Your dazzling startup dream can quickly turn into a nightmare when your cash supply runs out. With your company’s future hanging in the balance, you have to act quickly to find money. Unfortunately, every cash source has its own set of advantages and disadvantages.
From equity financing to loans and beyond, you have multiple options for reinvigorating your bank account. Consider how each option could affect the future of your business before making your choice.
1. Equity Financing
In exchange for a share of your business, equity investors will provide you with a cash infusion. In exchange, they’re entitled to a share of your profits, and they expect to see a return on their investment.
The biggest advantage of equity financing is that you don’t have to pay it back, and the capital isn’t treated as taxable income. The biggest disadvantage is that you cede control of some parts of your company depending on conditions set by your investors. Some investors will trust you to turn your own business around; others become hands-on, and they want influence over your day-to-day operations.
Before seeking equity financing, make sure you’ve developed a solid plan for improving your company’s performance. Investors want you to acknowledge how you got in trouble in the first place and present a workable strategy for turning it around.
If you have a line of credit or a relationship with a lender, you can obtain loans for investing in assets or working capital loans to meet your expenses. Loans have to be paid back, usually with significant interest, but you get your cash without sacrificing a piece of your business—or your autonomy.
Depending on your company’s performance and how long you’ve been in business, lenders might ask for collateral in return for the money. They might also reject your small-business loan application if your company has repeatedly demonstrated poor financial performance. If your personal credit history isn’t stellar and your business is floundering, you’ll have trouble getting an affordable loan.
Another disadvantage of loans relates to liability. Depending on how you structured your company, you might be personally liable if your business never recovers. If you default on a loan, and you’ve offered something valuable like your home as collateral, you could end up in serious financial trouble.
Although it’s better to initiate crowdfunding during a non-emergency, you can still get help from your fans in a crisis. Crowdfunding usually involves giving something in return for a person’s contribution, and your business might not be able to afford T-shirts and free merchandise for its donors. Because your donors receive no equity for their contributions, the IRS treats their donations as taxable income. Some argue that crowdfunding money should count as a gift, not as income, but no agency or court has made a definitive ruling.
Kickstarter generally advises startups to treat proceeds as taxable income, and it’s a good idea to discuss the issue with your accountant. If you opt for emergency crowdfunding, use it to pay for tax-deductible operating expenses instead of using it for capital investments.
Filing Chapter 11 bankruptcy won’t give you an immediate source of cash, but it will give you the option to reallocate money you’re currently pouring into company debts. You’ll have to demonstrate a plan for reorganizing your company, and you can expect significant oversight from a bankruptcy trustee. You may also have to confer with shareholders regarding how to reorganize your company, and some will be more cooperative than others.
Bankruptcy isn’t an immediate solution to your cash flow problems because the discharge process can take several months. Still, if you have a strong plan for reorganizing your company, bankruptcy can give your startup a chance to recover and refocus.
Making Your Choice
Your funding choices come down to four main issues: your desire for autonomy, your creditworthiness, your tax situation, and your realistic chances for future success. Choose the solution that fits your temperament, your risk profile, and your business needs, and renew your commitment to helping your business succeed.
A final word: if you’ve reached the point of filing bankruptcy, it’s time to seriously think about your startup’s future. The most successful entrepreneurs know when to stay and fight for their companies and when move on to the next opportunity.