7 sources of start-up financing
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Putting all your eggs in one basket is never a good business strategy. This is especially true when it comes to financing your new business. Not only will diversifying your sources of financing allow your
Keep in mind that bankers don't see themselves as your sole source of funds. And showing that you've sought or used various financing alternatives demonstrates to lenders that you're a proactive entrepreneur.
Whether you opt for a bank loan, an angel investor, a government grant or a business incubator, each of these sources of financing has specific advantages and disadvantages as well as criteria they will use to evaluate your business.
Here's an overview of seven typical sources of financing for start-ups:
1. Personal investment
When starting a business, your first investor should be yourself—either with your own cash or with collateral on your assets. This proves to investors and bankers that you have a long-term commitment to your project and that you are ready to take risks.
2. Love money
This is money loaned by a spouse, parents, family or friends. Investors and bankers considers this as "patient capital", which is money that will be repaid later as your business profits increase.
When borrowing love money, you should be aware that:
- Family and friends rarely have much capital
- They may want to have equity in your business
- A business relationship with family or friends should never be taken lightly
3. Venture capital
The first thing to keep in mind is that venture capital is not necessarily for all entrepreneurs. Right from the start, you should be aware that venture capitalists are looking for technology-driven businesses and companies with high-growth potential in sectors such as information technology, communications and biotechnology.
Venture capitalists take an equity position in the company to help it carry out a promising but higher risk project. This involves giving up some ownership or equity in your business to an external party. Venture capitalists also expect a healthy return on their investment, often generated when the business starts selling shares to the public. Be sure to look for investors who bring relevant experience and knowledge to your business.
BDC has a venture capital team that supports leading-edge companies strategically positioned in a promising market. Like most other venture capital companies, it gets involved in start-ups with high-growth potential, preferring to focus on major interventions when a company needs a large amount of financing to get established in its market.
Angels are generally wealthy individuals or retired company executives who invest directly in small firms owned by others. They are often leaders in their own field who not only contribute their experience and network of contacts but also their technical and/or management knowledge. Angels tend to finance the early stages of the business with investments in the order of $25,000 to $100,000. Institutional venture capitalists prefer larger investments, in the order of $1,000,000.
In exchange for risking their money, they reserve the right to supervise the company's management practices. In concrete terms, this often involves a seat on the board of directors and an assurance of transparency.
Angels tend to keep a low profile. To meet them, you have to contact specialized associations or search websites on angels. The National Angel Capital Organization (NACO) is an umbrella organization that helps build capacity for Canadian angel investors. You can check out their member’s directory for ideas about who to contact in your region.
5. Business incubators
Business incubators (or "accelerators") generally focus on the high-tech sector by providing support for new businesses in various stages of development. However, there are also local economic development incubators, which are focused on areas such as job creation, revitalization and hosting and sharing services.
Commonly, incubators will invite future businesses and other fledgling companies to share their premises, as well as their administrative, logistical and technical resources. For example, an incubator might share the use of its laboratories so that a new business can develop and test its products more cheaply before beginning production.
Generally, the incubation phase can last up to two years. Once the product is ready, the business usually leaves the incubator's premises to enter its industrial production phase and is on its own.
Businesses that receive this kind of support often operate within state-of-the-art sectors such as biotechnology, information technology, multimedia, or industrial technology.
MaRS – an innovation hub in Toronto – has a selective list of business incubators in Canada, plus links to other resources on its website.
6. Government grants and subsidies
Government agencies provide financing such as grants and subsidies that may be available to your business. The Canada Business Network website provides a comprehensive listing of various government programs at the federal and provincial level.
Getting grants can be tough. There may be strong competition and the criteria for awards are often stringent. Generally, most grants require you to match the funds you are being given and this amount varies greatly, depending on the granter. For example, a research grant may require you to find only 40% of the total cost.
Generally, you will need to provide:
- A detailed project description
- An explanation of the benefits of your project
- A detailed work plan with full costs
- Details of relevant experience and background on key managers
- Completed application forms when appropriate
Most reviewers will assess your proposal based on the following criteria:
- Assessment of expertise
- Need for the grant
Some of the problem areas where candidates fail to get grants include:
- The research/work is not relevant
- Ineligible geographic location
- Applicants fail to communicate the relevance of their ideas
- The proposal does not provide a strong rationale
- The research plan is unfocused
- There is an unrealistic amount of work
- Funds are not matched
7. Bank loans
Bank loans are the most commonly used source of funding for small and medium-sized businesses. Consider the fact that all banks offer different advantages, whether it's personalized service or customized repayment. It's a good idea to shop around and find the bank that meets your specific needs.
In general, you should know bankers are looking for companies with a sound track record and that have excellent credit. A good idea is not enough; it has to be backed up with a solid business plan. Start-up loans will also typically require a personal guarantee from the entrepreneurs.