Here’s the big picture: there are three basics ways to raise money for your start-up: (1) use your own savings and any revenue your start-up may produce (the fancy term of art for this is “bootstrapping”); (2) you can borrow the money; and/or (3) you can sell part of your business to investors. These are not mutually exclusive options; many companies raise money using as many as all three of these options.
Bootstrapping is great because your company will not have to worry about repaying debt. Major problems with it, though, are: (1) your start-up may need more money than your bootstrapping can provide; and (2) even if you can afford to keep funding for the foreseeable future, all the risk is on you. This is why even serial entrepreneurs who have made fortunes from prior startups typically do not fund a new company they found by themselves.
The option of borrowing certainly spreads the risk to others. And, if the interest rate at which your start-up can borrow money is low enough and if the other terms to which it must agree to be bound under the loan documents with its lender are reasonable enough, borrowing can be an excellent option. Those are big “ifs,” however.
Taking on investors (a/k/a partners if a limited partnership, shareholders if a corporation, or members if your start-up is organized as an LLC) avoids the risk of defaulting on a loan and the expense of interest. However, once someone else has an equity stake in your company, they may have a seat at the table with respect to many decisions going forward because such investors will be equity holders of your company.
The expression “the devil’s in the details” is appropriate when approaching financing. Three examples:
So, if you go back and read my first paragraph, you can rightfully point out that it is misleading. Well, guilty as charged but I did that with intention.
My point here is this: if you bootstrap and that bootstrapping involves taking money out of your pocket and putting it into the company’s bank account, you need to figure out what the legal and business relationship between the company and you is with respect to that transaction. In other words, will it be a loan or an equity infusion? The answer will depend on the answer to several questions about your particular situation.
If you are starting a business that you intend to own and operate, that business can be called a start-up in the sense that you are starting it up. You might start a repair business, a restaurant, a newsstand, or any one of an almost unlimited number of businesses and you could call each a start-up. That is not the way the term is generally used, however.
The term start-up is really reserved for a newly forming, or recently formed company that has the potential to scale to a very large business that can make its founders, early employees, and early investors very wealthy. At least that is the way Financial Poise uses the term.
But we can get even more precise: if you are experienced in this area, you may want to fault me for using the term start-up to include companies that are both in the very, very early stages and those that are in merely the early stages.
In other words, this was another intentional oversimplification. But I think you can handle the truth now: the term start-up is, depending on how precise you want to be, narrower. The following chart shows you what I mean:
|Seed stage||Concept or product development|
|Start-up stage||Operational but still developing product or service; no revenue; less than 18 months|
|Early stage||Product or service in testing/pilot production; maybe revenue; less than 3 years|
|Expansion stage||Significant revenue growth, maybe profit; more than 3 years|
|Later or mature stage||Positive cash flow, profit; typically more than 10 years|
Early investors in start-ups are commonly broken into the following categories:
©All Rights Reserved. December, 2020. DailyDACTM, LLC d/b/a/ Financial PoiseTM
Jonathan Friedland is a principal at Much Shelist. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts Magazine; Smart Business Magazine; The M&A…
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