In the old days, a company raised money, used it all to make a product, and then went to market. One shot at success. Today a business needs to develop a minimal marketable product with a portion of its available capital and see how it is received. Then use a bit more of their capital to make adjustments and improve the product over several interactions and not in one shot. This is known as the Affordable Loss principle.
Lenders balance risk with reward using three levers: Interest Rates, Down Payment Amount, and the Term of the loan. Once adjusted for risk and reward, the lender can adjust each lever up and down to maintain the overall desired risk and reward level required to make the loan.
There are over a dozen ways a company can secure funding. However, not all funding options are available to a business at any one time. The kinds of funding a business can secure are based on what stage of maturity they are: Early, Pre-Revenue, or Profitable.
When it comes to funding a new company, many founders fail to consider how a 401k or an IRA can be used to fund a startup even before reaching full retirement age or incurring penalties for early withdrawals.
When it comes to getting a loan, there are two factors that contribute to the rates and terms a lender is willing to accept to provide the loan, and they are the tangibility of the asset the loan will be used to acquire and the ability of the lender to liquidate the asset in the event of their need to foreclose and repossess the asset.
The earlier in a business’s life cycle, the more risk exists for any investment to pay off. Attracting any early-stage investment requires giving up a substantial amount of equity to get an investment. Using the story of the Ship of Gold, we demonstrate how removing incremental elements of risk allows companies to give away less equity as they raise the necessary risk/equity capital.
When it comes to getting a loan, there is a continuum. The debt continuum begins with large institutional banks that have very strict lending guidelines but offer the best rates and terms. They are followed by community banks that are more creative, but many charge more given the additional risk. Banks are followed by private lenders that are even more flexible but charge higher interest rates to cover the additional risk. Finally, there are specialty lenders that can fill the final gaps to gain access to capital.
Most entrepreneurs think they want dumb money. Dumb money assumes the business owner has everything they need to succeed. Smart money is where the lender can exert additional leverage in terms of additional contact or business expertise along with the money. Most small businesses need smart and not dumb money to succeed.
