Money is the most critical element in starting and running a business and an entrepreneurhas to find ways to get funding for his small business. There are different options that an entrepreneur can look at to fund his small business and each come with its own pros and cons. We take a look at some of the options and the things that an entrepreneur has to keep in mind.
Self funded: One of the easiest and surest ways of starting up and being an entrepreneur is to invest your own money in the business. Your own money has no strings attached to it and you can pretty much do what you want to. A business can be self funded through personal savings, but it does have some limitations. You may not have the optimum amount of money needed to start the business and the risk of using your savings to fund a business that may or may not work is always risky.
Bootstrapped: When a business is generally self funded, the entrepreneur may choose to bootstrap. This happens when the entrepreneur uses the cash generated by the business to keep it running and also grow the business. This is an ideal way to run a business, since the entrepreneur keeps complete control of the company and in fact does not have to pay any additional amount as interest that comes with every loan that one takes. On the flip side is the fact that money is again limited and growth for the business may be slow. Also, during economic uncertainty, cash flow may dry up and may make it difficult to run the business.
Friends & Families: An entrepreneur can also raise money from their friends and family members to start their business. This allows an entrepreneur to have access to a greater sum of money, without the losing any control of the company. Such investment by friends and family generally takes place on a personal level and the entrepreneur often does not pay any interest on the amount he has raised. However, the entrepreneur has to return the money and this sort of investment is generally not long-term in nature.
Angel: Angel investors generally form the first level of institutional investment. An angel investor is someone who funds a business for equity in the company, which means he would have a say in the affairs of a company. The amount of money invested by an angel investor is generally not very large, but two or more investors may join hands to invest a larger amount or just to mitigate the risk of investing in a small company. For a business angel investor can play a very positive role in terms of providing greater credibility and also mentorship. However, the entrepreneur ends up diluting his or her stake and control over the company. An angel investor also expects to make a return on his investment, so the pressure to provide a favorable exit to the investor is always a part of the business.
VC: Venture capitalist of VCs write bigger cheques and generally come in after an angel round, but not necessarily in that order. VCs have a bigger amount at their disposal to invest and hence can really help a business in providing the necessary money to scale up quickly.
VCs generally have a longer horizon in terms of being a part of the company, which can last between 5-10 years. However, for a bigger sum of money, an entrepreneur will end up giving a greater slice of equity in the company. This means a VC will generally have a considerable say over the functioning of the company.
Banks and NBFCs: Banks have been the traditional source of fund raising for small businesses and continue to play a pivotal role. In fact, much before the venture investing ecosystem developed in India, banks were the only institutional source of finance that small businesses could look at. Since venture investing is not for every kind of business, entrepreneurs rely on banks and NBFCs for finance. A bank or an NBFC extends a loan to a business, which the entrepreneur has to repay with interest. This method of debt financing is popular since it leaves the entrepreneur with complete control of the company.
Businesses need to submit a business plan, basis which a lending decision is made by the bank or NBFC. However, the flip side of this form of financing is that regardless of the situation of the business, you have to pay the principle and the interest on the loan. Also, in the current scenario, it has become difficult to raise a bank or an NBFC loan.
Alternate source of finance: Alternate sources of finance are a recent phenomenon and has become popular in the last 2-3 years. Alternate finance like P2P has proved to be beneficial for small businesses who are struggling to raise money from banks and NBFCs. In a model like P2P, which is also clubbed as an NBFC, individual lenders extend money as a loan to small businesses through an online portal. Much like other types of loans, an entrepreneur has both the pros and cons to contend with before taking a loan or funding through alternate modes of financing.