Similar to public companies, private companies also need funding for various reasons. A business typically needs the greatest amount of financing during the startup and growth phases, but it may also require a cash infusion for research and development (R&D), new equipment, or inventory.
Funding is necessary for a new business to get its feet on the ground and for established businesses to grow. Private companies don't have the same resources to raise capital as public companies do, such as issuing stock.
While funding options for private companies are numerous, each choice comes with various stipulations. Money from personal savings, friends and family, bank loans, and private equity through angel investors and venture capitalists are all options for funding throughout the life cycle of a private company.
Friends and Family
In the early stages of a private company, personal resources are used to finance business operations. Pulling from savings, taking a distribution from a retirement account, or taking out a second mortgage on a residence are common among new business owners. Once financing from personal resources dries up, owners may find funding opportunities among friends and family members. In most cases, private financing from close relatives or friends comes in small increments between $5,000 and $10,000, and repayment is often flexible. Additionally, friends and family who invest in the business do not often take an active role in operations.
Conventional lending through a financial institution such as a bank or credit union is available for a private business that can provide proof of a strong financial track record. A conventional bank loan may require owners to show revenue sources, profit levels, and detailed business plans before approving a loan, and as such is not appropriate for all private companies. For instance, a private business in the startup phase may not qualify for financing from a bank, nor does an established company that shows losses each year. However, bank loans provide a smart source of financing to developed businesses and allow for extended repayment over time with predictable fixed monthly payments.
An angel investor is typically a high-net-worth individual who lends funds in exchange for an ownership stake in the company. Because of the equity position within the company, angel investors are more likely to provide substantial amounts of capital when they find a business in which they want to invest. Most angel investors are professionals in private equity, meaning the business seeking funding must pitch its need for financing along with current financial statements, its business plan, and a viable exit strategy. Angel investors most commonly work with companies that have exponential growth potential and a desire to transition from private to public in the future.
A venture capitalist is similar to an angel investor. This is a group of high or ultra high-net-worth individuals or a company that manages the assets of those individuals. Because of the volume of money that flows into venture capital firms, businesses able to secure capital through this medium are awarded deals in the millions on average. Similar to angel investors, venture capitalists invest in companies with a strong track record of revenue and potential for extreme growth over time but also require an active role in business operations. Venture capitalists require an exit strategy, which makes this financing option best for companies that plan to go public or sell to another company in the future.
Although the novelty of crowdsourcing has worn off, websites like GoFundMe and Kickstarter are still very much options for private ventures that need an infusion of cash. The key is being able to communicate the business idea in a way that is exciting, concise, and engaging. How successful you are will depend on your ability to appeal to your social network as well as a mass audience of strangers. As such, some business ventures will translate better into a crowdsourcing proposal than others.
The Bottom Line
Private companies have different options when raising capital when compared to public companies. The majority of these options are quite different from one another so it is important to determine which option suits your business best and will allow it to grow successfully with your vision in mind.