Financing Youself: The Benefits of Risk

March 10, 2009sparxoo_admin

A Guide to Financing Your Business With Personal Funds

By Ethan Lyon, Senior Writer

While your dream may be to meet that VC firm with deep pockets, the reality is only 0.1% of businesses realize that opportunity. That’s why you need to be your first line of financing. Put your money where your mouth is and finance your business with personal funds. Remember, you are your greatest advocate.

It’s risky. But as we’ll outline in this post, risk can be a good thing. Actually, the more risk you take might help you later down the line when you decide to knock on the VC or angel investors door. Let’s start with the implications of financing yourself.

Spin: The Drawing Board

Before you begin to finance your business with personal funds, consider the risks. If your business fails, are you going to accept the possibility of such a financial loss? Stable personal finances while in the preliminary stages of your business development will help you can absorb any losses.  A great way to start a business is to moonlight on your new business while fully employed and collecting a paycheck.

Entrepreneur.com compares the concept stage of your business to an unhatched egg. The incubation process can be expensive. Do your upfront market research and planning while you are getting paid.  Figure out how much time and money it is going to take to start your business. Get honest about your finances before entering into a business endeavor so that you are prepared for challenges along the way.  Many businesses fail because they don’t have adequate funding for unforeseen delays or setbacks.

Our team recently met with an entrepreneur with a compelling idea.  But he was completely unprepared financially.  He was putting consultants on credit cards with the hope of getting investors to pay them off later.  This is not the best idea.  You don’t want to go into a financial tailspin trying to start your business or keeping it afloat.

How to Self-Finance
Before you go to a venture capitalist or an angel investor, make some progress on your own. Can you fund initial startup costs?  Can you tap into friends and family for help?

“Hello Uncle Larry, remember me…”
Friends and family are a great place to start. You might not need to seek additional investors if you can fund your business through established relationships. Consider the consequences of borrowing from family and friends. If your business fails, are you financially obligated to pay those from whom you borrowed?  Even if you are not obligated, will you destroy relationships?  Contracts might be your solution to relationship-ruining borrowing practices. Outline terms of agreement before borrowing and identify potential outcomes (including the scenario where they lose all their money).

Other avenues of fundraising by yourself
There are alternatives to funding your business through family and friends. Though the risks might be much higher, you can sell assets, borrow against your home, take out credit cars, tap into your IRA funds or borrow against your 401(k). These are very risky and might land you in serious financial straits. It is best to avoid financing in this way because you could lose everything very quickly if your business doesn’t become an immediate success.

Benefits of Risk
Venture capital firms and angel investors are interested in your business proposition, as well as the decisions you’ve made along the way. The more smart and successful risks you have taken to get to the venture capital firm, angel investor or bank, the more they will take your business seriously.

On the one hand, a second mortgage and credit cards show that you have a lot on the line if your business fails. This ensures that you are going to do everything in your power to not only keep the business afloat, but make it successful.  On the other hand, be careful not to put yourself in a personally disasterous financial situation as this will raise red flags about your financial management capabilities.

Looking Forward

According to the Small Business Administration, 66.6% of small businesses survive at least two years and 44% pass the four year mark. Those odds are not there to discourage you. They are there to make you think long and hard about financing your business. You need to understand the risks of your endeavour before taking the plunge. Additionally, in todays business environment startups have a more difficult challenge. But there are opportunities born from crisis. Use the market to your advantange and be a part of the 44%.