There are plenty of stories about people "bootstrapping" startups with their own money. That's not always possible. Many startups come to the point where they have to depend on investors.
When doing so, it's important to know the different types of investors. The most common types are:
- Angel investors
- Peer-to-peer lenders
- Venture capitalists
- Personal investors
Regardless of which investor you choose, get it in writing with forms from our business center.
A bank loan may be available to help you with startup costs. A bank will want to see a detailed business plan and a thorough description of your business and its prospects. A business proposal document also states the product or services being offered, your financial and management projections, and how you plan to implement your goals.
It's easiest to get a loan when you go to a bank with which you already have a relationship. Be prepared to prove financial responsibility and wait the time it may take to process the loan.
Check into seeking a loan backed by the Small Business Administration. The SBA sets guidelines for its partners-including lenders, community development organizations and microlending institutions-to follow. It guarantees that the loans will be repaid, adding some leverage to help the lender decide whether to loan you the money.
There are three different loan programs:
7(a) loan program
Eligibility for a 7(a) loan program comes by meeting certain requirements. Among them is owning a business impacted by NAFTA, implementing pollution control requirements or seeking a loan from a small community/rural-based lender. Check out the website to learn about these and other possible areas that may be eligible for a 7(a) loan.
Small businesses may be eligible for an SBA-backed microloan. Microloans are available for up to $50,000 while the average loan is about $13,000. Microloans, according to SBA, can be used to provide working capital or buy inventory or supplies, furniture or fixtures and machinery or equipment.They can't be used to pay existing debts or buy real estate.
504 loan program
The 504 loan program, administered through Certified Development Companies, provides small businesses with the assets needed to expand or modernize. It covers expenses including:
Buying existing buildings
Buying land and making improvements
Building new facilities or modernizing, renovating or converting existing facilities
Buying long-term machinery
Refinancing debt to help a business expand through new or renovated facilities or equipment
SBA states that a 504 loan is often structured so that the SBA provides 40 percent of the project cost and a participating lender pays up to 50 percent. That leaves you to cover about 10 percent.
A bank, even when seeking an SBA-backed loan, will want to see a solid business plan. It helps having personal experience in the industry or a good mentor who is well versed in the industry. You may also have to talk collateral, including possibly a home equity loan, and provide as much startup cash as you can.
Bank lending is also more conservative than it was before the mortgage crisis of 2007. Be ready to make your case.
There are angels on your side when it comes to seeking outside financing. This type of investor is typically an entrepreneur who has enough wealth to help others. Angel investors invest in businesses in which they believe but they realize may struggle to find other financing.
An angel investor may buy stock from a company or make a loan. Some serve as mentors and advisors. Some may specialize, such as high-tech angels who prefer helping to bring new technology to the marketplace and may or may not want to actively participate in the company.
Another type is a return on investment angel, who expects to see a financial payback from a high-risk investment. Return on investment angels are more likely to invest when the economy is stable or improving. They may not want to be involved past investing but are often hopeful that they will get a huge payoff if the company goes public or gets purchased by a bigger corporation.
Considerations when approaching angel investors include:
- How much control does the investor expect?
- How much control are you willing to share?
- What is the investor's motivation?
- How experienced is the investor?
- Does your venture meet the investor's investment requirements?
A promissory note spells out the repayment terms of the loan. We offer a promissory loan document template for free.
Welcome to starting a business in the high-tech world of today. Peer-to-peer lending lets people list projects online for consideration by potential investors. This type of investor brings the startup and small business owners together with entrepreneurs willing to help and invest.
Prosper and Lending Club are among websites that specialize in peer-to-peer or P2P lending. "We cut out the middleman to connect people who need money with those who have money to invest," Prosper states on its website.
Peer-to-peer lending steps, shared by the Small Business Administration, include:
Have a plan. Make sure to include what you find out from market research, competitive analysis, financial forecasts, expected returns and more.
Tell your story. Tell what you hope to achieve and what your background is.
Share your achievements and progress. Basically, sell yourself and your business. How much have you invested yourself and at what stage is your business? What milestones have you reached? You want to prove to potential investors that your business is on the path to success. Going peer-to-peer lending may cut out the middleman, but not financial common sense on the part of investors.
Your credit history plays a part in whether you can engage in peer-to-peer lending. You grant access to your credit score when you apply for a peer-to-peer loan. This type of investor may require you to improve your credit history before finding you loan-worthy.
If engaging in peer-to-peer lending, make sure you understand the terms of your loan and make payments on time. Falling behind can increase your fees and prevent you from seeking another peer-to-peer loan.
Check in your state to see if there are any specific regulations concerning peer-to-peer lending. Our On Call legal service can help you find a local attorney with that knowledge.
Once you've proven yourself a bit more, it's time to consider venture capitalists. This type of investor expect you to show you have a solid business plan. A venture capitalist also wants to see a high return of profit.
Venture capitalists may invest as much as millions of dollars. They will invest the money needed to help that happen. They do that by securing equity capital, or a share in your company. They are betting that the share will be worth more within time and will wait to get a return on the investment.
Giving up that equity capital means giving up some ownership or say in the company. Venture capitalists may also want a steeper return on their investment than what the interest rate may be on a business loan.
Consider having all parties sign a limited partnership agreement to spell out the rights and duties of each partner.
Your friends and family may be willing to lend you the cash to start a business, and you may be willing to take it. But think twice before heading in this direction.
Mixing business with family is risking, bringing business disputes to family gatherings and other events. You risk hurting not only your finances but also a relative's or friend's if the business doesn't take off as well as you anticipate. There are stories about people successfully choosing this option, but before you do, make sure your family ties are strong enough to withstand the pressures of doing business. Have each party sign a promissory note that spells out the repayment terms or, if you are partnering with a friend or family member, sign a partnership agreement.
These are the different types of investors that may help you launch your dream company. Remember, each situation is different, and take legal precautions before reaching out to any investor. Our On Call attorney service can match you up with a lawyer well versed in business law.