Financing a Start-Up  

From start-up to maturity, financing is needed at every stage of a business life cycle. The entrepreneur must determine what kinds of financing provide the most value and chance for success for their new venture.  

Debt and equity financing decisions are made in relation to financing cost and how much control over the company the owner is willing to cede. The trade-off between debt and equity is risk versus cost and control.  

Start-up stage financing 

Initial financing for the start-up phase usually comes from personal sources such as: 

• Personal savings 

• Credit card lines of credit 

These sources are known as bootstrap financing where founders use personal resources to fund the business. At this point, they might also seek some external seed investment such as: 

• Loans from friends and relatives 

• Bank debt from banks 

• Short-term trade credit from suppliers 

• Crowdfunding 

• Equity investment from accelerators 

• Angel investors 

• Corporate strategic partnership 

• Government grants 

Debt financing 

The cost of debt financing is the interest that entrepreneurs pay for the use of the money they borrow. They might need to pledge their assets (such as property) as collateral should they default on the loan.  

Sources of debt financing 

• Bank loans 

• Banks are traditionally the source of financing for small businesses. 

• The following documents are usually required when applying for a small business loan: 

  • A personal financial statement and one to three years of personal income tax returns 

  • Projected start-up cost estimates 

  • Projected balance sheets and income statements for two years 

  • Projected cash flow statements for one year 

  • A business plan  

• Trade credit 

  • A supplier provides product to a business but does not require payment for a specific period. 

• Customer advances 

  • A customer pays for a product or service in advance, allowing the business to use those funds to its pay suppliers. 

Advantages of debt financing 

• Ownership is not sacrificed; there is no sharing of profits. 

• Full control over the business is maintained. 

• The certainty of re-payments made by the borrower during the term of the loan. This allows the business to accurately budget its payback amount. 

Disadvantages of debt financing 

• Failure to make payment on its loan may result in the business falling into default, potentially leading to bankruptcy. 

• Stress on the entrepreneur 

Equity financing 

Equity financing is the raising of capital through the sale of the company’s shares. The downside of equity financing for entrepreneurs is the loss of some control over their company as ownership of the business is shared with investors. In turn, investors have a say over how the business is run. Equity investors seek to earn a competitive return on their investments.  

Sources of equity financing 

• Venture capital 

  • Investors pool their money to invest in existing companies that are expected to experience high growth. 

  • The venture capital company usually does not invest long term and expects to generate a large return.  

• Angel investors 

  • These are wealthy individuals who, or together with other angel investors in a network, invest in new ventures in exchange for an ownership interest in the business.  

• Equity crowdfunding 

  • This involves raising funds from the public (such as through forums, social media and crowdfunding websites) in exchange for shares in the company.  

Advantages of equity financing 

• The company is usually not required to make a regular payback from cash flow.  

• The company does not need to pledge collateral, and therefore its assets are not at risk.  

• Investors are motivated to help the business succeed and often lend their expertise and skills to the company.  

Disadvantages of equity financing 

• Equity financing is more difficult to raise than debt financing. 

• In exchange for capital, entrepreneurs must share ownership of the company and future profits with investors. 

• Entrepreneurs can lose their companies to investors if plans go awry. 

References 

Harvard Business Review Entrepreneur’s Handbook: Everything You Need to Launch and Grow Your New Business. Boston, Massachusetts: Harvard Business Review Press, 2018. 

Lam, Miranda S., and Gina Vega. Entrepreneurial Finance: Concepts and Cases. New York: Routledge, 2021.  

Swanson, Lee. Entrepreneurship and Innovation Toolkit. Canada: OPENPRESS.USASK.CA., 2017. https://open.umn.edu/opentextbooks/textbooks/493 

Banton, Caroline. Equity Financing. New York: Investopedia, 2021. https://www.investopedia.com/terms/e/equityfinancing.asp