Today I’m going to backtrack a bit and go into more detail regarding three choices in the “Traditional Funding Chain”:
- Boot Strapping
- Family and Friends
- Personal Retirement Plans
Boot Strapping – “I’d Rather Do It Myself!”
As an entrepreneur, you most certainly can “fund” your business as you’re getting started, using your savings and sweat equity, often taking no salary for your efforts. Many start-up entrepreneurs also become a one-man show while “legging in”…staying at their primary jobs or maybe working a second one.
Although this is the most common way of funding new businesses, it is also the slowest route to success. It can be a struggle, not to mention stressful. Unfortunately, looking for other ways of funding a business sometimes comes too late…after savings are used up and desperation is setting in.
The advantages of “boot strapping”, as I’ve touched on previously, can be:
- Developing your idea on your own time
- Controlling the decision making process
- Controlling your intellectual property (one of the most valuable assets of your company)
What you should be cautious about:
- You can end up at the mercy of economic cycles
- Becoming a “one-man band”, doing everything yourself
- Neglecting to put things (contributions) in writing, should there be partners involved; this point is very important. As the saying goes, “all is well until something goes wrong”.
The Friends and Family Plan –
If…or let’s say when…your new and promising enterprise appears to be heading toward success, it’s often friends and family who will want to chip in money to help grow the business, perhaps for a small stake in ownership. However, because they care about and believe in you, they may not always pay attention to important business aspects.
Taking funding support from friends and family does have its advantages:
- They want to help simply because they are already in your corner
- They aren’t necessarily doing it for the profit that’s expected
- You don’t have to give up your equity
Again, let me caution you to put things into a written agreement, however. The uncle you thought was giving you a no-interest loan may think he’s now part owner of your company, with voting rights.
Protecting Your Nest Egg – Personal Retirement Plans (401K & IRA)
“Funding” your business can be done by borrowing against your 401K or transferring retirement accounts, although this is not one of the better ways to do it. Many entrepreneurs cash out their retirement accounts and take the penalties. If you are considering this option, be sure to work with your financial advisor and/or an attorney to make sure you do it in a way that will, hopefully, benefit you and your business in the end.
The key is rolling over the money into a C-Corp retirement account that permits you to invest in the business through a stock purchase. Another consideration is to take a loan against your 401K while you are still working, as long as you pay it back before you leave your employer.
The advantages of this funding choice are also:
- Controlling the decision making for your business
- Controlling and protecting your intellectual property
Be cautious of a couple potential issues:
- If you’re under age 59 1/2 and you don’t handle things correctly, you’ll end up paying taxes on the money you use, as well as risking an early-withdrawal penalty.
- Professional Financial Advisors will charge for setup.
The three traditional funding options discussed above are more than likely the most well known and those that would come to mind first if wanting to follow the seed funding route. Watch for my next blog post for a description of a few other choices that may not readily come to mind but that might be worth considering.