Potential investors

Choosing the right type of people to help finance your business is an extremely important step.  Although a person may be willing to invest in your business or loan you money, there may be strings attached that make the offer undesirable.  Make sure that you are comfortable with all of the people that become financially involved in your business.  Establish precisely what their involvement and expectations will be before they invest any money.  Draft legal documents that validate the agreement.  Whether these individuals are friends, family, bank officers, venture capitalists, or angels, it is important to communicate the financial plan and vision for the future of your business.

Look for individuals who understand the nature of your business, have realistic expectations, and will leave you to run your business.  Someone that wants to become too involved in the everyday decision making process may overshadow your own thoughts and visions for your company - the very reason you want to be an entrepreneur!  Finding people that understand the ups and downs of starting a business and will work with you to make the company a success is also vital.  Time spent worrying about investors backing out is time and mental energy wasted.

Debt versus equity financing

The main types of financing are debt and equity.  Equity is ownership in the business; debt is money that must be paid back with interest in the future.  Examples of debt instruments are bank loans, personal loans, and bonds.  Stocks and any other form of investment that receives an ownership position is considered equity.  When individuals receive equity in your company they are receiving partial ownership.  If you incur debt to finance your business you are not losing any ownership, but you must pay back the principal of the loan, plus interest.

Debt financing is attractive because in taking on loans, you do not lose any ownership in your company.  If you are able to get a loan for $100,000 at a 7 percent interest rate over 5 years, and anticipate your company will generate enough profit to make the payments, debt instruments are very appealing.  But if you should be unable to pay even one of your monthly loan payments, you will be forced to either obtain the money from someone else (because a bank will not make you another loan), declare bankruptcy, or sell the business.  It can be very difficult to get a loan for your business.  If your credit report is bad or if you do not have enough assets or collateral to securitize the loan, you may need to seek equity financing. Equity investors often want a management/advisory position in the company.  Whether such arrangements are palatable will vary depending on the size of the investment and your need for capital.  Most entrepreneurs want to keep as much control over their business as possible.

A good mix of debt and equity financing makes sense for most businesses.  Even if you are able to completely finance the business from your personal savings, it's smart to start establishing credit with the bank.