to start this process is by asking a mutual connection to introduce you to investors. Your contact can serve as a character reference, if needed.
This process can take a while. If you’re looking for quick, easy money to start your business, raising venture capital may not be the right choice. Investors often want to see how you run your company before deciding to invest. Even after they supply funding, they may bide their time to see what you do with the money before investing more.
“Sensible investors stage their commitment to a company—they give enough money to conduct a value-changing test,” Sahlman says. “They preserve the right to abandon the venture by refusing to invest more money. They also design contracts that give them the right to invest more if the test yields encouraging results.”
There’s one factor that sets this option apart: Investors want to own a large, valuable share of your company in return for their investment. This allows them to sell their share in the future, when they predict your company will be worth a lot of money.
In Entrepreneurship Essentials, Sahlman shares Facebook’s journey with various investors and notes that it received $500,000 from angel investor Peter Thiel in its first round of funding in 2004. Just one year later, Facebook received a $12.7 million investment from prominent venture capitalist Jim Breyer.
Resist the urge to go big right away. Perhaps raising venture capital from investors is a second or third step for the funding of your business.
What's the Best Way to Finance Your Business?
Keep in mind that no two businesses are the same—only you know the ins and outs of your company’s needs. By weighing the risks and rewards of each funding option, along with your personal finances, predicted startup costs, and business expenses, you can select the best option for financing your business.
Are you looking to learn more about financing your venture? Explore our four-week online course Entrepreneurship Essentials and our other entrepreneurship and innovation courses to learn to speak the language of the startup world. If you aren't sure which course is the right fit, download our free course flowchart to determine which best aligns with your goals.
This post was updated on June 3, 2022. It was originally published on August 4, 2020.
