The Wall Street Journal recently detailed trends in how startups are financing themselves. If you don’t have a Journal subscription, this article will likely be behind a paywall, but to sum it up, young businesses are using bank loans and home equity loans less than in the past, owing to continued cautiousness from lenders following the Great Recession. Instead, they are relying on their own savings and family loans and high interest personal credit card debt.
Bank loans to businesses still exist, but they typically require two years of business activity. This is of course no help to businesses that require a cash infusion to get started, though it can be helpful for more established businesses who want to expand their business or to smooth cash flow. Personal credit card debt is relatively easy to obtain, but the interest rates are high, and if your business fails, you’re in a far worse position than when you started.
For those who want to start a business but don’t want to potentially blow their personal savings on a venture or be stuck with high interest credit card debt, the lower risk alternative is to sell equity to outside investors. You are giving up some of your business’s upside, but receiving financing that does not immediately (or perhaps ever) need to be paid back may be worthwhile for some companies. The Journal article mentions crowdfunding as a means to obtain equity capital, and while this is a young and developing form of offering equity, it has the potential to be a common and viable method for startups to finance themselves. Even when crowdfunding does become more commonplace, it will likely still be hard for completely new businesses to receiving financing, unless the founders have already had demonstrated success with other ventures. However, there is always the possibility of friends and family equity financing to jumpstart ventures to get to the point where they can then seek financing from the crowd.
Finally, even though there are many challenges involved with fundraising for new businesses, the silver lining is that in many cases, the cost of starting a business is far less than in the past as a result of recent developments in technology and the rise of the gig economy. Taking my own business of launching a law firm, in the past, I would have had to rent expensive office space, hire an assistant and full-time attorneys, etc., all of which requires a significant initial outlay. Now, a lawyer can run a virtual firm and have work performed on a pay-as-you-go, project-by-project basis. Pretty much the only significant initial outlay is the cost of a website. Accordingly, despite the challenges in raising funds in the current environment, it’s as good a time as any to launch a business because, in many cases, less financing is required.