The Different Types of Capital for Business: A Beginner’s Guide
Building a business is not easy. And finding capital is even harder. There are many different sources of capital, but which one do you choose?
In this article, we delve into the different types of capital regularly used for businesses starting out, and help you pick the one that fits your needs. Let’s get started!
The Different Sources of Capital
When starting a business, there are a lot of different places where you can source the capital. Each source has its own pros and cons, and each source caters to specific goals,. Let’s take a look at some popular ones.
Personal Savings
When you start a new business, using your own savings can be a great way to get the money you need. In fact, around 78% of new business owners start their business with just their own savings.
The positive aspect of this choice is that you get to make all the decisions without needing help from other people or borrowing money. It shows others that you're serious and confident about your business. But, there's a risk – if the business struggles, it affects your own financial situation.
Imagine you want to start a small freelancing business. These kinds of businesses don't need a lot of money upfront, so using your personal savings makes sense. You can use the money for things like advertising, buying software, or finding your first clients. This way, you have full control over how your business runs.
Loans
Loans can also be a very good option as a capital source when starting a business. There are many different types. Personal loans, for instance, offer quick access to funds based on your credit score, making them suitable for small businesses such as a freelance service. On the other hand, business term loans provide predictability with fixed repayment terms, but they may entail longer approval times and stricter eligibility criteria.
For startups seeking government support, SBA loans backed by the Small Business Administration offer favorable terms, and can be anywhere up to $5 million. Microloans, often provided by nonprofits or community lenders, cater to very small businesses with modest funding requirements and may come with mentorship opportunities.
There are many more types of loans that could be relevant to your business. This article by Forbes outlines the 13 most common ones.
Government
If you don’t want to dip into savings or seek support from investors, you can explore grants and government funding. They are often financial ‘gifts,’ that you don't have to pay back, and they often come with the goal of promoting specific industries or innovations. However, the process of securing government grants can be bureaucratic, and there are usually strict criteria to meet.
An industry where grants are very common is that of eco-friendly products. A government grant focused on environmental initiatives could be your ticket to kickstart a business that creates sustainable alternatives. In the US, there are the EPA Grants, for example, specifically created to promote the creation of environment-friendly ventures.
If you’re building a business in the United States, you can go to Grants.gov, which is a free online resource that connects you with more than 1,000 federal grant programs, totaling to approximately $500 billion annually.
Angel Investors
You can also get a boost for your new business from individuals that are willing to invest early on using angel investors. These angels are usually experienced entrepreneurs or successful business folks, but they could also be friends and family.
The interesting part is that you don't have to pay them back right away, and they might offer valuable advice and guidance. It's like having a mentor who also believes in your business. But, there's a catch – you'll have to give up a share of your business in exchange for their support.
Venture Capital
You can turn to venture capitalists. It’s a step bigger once again. VCs are groups of investors or firms with money specifically set aside to support promising startups. With venture capital, you get a big financial injection with the added bonus of expertise and connections.
Venture capitalists not only provide funds but also bring know-how to the table. However, there's a trade-off – they become part owners of your business. This means sharing not only the risks but also the rewards if your business takes off. But that is definitely not a given; about 90% of VC-backed businesses end up failing.
While many VC-backed businesses fail, many of the companies everyone knows are also VC-backed. That’s because many companies that grow to unicorn-scale have VC money involved. Some examples include Snapchat, Zoom, Coinbase, and Instacart.
Private Equity
Private equity is another option. You can compare a private equity firm to a business partner that invests in your company in exchange for a stake. Usually, private equity firms don’t just invest, but also want to actively be involved in their investments. They bring expertise and knowledge to the table, but do want to have a say.
If you’re open to collaboration and need a significant sum of money, private equity could be a great option for you. The investors work closely with the business and give strategic guidance to make it a success. It does not fit every type of business, but can certainly be a great option.
How to Choose What’s Best For You?
Deciding what source of capital to pick is not easy. If your business is just starting and doesn't need a ton of money, using your own savings is a straightforward way to go. You're in control, but keep in mind, if things get tough, it impacts your personal money.
Now, if you're aiming for big growth and want some serious support, venture capitalists or angel investors can be your financial partners. They bring in a lot of money and allow for fast growth, but you'll have to share some ownership.
Loans are another route. Personal loans work well for smaller businesses that need money fast, while business loans are better for bigger ventures. Consider how much money you need, how quickly you want your business to grow and how much risk you want to take on.
Choosing how to fund your business boils down to what you want and need. Loans give you more control but come with more risk, as you're on the hook for repayments. On the flip side, venture capital lets you grow fast and take big risks, but you'll own less of the pie if things go well. Each option has its trade-offs, so it's all about weighing what matters most to you and deciding what fits your business goals.
Key Takeaways
Let’s recap:
Personal savings give control but risk affecting personal finances if the business struggles.
Loans, including personal and business types, have pros and cons, requiring alignment with business needs.
Government grants provide free money for specific initiatives, despite bureaucratic processes.
Angel investors provide support without immediate repayment but involve sharing ownership.
Venture capitalists offer substantial funds, expertise, and connections, but come with shared ownership.
Private equity is perfect for businesses that need both money and guidance, because it’s like a business partner that also invests.
With this information in mind, you not only know what different types of capital sources there are, but also how to figure out which one fits your business best. Sleep well knowing the capital is taken care of!
