Most small businesses are started or expanded with money from one of seven readily available sources. They are in order of frequency:
- the savings of the person starting the business
- money from close friends and relatives
- scaling back cash requirements and substituting creative cost-cutting for financial equity
- selling or borrowing against equity in other property
- money from supporters or others interested in what you are doing
- bank loans, and
- venture capital.
I recommend never financing a business with only borrowed money, even if it’s possible. If you’re starting a new business and use your own money or sell equity, you can make your inevitable start-up mistakes cheaply and survive to borrow money later, when you know how better to use it. My general rule is that you should borrow less than half of the money you need, especially if you’re starting a new business.
If you’re expanding an existing business, make sure that you can handle the cash payments necessary to repay the loan even if business isn’t as good as you hope. In other words, it’s usually more dangerous to borrow too much than too little. If you have to raise nearly all the money from others, I recommend selling equity instead of borrowing. Now let’s look at each of the most likely funding sources for new and expanding businesses in more depth.