Funding for the Rest of Us Entrepreneurs
Author: Jeff Maglin
One of the first items that an entrepreneur considers when starting their business is funding. Commercial banks, venture capital firms and angel investors are the most recognized sources of debt and equity financing. They also are the least likely to fund start-ups.
According to the Small Business Association (SBA), there are 6 million start-ups in the US every year, 600K of which are employer based firms. In 2009,
- Banks made approximately 50K SBA backed loans to small businesses, with about 1/3 to start-ups (SBA Summary of Performance Information 2009). Note: Although I was unable to find statistics on the number of bank loans to start-ups without SBA backing, the Kauffman New Firm Longitudinal Study estimates 5% of new firms obtain business bank loans.
- Venture Capitalists invested in 440 start-up/seed stage companies (MoneyTree Report).
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Angels invested in 20K early stage firms (University of New Hampshire of Venture Research).
That leaves approximately 95% of all new businesses not funded by these entities. What are the primary sources of financing for these businesses? The Kauffman Foundation longitudinal new firm study provides the most comprehensive statistics to date:
Owner – 75% of new firms use owner’s equity and 25% use owner’s debt to finance their start-up. Owners fund the business from a second income, personal savings and borrowing from personal assets, such as home equity and retirement accounts. Owner financing is the easiest and least complicated financing to obtain as there are no outside parties to whom to answer.
Credit Cards – 58% of new businesses use credit cards to finance their operations in the first year, 33% of these firms carrying an outstanding balance. The primary advantage of credit cards is that it is one of the easiest forms of credits to obtain. The primary disadvantage is that it is very expensive debt with annual interest rates at 15% and higher.
Friends & Family – Family and friends help fund between 10-15% of new businesses. They are twice as likely to lend as to invest. Family and friends are a more receptive audience than other potential investors and lenders but also carry the inherent risk of negatively affecting personal relationships if the business fails or expectations are not clearly defined.
Alternative Lenders – Financed less than 5% of new firms in the study. Lending innovations such as micro-lending and peer to peer lending bring hope of this being a greater source of start-up funding in the future.
The reality of start-up funding is that most new businesses rely primarily on their personal assets or personal debt. Outside equity and debt financing is limited to a small percentage of start-up businesses. These facts have not prevented millions of people from starting their own businesses every year in the US, nor should it dissuade you.
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