The Kauffman Foundation released the below graphic about the funding sources used by new businesses. The businesses’ lists were generated from Inc. Magazine’s annual
rankings of the fastest
growing businesses in America. Those businesses were surveyed to determine the type of funding utilized.
A common mistake made by business owners is launching a business with debt financing. I was happy to learn that 67.2 percent of the businesses surveyed started off using personal savings, often referred to as ‘bootstrapping’, instead of taking on debt. Furthermore, 13.6 percent of the businesses have not used any kind of debt financing.
The results of this survey help dispel a couple of myths surrounding external financing. For instance, new businesses have unrealistic notions that they can start their business with government grants, angel investors or venture capitalists. Notice that the chart reflects only 3.8 to 7.7 percent were able to tap into those funding streams. These methods are not relevant for most start-ups unless an incredible innovation exists that can be successfully scaled in a short amount of time. After over a decade of working with entrepreneurs, I have yet to meet someone who received a government grant to start their business. Remember, as a rule of thumb, external funders want to recoup their investment quickly while receiving a nice return on their investment. Also, you will likely be giving up some equity, or ownership, of your company.
Credit card debt is the absolute worst kind of debt you can take on, yet 34 percent of respondents fall into this category. If credit card balances are diligently managed and balances paid off regularly, then it may provide short-term solutions to enhance cash flows or cyclical fluctuations. Several businesses make a catastrophic error by solely using credit cards to finance their business – ultimately leading to the demise of their companies. After all, it’s “easy cash” meaning that the business owner isn’t held accountable or required to justify expenditures. A typical scenario plays out like this: a business owner allows their credit card debt to accumulate, sometimes even reaching the maximum available credit. The business hasn’t secured enough sales to pay off the balance, so he or she starts making minimum payments. They are now accumulating high interest rates on top of the monthly balance. Business owners that use their personal credit cards can make the situation even messier. I have encountered a few companies whose credit card debt reached $40,000 and, sadly, their business never got off the ground. As a result, they had to close their business and file for bankruptcy.
The best way to start your business is with your savings. It allows you to have full control of your business while you reap all the benefits of your success. If you have a business idea, determine the amount of money needed to start phase I. Try to save until you reach the initial amount needed to launch your business. Keep the operations as lean as possible while you launch as most people underestimate the amount needed to enter a market. Now you can set your sights towards your next goal in phase II. At this point you will likely have confirmed whether or not you were correct about the market conditions and have hopefully achieved a nice sales volume. Now you have historical data reflecting the cyclical flows of your business and ‘skin in the game’, meaning that you have personally taken on risk (investors look for both). You are also in a much better position to create realistic projections or forecasts based off of your historical data – not to mention a firmer calculation of how much investment is needed to reach subsequent stages.
Be smart about the kind of money used to launch your business. You have everything to gain but a lot to lose.