Pros and Cons of Startup Financing Sources

By Iris Gonzalez
Margot Slosson startup financing sources

Margot Slosson is director of the LiftFund Women’s Business Center, a program of LiftFund, the largest micro and small business lender in the U.S. The nonprofit organization is headquartered in San Antonio, Texas and provides loans and business training to enterprises of all kinds—from startups to established businesses—in 14 different states.

As director of the Women’s Business Center, Slosson helps entrepreneurs successfully launch and grow their businesses with individual consultation, training, and targeted programs. She shares insights into the pros and cons of financing sources for startups or small businesses.

Whether you are launching a new business or growing an existing one, capital is essential to success. Founders have a growing number of funding options available—but which funding sources are best at particular stages in your business? What are the best ways to use funding?

Equity is cash paid into the business—either the owner’s cash or cash contributed by one or more investors. Understanding the pros and cons of common forms of startup financing like self-funding, external equity, and external debt can help entrepreneurs make informed decisions about how to secure the right kind of capital at the right time.

Bootstrapping or the self-funding a small business is often the first step in starting a company, especially women-owned small businesses. Self-funding or asking family and close friends for personal loans has the advantage of allowing owners to keep full control and ownership of the business but limits business growth potential. Many founders overlook external sources of funding as an option for growing the business beyond one’s personal means. Undercapitalized businesses also have lower survival rates, less overall growth, and lower rates of take-home pay for the owner.

External equity is funding entrepreneurs use to spread the financial risk of a business venture, while also requiring the entrepreneur to share the wealth and reward should the business venture succeed. Three common sources of external equity are angel investors, venture capitalists, and equity-based crowdfunding platforms.

Under the best circumstances, investing in a strong company can be a win-win situation. The most attractive businesses for equity investors are ones with a proven revenue stream of paying customers and a business model that can scale or grow significantly. Entrepreneurs also stand to gain more than capital from investors. The best investors provide advice, insights, and connections to help accelerate the growth and success of the business. And equity helps scalable businesses in need of large amounts of capital beyond the owner’s financial capacity.

Pursuing external equity is not for everyone. In exchanging ownership in your business for money, you lose some control. This depends on the amount of ownership you give and type of investors you take on, but you will be accountable to and need to report to others. The financial feasibility of your business taking on investors is another factor to consider carefully. If the business’ revenue potential is capped due to geographical constraints, government regulations, the entrepreneur’s desire to stay small, or other reasons, it will be difficult to appeal investors, let alone repay expected returns on investment.

As a business owner, you must consider if you are willing to give up a portion of your ownership and control in the business in exchange for raising capital. Be sure to detail how and when to pay your investors and the negotiated terms for the funding received.

External debt, which includes commercial loans, lines of credit, and crowdlending, are good options for small businesses and startups when leveraged properly. Debt allows you to retain full control of the business. Your lender will ask for your business plan and other documents to ensure you are financially prepared to take on new debt before they extend you credit—but they will not be involved in ongoing business operations, as long as you stay current on loan payments. As an owner, you alone are responsible for repayment, but that repayment has an end date, and there is no sharing of profits. In most cases, capital costs for debt financing will be less than the cost of capital for equity financing.

External sources of funding can help entrepreneurs start a business or scale the company for aggressive growth. Female entrepreneurs face additional challenges including social and professional networks with fewer economic resources, an unconscious association with less credibility and lack of legitimacy, investor gender biases favoring male founders (even by women investors!), and higher levels of risk aversion.

Women entrepreneurs can start by shifting their mindsets and attitudes about money and think of money as “an exchange of energy” (thanks to business consultant Jan Goss Gipson), one that upholds our value and addresses the unfounded links between women and a perceived lack of credibility. We can also embrace what makes us unique as female entrepreneurs. Women who are “risk averse” in reality are executing due diligence and taking calculated risks, desired qualities in a founder.

Entrepreneurship can be scary and lonely. Exploring external financing options that work best for your business equip you to grow your business beyond your resources as a single-employee company. Amongst the thousands of decisions you will make will be the ones about money: how to get, how to use it, and how to grow it. Research, ask questions, crunch numbers, and connect with those that have successfully obtained external funding to make informed decisions for your economic prosperity, as well as that of your community.

Featured image is a courtesy photo of Margot Slosson, director of the LiftFund Women’s Business Center, a program of LiftFund.

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