When the pandemic hit, it made a significant dent in every aspect of our lives. 2020 left us with more uncertainty about the future than we’d ever experienced before. Many feared the worst for the economy—another “Great Depression”. 

Unlike America in the 1920s though, people have been a lot more resilient. In his inaugural speech, President Joe Biden spoke about the American values of being ‘restless, bold and optimistic’. This was clearly reflected in what is referred to as a “once-in-a-generation surge in startups”.

America’s entrepreneurship boom is a very positive sign. Recent research published by The Economist has shown that “90% of the net rise in the number of sole traders is being driven by people with a gross household income of less than $35,000, a group that was especially likely to lose their jobs when the pandemic struck, and who would have seen a particularly large income boost from the stimulus measures.” In fact, statistics show that the United States is one of the best places in the world to start a new business.

In a list of “Entrepreneurship Facts” published by Hubspot, entrepreneurship rates have been trending upwards in the United States for the past 19 years. Not only that, the U.S. has the highest rate of early-stage entrepreneurship in the developed world at 15.6%. In 2020, there were 33.7 million small businesses in the United States, accounting for 99.9% of businesses. 

While this does cement our belief that we do indeed live in the land of opportunity, that doesn’t mean that starting a small business is easy; There are several hurdles one has to overcome—limited resources, seemingly endless paperwork, and more. 

The Top 5 Challenges when Starting a Small Business

Lack of Funds

Finding funds for your business is always stressful. While you may not need as much of an investment as a large establishment would, you need to think long-term and make sure you have enough to keep the business running for the long haul. The good news though—according to an article published by Forbes—is that “The cost of launching a startup today is 1000% lower than it used to be twenty years ago. With open source technology and low-cost cloud-based tools, the barriers to launching a startup are at their lowest.” In short, there’s really no time like the present!

Legalities and Paperwork

The red tape and bureaucracy may seem daunting at first, but the best way is to dive right in. From registering your company to obtaining all the right legal licenses, you need to cross all T’s and dot the I’s before you begin operations. Thankfully, there are plenty of online resources available as well as free and discounted services offered by small business development centers supported by the U.S. Small Business Administration.

Finding Customers

While you may already have a few targets in mind, you need to cast a wide net in order to really get going. Correctly identifying your correct target demographic is crucial. Once you have built a target persona, you’ll need to work on building contacts, generating leads, and attracting customers.

Hiring a Team

In an article by Forbes titled “5 Big Challenges To Launching A Startup And How To Overcome Them”, data shows that teams are more likely to build a successful startup than solo founders. Simply put, even as a sole owner, you can’t do everything alone. Build a team that’s armed with skills that will complement each other’s—and yours. The three most important recruiting questions you need to ask yourself are: Who should I hire? When do I make the first hire? How do I manage the team and evaluate progress?

Budgeting

It’s important that you create a budget and stick to it. Starting a new venture can be expensive and spends can quickly get out of hand if you don’t rein them in immediately. No matter your source of funding, plan ahead for the long term and resist the urge to splurge unless absolutely necessary.

Every small business owner needs a business bank account to keep business and personal funds separate. According to Money Crashers, BlueVine business checking account is a great choice, thanks to a 1.00% yield (annualized) and no maintenance fees. Or, consider an eligible Chase Business Checking® account; you could earn a $300 bonus when you open your account and complete qualifying activities.

In addition to self-funding, there are more sources of finance for small businesses than ever before—which makes sense given America’s startup boom. In addition to bank loans, there are venture capitalists, angel investors, partner financing, government grants for certain fields of work, and even crowdfunding; not to mention informal lending, equity, and even seed money from friends and family. The possibilities are endless. To quote the U.S. Small Business Administration (SBA), “How you choose to fund your business could affect how you structure and run your business.”

3 Main Ways to Finance your Business

Broadly speaking, there are three main ways to finance your business, namely: Self-funding, Loans, and Investors.

Self-Funding

As the title suggests, this is when a business owner makes use of his/her own financial resources to fund their venture—also known as bootstrapping. These funds come from their own “resources” which can be in the form of their savings, family money, selling personal assets, or even turning to close friends and relatives for capital. 

It can take years to get your company to where you want it to be. Self-funding can be tricky and often stressful but most entrepreneurs who do choose to go down this road say that they wouldn’t change a thing—the most important aspect to them is to retain complete ownership of their business without giving away too much of their company to investors or having other stakeholders to answer to. What you will mainly need for this is patience, perseverance, and optimism. You will be taking a lot on your shoulders and it’s important you remain steadfast in your resolve. Business.com lists some great insights into what goes into running a bootstrapped company.

