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, new equipment or inventory. While funding options for private companies are numerous, each choice comes with various stipulations. Money from personal savings; friends and family; bank loans; 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 prior to approving a loan, and as such is not appropriate for all private companies. For instance, a private business in the startup phase does 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 of $11 million 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.