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7 Experts on How to Know When a Business Idea Needs Funding

Caroline Goldstein

Staff Writer at Fundera
Caroline is a small business and finance writer at Fundera. Before coming to Fundera, she received an MFA in Fiction from New York University. She loves finding creative ways to help entrepreneurs grow.

Entrepreneurship is an inherently creative pursuit: After all, every hugely successful (and not-so-successful) company began with an innovative idea. But how did those small business owners know when their business ideas needed funding?

You, too, might have come up with a great concept for a business and think the time to launch is now, but you’re not sure if potential investors will agree. Or you might be running a new startup, and you’re wondering if it’s time to find additional funding to keep growing your business—but you’re not confident that you’re eligible yet for a small business loan.

To fund or not to fund? At a certain point, lots of small business owners and people with big business ideas ask themselves that question. To help you find your answer, we’ve tapped small business owners and financial experts to share their tips on how to know when your idea is ready to make a financial leap.

Whether your business idea is still incubating or it’s in its very early stages of life, these experts can help you identify if, and when, that business idea needs funding. And once you’ve taken our experts’ advice and decided it’s the right time to supercharge your company’s capital, we’ll show you the small business financing methods that are the most accessible to brand-new ventures.

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When to Seek Funding for a Business Idea

Sign 1: Say “yes” to these three questions.

You’re confident in the strength and feasibility of your business idea, and you’ve installed a qualified management team to make that idea a reality quickly. If that’s the case, then you’re ready to seek business financing.

“The formula for determining when to seek funding for your business idea is pretty simple:

  1. Is your business idea unique, and does it have a defined benefit for the customer’s needs? (And, ideally, is your idea protectable via intellectual property?)
  2. Is your idea technically feasible, and can you get it to market in 12 to 18 months?
  3. Does your management team have the experience it takes to turn this idea into a reality?

Those would be the first three questions I would ask yourself about your business idea. The answer needs to be ‘yes’ to all three questions before I would consider recommending them for fundraising.”

Brian Cairns, CEO of ProStrategix Consulting in New York City, NY

Sign 2: You have a workable plan of operation for at least a couple of years down the road.

Before you seek small business financing, draw up a detailed business plan for your idea that covers two-plus years of projected expenses. That’ll help you make sure you can afford any business loans you’re thinking about.

Your business idea is ready for funding when you have a long-term business plan. A one-year plan isn’t enough. You need to be confident that you have a logical plan for at least the next couple of years.

To do that, create a spreadsheet with your current or potential expenses. Before taking any loans, it’s crucial to know exactly how much money you’ll need to get your venture off the ground. Taking a loan that’s too small to actualize your idea is no help—you’ll get stuck in the middle and could risk losing everything. Similarly, borrowing a sum that is above and beyond what you need for your business idea can put you into debt [that you can’t recover from].

Also, you’ll know if your business idea is workable when you’ve done your market research. Try to determine if there is a real need for your business idea. If you are facing a thousand competitors, you may want to rethink your plans. Postpone taking a loan until you’ve come up with another business idea that seems more viable to succeed.”

—Nate Masterson, Finance Manager of Maple Holistics in Farmingdale, NJ

Sign 3: You know exactly how your product or service fills a demand in the market.  

You’ll need to figure out how to model your business to best suit customers’ needs. That takes time, and some trial and error. But once you know exactly how your product works, you’ll spend the capital you do raise wisely.

“Knowing when it’s time to raise money for your business is key. If you raise money too early, you risk burning the cash on expenses that weren’t necessary. It’s important to be as lean as possible until you’ve found product market fit. Once you feel like you have a clear sense of what your customer wants, how you can address their needs, and you want to scale your business, that’s the time to look for funding.

I spent one full year building Mirra before I started looking for investment. During that first year, I conducted a lot of experiments. When I finally found the business model that worked, I knew it was time to reach out to investors. Because of the clarity I gained from my prior experiments, I’m very clear on what I want to spend the money on, which makes me a lot more capital-efficient.”

—Katia Ameri, Founder & CEO of Mirra in Santa Monica, CA

When to Seek Additional Funding for a Growing Startup

Sign 1: Your profits are catching up to your original loan.

Your startup is ready for the next round of funding when you’ve graduated beyond your original investment, and you’re using your own profits to cover your expenses (but it’s still not enough to sustain your projected growth).    

“We raised $250,000 in angel financing our first year in business. How did we know the time was right to seek additional funding? Simply stated, we could confidently say that we would spend our own money alongside the angel investors’ money.”

—Zach Hendrix, Co-Founder of GreenPal in Nashville, TN

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Sign 2: Your existing capital can’t cover your growing demands.

If your operation is growing so quickly that profits can’t keep up with demand, then it’s time to seek additional financing to make sure you can scale to meet needs.