You can self-fund your project through:

Tapping Personal Accounts

Using your own personal finances—checking or savings accounts, an inheritance, or even cash under your mattress not only gives you control but also shows future investors that you’re willing to put your money where your mouth is. More often than not, this helps you win over potential investors down the line.

Friends and Family

This, of course, depends entirely on your personal dynamic and needs to be worked out between yourself and your ‘stakeholders’. Whether you want to let them in on some of the action or just lay out a straightforward repayment plan is totally up to yours and their comfort zones.

Selling Assets

If you have any valuable assets that you are willing to part with in exchange for starting your business, you’re not alone. Many an entrepreneur has sold off items of value such as property or family heirlooms in order to start their own endeavor. Just be aware of the risks that come with starting any business.

Using Credit Cards

Both your credit score as well as your financial history will be considered when applying for a business credit card. Since you will be taking the sole onus of repayment, both your personal and business-related credit and financial history will be taken into consideration. While it’s relatively easier to apply for a business credit card than for a bank loan or line of credit. 

Business credit cards offer a higher limit plus a lot of benefits like reward points, cashback schemes, discounts, and other such perks. It is extremely important to pay your credit card bill on time to ensure smooth, uninterrupted service and/or risk of cancellation. While you can withdraw cash using a credit card, it’s generally perceived as a bad idea as it accrues additional interest. If you already have a credit card to your name, it will be easier to apply for a business credit card- but keep in mind the “unlimited liability” which makes you solely responsible for all the spending via card.

Dipping Into Retirement Funds

There are three ways of using your retirement funds to start a business depending on your current retirement plan.

In case you have an IRA (Individual Retirement Account), you can take out a taxable distribution any time you like. According to the Forbes Financial Council:

“...taxes will be due, and an early distribution penalty will apply if you are younger than 59 ½. Roth IRA distributions are tax- and penalty-free at that age. Before that, only contributions made to the Roth can be withdrawn without consequences.

Unlike an IRA, a 401(k) qualified plan or other(sic) pension plan must satisfy certain “triggering rules” before the funds are accessible. Essentially, one must reach the age of 59 ½, separate from their job, or suffer a hardship before gaining access to the plan funds for distribution purposes.

The downside of taking a distribution from your retirement plan is you are taking out funds that are growing in a tax-advantaged way. Moreover, if you are younger than 59 ½, you will be hit with that 10% early withdrawal penalty.”

In case you have a 401(k) Plan that allows for a loan, you can borrow either 50% of your account value or a maximum of $50,000. Repayments need to be made every quarter and you are given up to 5 years to repay the loan with prime interest rates— which are inevitably paid back into your own plan.

The benefits of using this option are the penalty-free and tax-free use of your savings. The main drawback is that you have acc to only a limited amount as mentioned above.

A third option is The Rollovers as Business Start-Ups project (ROBS) which also allows penalty-free and tax-free access to your 401(k), and without any withdrawal limit. Additionally, you are allowed to earn a salary for yourself as part of your business expenses.

In an article published by Forbes, the ROBS option typically involves the following sequential steps as listed below:

1. An entrepreneur establishes a new C Corporation.

2. The C Corporation adopts a 401(k) plan, which can invest in company stocks, called “qualifying employer securities.”

3. The entrepreneur rolls over or transfer funds from their retirement plan into the new 401(k) plan.

4. The C Corporation’s stock can then be purchased at fair market value.

5. And finally, the sale of the stock generates the capital needed to fund the business.

It is important to note you must use a C Corporation when setting up a ROBS. You cannot utilize a limited liability corporation, sole proprietorship or any other type of entity. The drawback of the C Corporation is the double taxation. The business gets taxed first, and then, the shareholders also get taxed.

Borrowing Against Your Home

Taking out a second mortgage— also called a home equity loan, comes with variable interest rates. The interest rate for a second mortgage is typically higher than for the first mortgage. This method is usually very structured and follows the same rules and expectations as your primary mortgage. According to Investopedia, “they also have a set term, such as 15 years. Each payment received is divided between interest and principal (in the same manner as a primary mortgage). The loan cannot be drawn upon further once it is issued.”

Working a Side Job to Raise Capital

The saying “don’t quit your day-job” actually makes a lot of sense when raising funds to start your own business. Many entrepreneurs work with the explicit goal of reaching a financial target that will afford them the freedom to become a business owner. Though this process might take a bit longer, general consensus is that it’s totally worth it!

