Companies need access to capital to grow. The funding opportunities available to a company vary by the structure of that company, such as public or private.
Public funding opportunities include public grants and the ability to raise funds by selling shares of company stock. Private investment opportunities include a somewhat different mix of ways to raise money, which the following sections will explore in greater detail.
Introduction to Private Funding
Private funding refers to the private sector's ability to raise capital. This type of funding is critical for businesses in the startup phase, which need access to capital before taking a company public. It is also important for small businesses that may not wish to go public yet still need financing.
Types of Private Funding
Common types of private funding include:
- Personal loans—Rather than seeking a grant opportunity, business owners will often ask friends and family members to invest in their business with personal loans.
- Bank loans—Banks and credit unions often provide small businesses with loans they can use to fund growth and operations. These financial institutions typically need to see detailed business plans and financial statements to approve funding.
- Angel investors—Angel investors enjoy investing in new businesses in exchange for an ownership stake. Usually, angel investors want to see a strong pitch deck with a business plan and solid financials before agreeing to invest.
- Venture capital—Similar to angel investors, venture capital firms invest in businesses with a strong track record and innovative concept. These funders usually want a strong exit strategy, making this a favorite option of startups that want to eventually go public.
- Crowdfunding—Crowdfunding platforms play an important role in the funding ecosystem for private ventures.
- Foundations—A private foundation may be a source of funding for private companies though a foundation grant.
Benefits of Private Funding
Private funding offers an important growth opportunity for companies in the private sector. However, many individuals and entities who support private business have their own vested reasons for doing so.
In the case of venture capitalists or angel investors, these early funders want a sizable return on their investment. In the case of a private foundation, the funding source will frequently have criteria that impact how their investment can be spent.
Although there may be strings attached with some types of private funding, there are many benefits to this type of funding source, too.
Benefits include:
- Potential for large donations—Compared to a public company, which needs to sell a lot of shares to generate a major cash infusion, a private company can get a large donation from a single donor, such as an angel investor.
- Aligned with mission—Private companies can find funders that are in alignment with the company's mission and thus more likely to be supportive of its business goals.
- Less bureaucracy and oversight—Companies that receive public funds typically must report on these funds in various ways, which is time and resource-intensive. With private funding, there tends to be less of a need for reporting and oversight.
Because private funds are easier to obtain in some cases and come with fewer regulations, private companies tend to enjoy several advantages as a result.
Particularly in the startup ecosystem, there are important mentorship networks that accompany access to capital from venture capital firms and angel investors.
Larger donation amounts and a faster speed of funding frequently means that businesses can innovate faster, which brings a critical edge over the competition. When a company can bring new products to market quicker, it benefits from having a first mover advantage.
Equity vs. Debt Financing
The sources of funding listed above include a mix of equity and debt financing.
Equity financing is when a business raises capital in a way that doesn't negatively impact cash flow. For example, the business may sell something or trade an asset (such as a percentage of ownership stakes) in exchange for cash.
Debt financing is when a business raises capital by taking on debt, such as a bank loan. This represents a liability on the balance sheet.
Both types of financing have their place. To decide the path forward, companies should consider which they prefer, taking on a liability or giving up control of an asset in exchange for capital.
The Role of Crowdfunding in Private Funding
While the novelty of crowdfunding has worn off, it still represents an important funding option for businesses. Crowdsourcing platforms introduce an idea to a potentially limitless pool of buyers. They tend to work well for companies developing products, including creative products.
Musician Amanda Palmer has successfully used crowdfunding platforms such as Kickstarter to launch albums, eschewing record labels and retaining a greater share of profit and artistic rights, to give one example.
Strong crowdfunding campaigns have an element of mass appeal. They take a high concept idea and communicate it in a way that is easy to understand, exciting and intriguing.
People either want to donate right away because they know they need the idea, or they want to tell a friend immediately because the idea is so cool and unique. Projects that can capture this vibe — or ones that sell to an already-existing audience — will fare better on crowdfunding sites than ones that don't have that high concept hook to leverage.
Navigating the Private Funding Landscape
A solid business plan is a prerequisite for most forms of private funding.
Before companies seek investment of any kind, they should ensure their business fundamentals are strong. They should work up business valuation that shows the potential upsides while reflecting a realistic take on current positioning. They should prepare investor materials that convey the opportunity and potential for rewards. Finally, they should practice giving their pitch and fielding questions, using data rooms for startups to store and share supporting documentation.
This practice prepares owners to understand where their pitch may be weak, what kind of information potential investors want and may not see in the presentation, and how they can better convey their opportunity from an investor standpoint.
Any supporting materials, such as a pitch deck, should complement — and not detract from — their pitch.
For example, overloading presentation slides with too much text can cause potential investors to miss the key takeaways.
While there are private equity firms that reach out to businesses, most business owners will need to do their homework and identify potential VCs, angel investors or grant opportunities that fit their needs and business model. This can be time consuming, so business owners should plan accordingly and not leave fundraising for the last minute.
With all of these strategies, businesses will have an easier time obtaining funding if their business plans and finances tell a compelling story. For this reason, businesses should invest in private company financial reporting software to pull together the reports and statements needed to apply for a funding opportunity.
Small businesses and startups have many ways to access capital, which is ultimately good news for business owners. By understanding the advantages and disadvantages of different funding pathways, business owners can take a proactive stance in pursuing growth and business goals. If one strategy does not work in the desired way, there are others to fall back on.