“How do you identify that your business idea needs funding? Essentially, when you don’t have enough money to keep up with the expenses it takes to continue growing.

After nine years of business, I can assure you that one of the most important decisions we made was to decide when we needed to raise capital. During the first two years, our company grew organically, steadily, and by using our own savings. Everything was bootstrapped.

However, there came a time when our growth began to accelerate for several reasons: Our service was improving, and this led to an impressive growth in word-of-mouth recommendations; we were interviewed in different mass media outlets; and we improved our digital marketing strategy.

It was because of this exponential growth that it was not viable anymore to keep growing our company with only our own savings and by reinvesting our profits. At that point, we needed to seek outside investment.”

—Cristian Rennella, CEO & Co-Founder of oMelhorTrato.com in Córdoba, Argentina

Sign 3: Your expenses are exceeding your working capital, but your future profit margins are projected to increase.

You’ll need more funding when your operational costs exceed your existing capital amounts. But your future gross margins should be increasing, too, because your lenders will want to see evidence of profitability.

“In my opinion, these two factors determine when you should raise additional capital for your business:  

  1. The cost of raw materials/supplies
  2. Expected gross/net margins

It’s time to consider funding when your forward-looking expenses (cost of goods sold, or COGS) for the next month exceed twice the amount of your working capital. That’s the point at which satisfying both your fixed and your variable costs becomes untenable.

Then, it’s time to pull the trigger and apply for outside financing when your future gross margins can increase by 33% or more. That’s because the fixed costs necessary to operating your business start to creep up during a company’s growth stage. So you need to keep all of these costs in mind when calculating your business’s ability to raise and effectively use financing.”

—Robin Lee Allen, Managing Partner of Esperance in San Francisco, CA

Sign 4: You’re pushing yourself to your limits—but you still can’t keep up with the pace of your company’s growth.

Your business needs funding when you need to grow your team, and your resources, to fulfill your customers’ demands.

“Ultimately, the point where it’s time for business owners to expand their funding options has to do with growth.

If you can no longer meet the needs of your customers; if you need to hire more employees because you can’t get the job done with your existing, small team; or if you feel pushed to your limits, and your resources are too minimal to handle the demands on your business, it’s time to graduate to larger financial resources to assist you.”

—Deborah Sweeney, CEO of MyCorporation in Calabasas, CA

  

Funding Options for Startups

Whether you need to get your unique business idea up and running or if your startup is experiencing its first growth spurt, every business needs money—and, in many cases, you’ll need a small business loan to do that.

But as a new business, a traditional term loan—whether from an online lender, or a traditional lending institution like a bank or a credit union—will be tough to secure, simply in virtue of all of the standard business loan requirements. For brand-new businesses, providing years of bank statements, tax returns, and profit & loss statements just isn’t viable.

So, you might not be able to secure a traditional term loan. However, there are lots of alternative methods to get funding to start a business, or to supercharge a burgeoning new business that’s outgrown its seed money.

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No-Debt Funding and Raising Capital

When you’re just beginning to turn your idea into a real-deal business, the best way to find funding might be to forgo the small business loan application process entirely. If you’re worried about taking on debt, you can fund your startup by appealing directly to the people your business might soon be serving.

  • Friends and family: The first place many brand-new entrepreneurs look to for funding is the people closest to them. Drafting your friends and family to pitch in to fund your idea is a great way to kickstart your business, especially if you don’t have the detailed business plan or financial evidence most lenders need to extend you a loan. You can either sell equity stake or take on a loan (which is debt, yes, but much different than one from an institutional lender).

    But when you mix business with pleasure, things can get dicey pretty fast. So, follow the best practices for seeking funding from friends and family to make sure you’re not sabotaging your most important relationships.   
  • Angel investors: True to their name, angel investors are individuals who swoop in as an entrepreneur’s aid to finance their business. Since angel investors are using their own money, they have to believe in the business and feel confident that it’ll thrive. Before you seek one of these special investors—whom entrepreneurs often find through their own, personal networks—you absolutely must write a business plan.

    In return, most angel investors will claim equity in the company they’re funding. So, if you go the angel route, you absolutely have to be okay with relinquishing some control over the direction of your business to your investors.
  • Crowdfunding: Crowdfunding is a super-accessible option for entrepreneurs at the experimental beginnings of their ventures. Since you can’t always count on leveraging astronomical numbers through crowdfunding campaigns (though it’s definitely possible!), financing through sites like Kickstarter and GoFundMe are best for entrepreneurs who need a little boost to get them started.

    The majority of entrepreneurs, however, don’t raise a lot of money this way—so don’t count on this for a major source of runway.

