“It’s like borrowing money from a mob boss—under the right set of circumstances, it can make sense.”
If you’re thinking about launching a new business there are basically three financing options available: equity, debt and bootstrapping. Choosing how and where to finance your business is no small decision–and can literally make the difference between realizing your business dreams or losing control of everything you’ve created.
In a recent interview with Rod Kurtz, Editor-at-Large with American Express OPEN Forum, serial entrepreneur and investor Rob Adams shares hard-earned insights about financing that every potential business owner should thoroughly grasp.
“What are the main types of financing available to entrepreneurs?”
The three types are equity, debt, and bootstrapping. Equity, most entrepreneurs know as venture capital. Debt, most people know as borrowing money from a bank. And bootstrapping is that the business generates enough cash from the start to not require any outside funders.
“I hear a lot about venture capital. Seems like there’s always a new startup in the news raising millions, which is obviously tempting. How do I know if it’s right for me?”
Venture capital is a form of private equity, and by definition, it means you’re selling a piece of your company. It typically applies to business models that are tech or life sciences, because they can be super high-growth and profitable, but cash-flow negative. When they’re cash-flow negative, they have no assets to collateralize, which is why it’s such a high-risk, high-reward business. And the investor owns a percentage of a higher-risk company. Regardless of urban legends, I can own one percent of your company and control 100 percent of what you do, through a concept of management rights. What I like to say, it’s like borrowing money from a mob boss—under the right set of circumstances, it can make sense, but you need to know what you’re doing.
“Debt is the one I’m most familiar with. Does this make more sense for a company like mine?”
Debt or bank loans make the most sense when there are reasonable assets involved. The classic example is manufacturing—I’ve got an assembly line, I’ve got work in progress, I need a new welding machine for $100,000 and it’ll help produce an additional $150,000 of cash flow for the company, more than enough to cover it. I go to a bank, they collateralize the welding machine, so if I fail to pay back this debt, all they do is take that welding machine back. Debt is far more management-team friendly, because they have the rights to a specific asset if the company doesn’t perform, as opposed to the entire company. Anyone who’s borrowed money for a car or has a mortgage knows how this works: If you stop paying, they repossess.
For details on the third option for startup financing, bootstrapping, and other tips on how and where to finance your business, see If You Could Ask an Investor Anything, What Would It Be?
Other articles on new business funding:
- Angel Investing and All That Money Stuff
- Three Hints for Funding Clean Energy Startups
- What Questions Will an Investor Ask You?
- Age of the Thrifty Entrepreneur
Photo: Zef Nikolla/Nasdaq