The pros and cons of self-funding

Pros:

1. With your own money on the line, you will be more motivated to run your business to the best of your ability, leaving no stone unturned.

2. You have complete control over how you run your business.

3. You set your own goals and timelines—financially, professionally, and personally— depending on your resources, and are not at the mercy of investors.

Cons:

1. The risk is entirely yours. All onus falls directly upon you—fees, expenses, salaries, marketing et al. Think carefully before taking on too many employees who look to you as their primary source of income.

2. The risk of falling into debt by using personal credit cards or line of credit. In an article for The Hartford, Emily Chase Smith, author of The Financially Savvy Entrepreneur, says many entrepreneurs get in trouble. “A lot of small business owners are taking on debt on the personal side. Let’s say they’re taking on a line of credit for their business with the bank. They have to then personally guarantee that money,” says Smith. What’s the risk of that? “If the business goes under, then the entrepreneur will either spend the next decade paying it off on the personal side or need to file for personal bankruptcy.” Those are two undesirable outcomes you need to be sure you can live with.

Bank Loans

Although a type of self-funding, we decided to give “Bank Loans” a category of its own as there is a third party involved, plus the application process differs from those mentioned above. 

• When applying for a bank loan, your credit score plays an important factor. Know your credit score and then do as much research as possible by comparing multiple lenders and their offerings before making a choice. 
• Next, work on making yourself the perfect applicant for a small business loan by preparing a detailed business plan, complete with an expense sheet and your estimated financial projections for the next five years. Not only will this help your chances of securing a loan, but it will help you better understand what you’re getting into regarding how much you will actually need to keep your business running long-term.

• The best type of loan to get is one which offers low to zero fees, a low annual percentage rate, and longer repayment terms. Here are Nerdwallet’s tips on the Best Personal Loans of February 2021.

• A recent USnews article published that “The Federal Reserve has held interest rates near zero amid the COVID-19 crisis, which can reduce the cost of a personal loan – if you can get one. Borrowers will likely face stricter lending standards as lenders try to protect against the coronavirus downturn.

“Still, if you have strong credit and steady income, finding the best personal loan for your needs at a low-interest rate could save you thousands.”

Investors

According to Goldman Sachs, venture capital funding has more than doubled globally this year, with an estimated $50.5 billion having been invested in new businesses.

Unlike personal investments or bank loans, a venture capitalist will offer their investment in exchange for ownership of a chunk of your company. These stakeholders—whether a single angel investor or a VC firm—will usually play an active role in decision making. It’s typical for your VC to expect a seat on the Board of Directors of your business, as well as maintain a certain amount of control over how the company functions. Basically, unlike taking a loan where you risk being in debt, your investor purchases equity with a long-term growth perspective of growing their wealth as your company profits grow.

So, what do you need to do to attract a VC? Business.com suggests that “Depending on the VC fund, businesses need to have a growth rate that is three to ten times in five years to get on their radar. Beyond the growth trajectory, your product or idea must solve a problem and the founders have to be passionate about what they're doing.”

Here are some great tips to help you prepare for the hunt for a reputable investor:

• Clearly mention your projected growth rate along with strong facts and figures to support your estimation.
• Present a solid business plan that is aligned with your VC’s investment criteria.
• Make sure you’re “stage-ready”—everything from your team to your product/service and paperwork must be in place and ready for review. You only get one shot at making a good first impression so have everything in order.
• Target the right Venture Capital Fund. Do your due diligence and identify the VCs that are most likely to invest in your vertical

Pros and cons of the “investor” route.

Pros of Venture Capital

1. The money is entirely yours to run your business in exchange for a stake in your company.

2. As VCs expect high returns on their investment, they offer you their support, expertise, and resources to help you grow.

3. VCs will introduce you to their network and open more doors for your business.

Cons of Venture Capital

1. Less control over your company. Remember, you’re not the only one with skin in the game so you will have to forfeit sole decision-making power.

2. Most VC firms expect early scaling and might push you to go live before you are fully ready. The timelines and goal-setting will not be entirely in your hands and you will be answerable to your investors.

3. Not every business is suitable for venture funding. VC firms only invest in 0.01% of high-risk businesses that will disrupt the industry in which they’re being established. You may not want to build this kind of business. 

Conclusion

Every source of financing has both positives and negatives. A lot of factors go into deciding which path to take, including how much money you have and need, where your money is and your requirements to keep things running. Choose wisely as you go from being an employee to calling the shots as the boss.