→TL;DR (Too Long; Didn’t Read): Unlike other small business loans, funding methods like angel investors, friends and family, and crowdfunding campaigns don’t require formal documentation of your business’s financial history—making them ideal for entrepreneurs who are just getting started.    

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Debt- and Asset-Based Financing

When you think of a small business loan, you’re probably thinking of a traditional term loan. That’s a lump sum of cash that you repay, plus interest, over a set amount of time. But most new businesses have a tough time qualifying for term loans, like term loans and SBA loans, because of their rigorous eligibility requirements.

Instead, look toward these three secured business loan options, whose applications are much more accessible for businesses with limited financial histories.    

  • Equipment financing: If you’re building your business from the ground up, you’ll probably need equipment, whether it’s ovens for your bakery, trucks for your gardening service, or computers for, well, pretty much every business out there. That’s where equipment financing can help.

    Because the collateral is built into the loan itself—aka the physical equipment you’re financing with the cash you’re borrowing—lenders are much more likely to extend equipment loans to new businesses. In other words, equipment loans for startup businesses are more accessible since they pose less risk to lenders. Lenders have a guaranteed asset they can seize in case the borrower defaults on their payments.

    The price of the equipment you’re borrowing determines the price of your loan, so interest rates can be as low as 8% or as high as 30%. But these loans give you access to the raw materials you need to get your business up and running. That way, you can build up the strong financial history you’ll need to graduate into larger or more flexible loans down the line.
  • Short-term loan: If you’ve been making money off your business idea for at least a year and you’re ready to seek additional funding, a short-term loan from an alternative lender might be your best financing option.

    In general, it’s much easier for younger businesses to qualify for short-term loans from online lenders than it is to qualify for bank loans. That’s mostly because short-term loans are less risky for the lender than bank loans: capital amounts are lower, repayment periods are shorter, and interest rates tend to be higher.

    Short-term loans can provide exactly the capital boost that growing businesses need to keep up with demand. Plus, this is a great option if you need cash fast: If you’re approved for a short-term loan, you might see that money in your business bank account in as little as a single day.

    You’ll need to provide stats on annual revenue, so short-term loans work best for businesses of at least a year old that can show evidence of profitability and future growth.
  • Business credit card: Just like your personal credit card, a business credit card gives you easy access to a flexible, revolving line of capital that you can draw down from whenever you need or want. Plus, most business credit cards come with lots of perks that’ll help you run and grow your business, like cash back on everyday purchases, which you can then reinvest back into your business.

    Keep in mind that when you apply for a business credit card, the card issuer will definitely ask for stats on your business, like your business entity type, age, and your annual business revenue. So, at the very least, you’ll need to have established your business’s legal structure and acquired an Employer Identification Number (EIN) before applying.

    On that application, you’ll also provide your personal annual revenue and personal outstanding debt. The card company will do a hard pull on your personal credit score to see how well you’ve managed your own financial obligations in the past.

    If your business has zero-to-limited financial history, the credit card company heavily values all of that personal information in determining whether to accept your application. So, as long as your personal financials are in pretty good order, don’t worry too much if your business is brand-new. You’ll still have a good shot at scoring a business credit card.

    

→TL;DR: Equipment loans, short-term loans from alternative lenders, and business credit cards are among the most accessible types of debt financing loans for brand-new businesses.

How to Identify Whether Your Business Idea Needs Funding

Only you can know if your business is ready for funding. But these tips from current small business owners can help get your wheels spinning:

Your business idea can use funding if:

  • Your idea meets an untapped need in the marketplace.
  • Your idea is unique—i.e., something like this doesn’t already exist on the market.
  • You have a detailed business plan, including projected expenses, that covers 2+ years of business.
  • You’ve commissioned a management team that’s able and qualified to put your plan into motion within the next year or so.

If you’re a new business, you should seek additional funding when:

  • Your company’s profit is catching up to the amount of your original funding.
  • Your company’s capital can’t keep up with customer demands.
  • Your growth is exponentially increasing.
  • Your operational costs exceed your existing capital, but your profit margins are projected to increase, too. That way, potential lenders know you won’t immediately default on your loan.

The bottom line? Financial planning is absolutely crucial when you’re in the beginning stages of your business, even if you’re running that business out of your bedroom (or hope to run your business out of your bedroom, sometime in the near future). With a clear and thoughtful financial plan in place, you’ll make any potential lenders just as confident in your new venture as you are—and watch the seed of your idea grow into a full-fledged business.

  

Quotes have been lightly edited for clarity.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

Caroline Goldstein

Staff Writer at Fundera
Caroline is a small business and finance writer at Fundera. Before coming to Fundera, she received an MFA in Fiction from New York University. She loves finding creative ways to help entrepreneurs grow.

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