"If you crack open most entrepreneurship textbooks, you'll find that they talk a lot about how entrepreneurs finance their businesses," begins a brilliant essay on the subject by Scott Shane, the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.  (The essay appeared on American Express's Open Forum, go figure.)

"Because these books are targeted at students in courses that focus on the creation of high potential businesses, they spend a lot of time discussing venture capital, angel investing, and other sources of external equity capital," Shane writes. "As a result, they don't describe how most entrepreneurs finance their businesses."

In reality, he says, there are four common ways and not one of them is exotic.

1. Actually, they don't require a lot of money. Most entrepreneurs don't need much capital to get started, Shane writes. This is consistent with what I have found and with a Kauffman Foundation study that said it costs just north of $100,000 to get the typical business underway.

2. Much of the money they do need to finance new businesses comes from their founders. "The most common source of that capital is the founder's own savings, with the majority of businesses only obtaining money from this source," the good professor writes. "As a result, more people finance their start-ups with their own money than get money from banks and friends and family members combined."

3. External financing is more likely to be debt than equity. "A study of young firms in Minnesota, Pennsylvania, and Wisconsin found that less than 10 percent of the firms had received an external equity investment, but half had borrowed money from an external source."

4. Much of the borrowing is personally guaranteed. Yes, being incorporated protects your personal assets in case of bankruptcy. However, lenders know that and frequently make entrepreneurs sign for the loans personally to make sure they can get their money back should they lend money to a company that fails.

As you can see from the above, funding a small business is usually pretty basic.

Keep that in mind, and get underway.

 

Published on: Jul 13, 2014