The Method of Financing A Business Can Have Implications On How The Business Is Organized And Managed

An entrepreneur starting any type of business venture has one of the most enjoyable tasks in the business world. However, before there’s a launch of any product, service to any client, or hiring of any staff, there is one important preliminary question to consider. How are you going to finance the business?

The question of financing, though predominantly a financial question, has ramifications for every structural operational facet of the business. From the legal formation and the ownership of the business to staffing, business decisions, and the overall goals of the business for the future, the financing option you choose dictates your business’s fundamental constitution.

The following is a detailed examination of how funding contributes to both the structure of the business and its daily operations, and how and why the majority of new founders do not understand the significance of this funding approach.

The Availability of Financing Options Determines The Kind of Legal Structure You Are Able To Adopt

Certain legal structures are more flexible for different types of funding. This is usually one of the earliest decisions that you will be faced with in your venture.

Bootstrapping Allows for Simple Structures

When you self-fund your venture, you’re able to select the simplest setup possible, such as a:

• Sole proprietorship
• Partnership
• Single-member LLC

These types of structures make it possible for you to move fast, avoid lengthy and complicated governance, and keep all the control to yourself.

Investor Funding Often Requires Incorporation

When you pull in investors, be it angel investors, venture capitalists, or equity crowdfunding, they’ll want you to have a more formal structure in place. Investors will want:

• Stock issuance
• Legal representation
• Ownership rights
• Board of directors
• Formal governance

That usually means you’ll need to go the corporation route, especially if you plan on equity issuance or looking for significant funding in the future.

Loans May Influence Your Entity Choice

If you plan on bank loans or government-backed loans, they may want or expect a structure in place that separates the business and personal liability. That usually means you’ll have to go the route of an LLC or corporation that will protect your personal assets along with the business as a whole.

In a nutshell, your funding strategy will dictate how you will have to legally shape your venture from the get-go.

Funding Determines Control and Decision-Making Power

Control is one of the biggest issues tied to the funding. Every funding option comes with a different level of ownership and decision-making control that you’ll have to let go of.

Control Dilution Due to Equity Funding

Control dilution is inevitable since investors will demand a say in the company. Standard investor control will come in the form of:

Board representation

Major decision veto powers

Control over important appointments and resource allocations

Decision making on key resource allocation

Control structure will ultimately set the pace of progress in the firm.

While investors provide control and a sense of independence, their contribution will come at a hands-off approach.

Financial Disciple and Retained Ownership with Debt Funding

Debt funding will have clear ownership advantages, but comes with:

Repayment schedules with potential payment demand

Debt and payment terms will control a firm’s direction strategically.

Resource allocation in a firm Additionally, their ownership comes with control over management’s risk taking and resource allocation in the firm.

Complete Ownership but Resource Constraints with Bootstrapping

Complete control comes at the prices of resource constraints. Restricted access to critical inputs in the firm will paralyze growth and slow recruitment of personnel, resources and ultimately marketing.

Thus, the extent of control over the firm’s resources determines the funding path to a great extent.

Operational Strategy is Apparent in the Funding Simply

Operational direction and ownership of the firm will depend heavily on the Firms funding options.

Investor-Backed Companies Have A Growth Mentality

With investors needing an ROI from a business, these companies will go in the direction of:

Accelerated Growth

Intensive Promotion

Extensive Recruiting

Iterative Improvements

Risk Assumed For The Growth Potential

You could be operating with target metrics from a performance dashboard within daily deadlines from an investor or board.

Debt-Financed Companies Have A Different Mindset

With companies that have debt, there are expected payments that create rules relating to revenue. This can result in:

Predictable Revenue Requirements

Profit Management

Customer Loyalty

Expense Management

High Control On Spending

Such companies will have a mindset of stability instead of rapid growth.

Bootstrapping Demands A Lean Approach

Running solely on personal funds will create the need for:

Impressions Low

Gradual Hiring

Role Multiplication

Financial Care

Slow Progress

Operational lean systems could create a situation with increased time needed for growth.

Different Financing Affects Your Financial Systems and Reporting Requirements

This will increase the administrative load that relates to the different types of financing that is often overlooked.

Companies With Investors Need More Formal Reporting

Your investors will want transparency and may ask for:

Periodic earnings reports

Predictive forecasting

KPIs tracking

Board meetings every three months

Annual audits, for big companies

It adds complexity and sophistication to your financial systems while increasing administrative costs.

Lenders Need Reports With Predictability And Compliance

Reporting for loans takes the form of:

Income statements

Reports for assets and debts

Tax papers

Insurance or collateral

Certificates of compliance

This gives assurance to lenders that the business is healthy enough to fulfill its payment obligations.

Bootstrapped Businesses Need Minimal Reporting

When you fund your own business, you also need to make sure the bookkeeping is in order, but there are no reports that an external party requires. This opens up the simplicity of the business and also has the effect of lower overhead costs.

Your Funding Option Changes Your Risk Profile

How you fund your business also determines how much risk you hold. It can be both personally and professionally.

Equity Funding Lowers Your Personal Financial Risks

When a company goes under, its investors lose money, but creditors will get paid back. This may however come with:

Less control

Target pressure

Stricter growth timelines

The business risk is now shared, but the responsibility is heavier on the leadership.

The Effect of Funding on Financial Risk Exposure

Debt entails specific responsibilities. When there is a decrease in revenue, payment on the loan has to still be made. When a loan is personally guaranteed, your assets are forfeited.

Bootstrapping Puts More Pressure on the Founder

Self-funding is the same as:

Losing money is your responsibility

There is no extra financial help

Personal loss could be a failure

But bootstrapping also means that every reward goes to you alone.

Funding directly impacts how you strategize and your exit options

Funding significantly impacts your goals in the long run.

Businesses with investors anticipate a larger exit

Investors expect

Acquisition

merger

IPO

A high growth machine with a high valuation

A drop in business growth negatively impacts your business.

Businesses with loans and those bootstrapped have more exit options.

You can grow at your own pace without the pressure. With money:

You can keep the business for as long as you want.

You can pass it to your family.

You can sell it whenever you want.

You can run it as a business.

People often enjoy better working conditions.

More business and people working.

Conclusion

The options you have while starting a business are numerous, but the impact of your funding decision is important. It will define the form of your business, your ownership, decision-making power, structure, operational style and financial discipline, risk level and objectives.

The most preferable way to fund a startup is based on how much control you want to keep, how much risk you are willing to take, how fast do you expect the startup to grow, and your personal values as a founder.

Deciding on the best source of funding is essentially deciding which direction you want your business to lead towards.