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Borrowing from banks is every small
entrepreneur's nightmare. One gets turned down
for bank loans for a variety of reasons,
including lack of assets, collateral and business
experience. Don't despair, however. There are
several common types of alternative sources of
capital for setting up a business available to young companies.
Savings and Investments
The first source you should consider is your own
savings and investments. One disadvantage though
of self-financing is that if things did not turn
out the way you want them to be it will be your
money that goes down with the ship.
Angel investors are affluent individuals who
provide capital for a business start-up, usually
in exchange for ownership equity. These
individuals are looking for a higher rate of
return than would be given by more traditional
investments (typically 25% or more).
Angel investors are an excellent source of early
stage financing and high-growth start-ups. They
are often willing to tread where there is too
much risk for banks and not enough profit
potential for venture capitalists. And since
angel investors are often retired business owners
and executives, they can also provide valuable
management advice and important contacts.
Peer to Peer Lending
Peer-to-peer lending is a means by which
borrowers and lenders may transact business
without the traditional intermediaries, such as
banks. It can also be known as social Lending,
ordinary people lending money. The process may
include other intermediaries who package and
resell the loans--examples are Prosper.com and
Zopa-but the loans are ultimately sold to
individuals or pools of individuals. Prosper.com,
which is available in the US only, offers business loans for small companies.
An enabling technology for peer-to-peer lending
has been the internet, which connects borrowers
with lenders, for example through an auction-like
process in which the lender willing to provide
the lowest interest rate "wins" the borrower's loan. (wikipedia.com)
Instead of a bank loan, borrow smaller sums from
several family members, friends, or colleagues.
The lenders have no legal ownership in the
business, but can act as advisors and
cheerleaders for your venture. Remember though
that nothing causes tension in a family like
lending money that is never paid back.
Many business owners use their credit cards to
fund their businesses. Credit cards offer the
ability to make purchases or obtain cash advances
and pay them at a later time. But as a long-term
financing method, they can be expensive. Most
credit cards will charge you 2% to 4% of the face
value of a cash advance as a "fee" making this method of financing very risky.
Another source of capital for setting up a
business is bootstrapping. It is a way to finance
a business by saving rather than borrowing money.
It's being as frugal as possible so your business
can be started on as little cash as possible.
The use of private credit cards is the most known
form of bootstrapping, but a wide variety of
methods are available for entrepreneurs. Other
forms of bootstrapping include owner financing,
minimization of accounts receivable, joint
utilization, delaying payment, minimizing inventory and subsidy finance.
While bootstrapping involves a risk for the
founders, the absence of any other stakeholder
gives the founders more freedom to develop the
company. Many successful companies including Dell
Computers were founded this way.
Venture capital is not suitable for all
entrepreneurs. It is an option for small
companies that have a seasoned management team
and very aggressive growth plans; however,
venture capitalists will rarely invest in small
businesses that have no intention of going
public. If a company does have the qualities
venture capitalists seek such as a solid business
plan, a good management team, investment and
passion from the founders, a good potential to
exit the investment before the end of their
funding cycle, and target minimum returns in
excess of 40% per year, it will find it easier to raise venture capital.
The venture capitalist objective is to invest in
a company for a short period of time say 5
years and then cash out of the business while
making a significant return on their investment.