Funding Your Business

There are a variety of ways to fund your business, each with its own set of costs and benefits. The discerning entrepreneur will first weigh the various types of capital applicable to their business before pursuing funding.

A catchy statistic we like to throw around at Render Capital, and indeed at many like-minded organizations, is that less than 1% of companies in the United States raise venture funding. It remains effective at pointing us to the reality that one form of funding, and the types of businesses it is best suited for, receives much more than its fair share of attention in most conversations about funding businesses. There is, in contrast, a rich diversity in forms of business in our national and local economies, and complementing that diversity is a diversity of ways to fund a business.

Three disclaimers before jumping in. First, for simplicity, we will focus on three summary buckets of funding types: grant, debt, and equity. In reality, there is wide variety within each category, as well as hybrid structures. Second, with the pointed exception of funding a business through customers, we will avoid better-or-worse language, as the best form of funding is unique to each business, its context, and its owners. Third: customers are the best source of funding for any profitable venture. Acquiring more and better customers should be the goal for seeking all other forms of funding. Business owners typically seek external funding because they need to spend money to build a product before they can attract customers, or to accelerate customer acquisition. In all cases, customers are the goal of a sound business.

Grant Funding

Grant funding describes all forms of funding that are both non-dilutive and awarded with no expectation of repayment of the contributed capital, or any interest on it. This type of funding is typically awarded for mission reasons, applicable when there are organizations, philanthropic or for-profit, with a mission objective satisfied by the receiving company.

Grant funding’s greatest advantage is that it is non-dilutive, the receiving business does not need to sell any ownership in exchange for funds, and the capital carries no expectation of repayment. Grant funding can, however, come with its own non-financial costs in the form of obligations like reporting requirements. An additional, powerful benefit is that grant funding can be catalytic: subsequent investors and owners alike benefit from free leverage on every other dollar invested in the business. A grant may further serve to de-risk an investment enough to activate investor capital that would otherwise have remained on the sidelines.

Debt Funding

Debt financing represents the range of vehicles through which an investor loans capital to a business with the expectation that the principal, plus interest, will be repaid under negotiated terms and timelines. This includes both traditional bank debt and alternative forms of debt capital, such as revenue-based financing.

The major advantage of debt financing is that, like grant funding and unlike equity funding, it is non-dilutive. The business owner need not sell off a portion of their business in exchange for the investment; instead, a lender evaluates the creditworthiness of the business and invests believing the principal will be repaid along with the negotiated premium.

The costs of debt funding include decreased solvency, which increases the risk profile of the business, and a loss of flexibility in management. Debt investments typically carry financial covenants designed to enable the lender to recover their investment, for example, requiring the business to maintain a minimum cash balance, or restricting certain activities. Violation of financial covenants, or an inability to keep up with repayment, can trigger the forfeiture of the entire business. And while debt investments are catalytic at the beginning of their term, the subsequent obligation to repay principal and interest can decrease operational flexibility and become a barrier to growth if the initial infusion of capital does not sufficiently accelerate the business.

Equity Funding

Equity investments generally describe the exchange of investment capital for ownership in the business itself.

Perhaps the strongest advantage of raising equity is the alignment it creates between the business, its original owner, and the investor. An equity investor becomes an owner and is repaid the way other owners are compensated, through profit distributions, or upon the sale of the business (with the important exception that equity investments typically provide investors a liquidation preference). Because of this alignment, equity investors are partners rather than creditors; they are vested in the success of the business and incentivized to leverage their networks and expertise to support its growth.

Equity investments carry their own drawbacks. They are described by many as the most expensive form of funding, and with good reason, owners sell a portion of the business and the affiliated upside in exchange for investor capital. For an illustration: if your business is worth $1 million and you sell 10% to an investor, and the business grows until it is worth $50 million, the stake you sold has cost you $5M at maturity. Furthermore, equity can be the most restrictive form of funding for the original owner. The moment you take on an equity investor, you are no longer the sole owner of your business, and depending on the terms, the original owners may find they have taken on a boss and lost some control of the governance of their business.

With all of this in mind, the discerning entrepreneur in need of capital will first weigh the various types of capital applicable to their context before getting tactical in the pursuit of funding.