The Worst Small Business Financing Strategy Ever?
There are many mistakes that a small business can make when it comes to financing. The worst of these mistakes is being mislead by the idea that you should use your own money as an investment to get started. It makes sense to think, "If I invest $100K into my company, then in 18 months I'll have $200K, which will allow me to grow my business." But this is not how investing works, and it almost always leads to disaster for small startups.
In the first year alone you will likely spend more than that on legal fees, equipment purchases and other start-up costs. If you get in the habit of assuming that you'll have more than a year before your investment will be self-sufficient, then you won't ever hit a point where the rest of your expenses start to exceed the amount that comes in. Still, if you thought you needed $100K to get started, this is not "your own money" but "borrowed money" that will be returned after a few years. As a result, almost all small business owners end up taking more money out of their company than they put in.
This mistake is also sometimes known as "equity financing", which sounds like it would work better than just calling it "lending against your own equity.
It's more accurate to call it "equity-based financing". For instance, if you're starting out in an industry where lots of new companies fail, then you should be very cautious about relying on equity financing. You'll almost certainly spend most of your time in debt service, which will cause your company to struggle with cash flow issues and generally make life miserable for the owners. "Equity" is a much better description for what you're using.
Another reason why this strategy is not as good as it sounds is that the money "you" are lending hasn't really been yours yet. This is a very important point that young entrepreneurs often overlook. If your business does not get financed, you won't be able to make the business work. This is what happens to most startups that are funded with "investments" from friends and family instead of a real lender.
The reality is that you can't repay your "loan" from your sole income. Instead, the goal of equity financing is to raise enough capital that you can pay off the loan early and avoid these problems. Leaning on friends and family is often an easy way for young entrepreneurs to think that their business could make it without any sort of outside investment at all, when in reality they need large amounts of money to get started. Equity "investors" usually get a cut of the profit and their input is limited to strategic decisions.
Leaning on friends and family almost always becomes a problem when business struggles start to happen. When you're starting out, it's best not to even think that you won't need outside financing; however, the best business owners are already considering ways that they could reward their investors for their support. For example, you can give early investors preferred stock in your company and get out of debt faster. People who take equity in your company should share some of the risk with you, but not all of it.
Of course, you can also just give them stuff.
Equity financing does not work very well for young companies, and without a lot of outside investment it is usually much easier to get started. In the long run, this is better for the business because investors will be more willing to invest when it's clear that your company will have a future. Plus, entrepreneurs rarely have the time and resources to fund multiple startups. Instead, they should focus on building one successful business and then doing all they can to keep that business growing once it's established.
Another important thing to remember about equity financing is that the interest you pay will be much higher than you would on a regular bank loan. The main reason for this is that the lender wants to get repaid as soon as possible and will therefore demand a ridiculously high interest rate.
In addition, it's not a very good idea to try to pay all of your expenses with just one source of revenue. It's usually better to keep some operating money in the company and have a small amount of personal savings held away in case your business fails, plus a little extra money set aside for emergencies.
Equity-based financing is not a good idea for small businesses. It's usually a bad idea to start a business to get rich, so avoid treating your startup like an investment in the stock market.
Most young entrepreneurs overestimate how quickly their business will succeed and underestimate how much money they'll need to get started, which is why most startups fail within the first two years. To prevent this from happening, it's important to stick with the basics of starting up: do what you enjoy and charge enough money to keep your business self-sufficient.
If you follow these guidelines and use them to create a working business plan, then you will almost certainly be able to get started with your small business with the money that's already in your bank account. This is how most small businesses are started.
What are some other mistakes young entrepreneurs make? Let us know in the comments below!
*Image from Pinterest.
Related:
The Top 7 Mistakes Small Business Owners Make
4 Things That Keep Entrepreneurs Up At Night
Photo credit: SharkDoggz on flickr.com, modified.
Too much valuable content? You'll never run out of ideas or information when you read fresh content from our blog each day. Our daily email serves up an update from the site and a dose of inspiration for the day ahead delivered to your inbox every morning. Yes, sign me up! I want to join the exclusive club of Tinypass Insiders! We hate spam too and won't ever sell your information or send you unnecessary emails (we also use cookies so that we know not to) - we promise. Thank you for your trust.
(Visited 5,849 times, 1 visits today)
Comments:
Sales Page Preview
comments so far. Comments posted to EasyBranches will be reviewed and approved within 24 hours. rarefishingblog.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to amazon.com and affiliated sites.
Conclusion: Equity financing is usually a bad idea for small businesses. It's usually a bad idea to start a business to get rich, so avoid treating your startup like an investment in the stock market. Instead, follow these guidelines and use them to create a working business plan, then you will almost certainly be able to get started with your small business with the money that's already in your bank account. This is how most small businesses are started. If you follow these guidelines and use them to create a working business plan, then you will almost certainly be able to get started with your small business with the money that's already in your bank account. This is how most small businesses are started.
Comments are closed after 60 days.