The Capital Ladder: How Businesses Get Funded

Most people ask where to get money for a business. The more useful question is what you can do from where you are standing today. This post answers that one.

A 20 year old recently asked us three questions at once. Do you need a steady job to get a loan? Are loans the only option? Where do you find investors?

Those are fair questions. They are also questions about the top of a ladder, asked by someone standing on the ground. Money comes into a business in a set order, and most new owners reach for a rung they cannot touch yet.

First, Build a Plan That Does Not Need Funding

We do not tell people to go find money. We tell them to build a plan that makes a profit without it. Funding should speed up a business that already works. It cannot make a broken one work.

The most common funding mistake is not picking the wrong lender. It is building a business that only works if somebody else pays for it. Then the hunt for money becomes the job, and the business never starts.

Picture two people opening the same kind of shop. One needs $200,000 before the first customer walks in. The other starts out of a van, pays for the buildout from six months of profit, and walks into the bank with deposits to show.

The second owner is not more talented. She picked a business she could start without anyone's permission. If your plan dies without outside money, outside money will rarely save it. It usually just delays the failure and adds a personal guarantee to it. Businesses that cost a lot to open make this worse. We wrote about that in Why Your Dream Business Might Be Your Worst First Business.

The Five Rungs, in Order

Almost every business funded from zero climbs the same five rungs. You move up by making the rung you are on produce something a lender or an investor can look at.

Rung 1: Pay For It Yourself, Which Is Not a Consolation Prize

Nobody wants to hear about rung one. It sounds like being told to go get a job. It is not. It is starting a business that brings in cash the first week instead of burning cash for a year.

Consulting, freelance work, trades, cleaning, care services. These cost almost nothing to start, which means they cost almost nothing to get wrong. Every dollar they bring in is a dollar you did not have to ask anyone for. Every month of deposits is proof that makes rung two possible. We cover how that start works, including why insurance matters more than an entity this early, in Can You Start a Business With No Money?

Here is why this rung matters so much. Lenders lend against history. Investors invest in traction. Rung one is where you make both out of nothing.

Rung 2: Put the Profit Back In and Build Credit

Once money is coming in, your business becomes its own bank. This is where good personal credit finally pays off, though not the way most people expect. It will not get you a startup loan. It gets you the small, boring tools that let a working business buy things before customers pay.

• A separate business bank account: the first thing any lender asks to see, and the thing that makes your sales look like business income.
• A business credit card: usually approved on your personal credit at first, and usually backed by your personal guarantee. Use it for timing, not as funding.
• Vendor and trade accounts: net 30 terms with suppliers are free money, and they build a credit file in the business name.
• A small line of credit: realistic after a year of deposits and a real relationship with a local bank or credit union.

Reinvesting is slower than borrowing. It is also the only money that never has an opinion about how you run your company. Most owners stay on this rung longer than they planned, and most are glad they did.

Rung 3: Friends, Family, and Microloans

This is the honest answer to "where do you find investors." You find them where you already are. The first outside money in most small businesses comes from someone betting on you, not on your spreadsheet.

Amounts here usually run from about $5,000 to $50,000. The sources are family and friends, community lenders and nonprofit microloan programs, many of which run at the state or regional level. Sometimes a local pitch contest or a small business grant. Terms are simpler than a bank's, and nobody digs very deep.

That last part is exactly why this rung breaks relationships. Money from people who love you is still money. Undocumented money is the most expensive kind there is.

If someone hands you money for a share of the business instead of repayment, that is not a loan. That is a securities deal. It comes with filing and disclosure questions that change by state and by structure. Have that conversation before you take the check, not after. Our flat fee pricing covers promissory notes, operating agreements, and investment documents, so you know the cost before you agree to the deal.

Rung 4: SBA and Bank Loans, and the Steady Job Question

Here is the direct answer to the question that started all of this. Banks and SBA lenders want to see where the payment comes from. For a running business, that is cash flow. For a true startup with no history, it usually means outside income, a co-borrower, or real collateral. No income, no history, and no collateral is the one combination that almost never gets approved.

Startup borrowers under the SBA 7(a) program are also expected to put money in, commonly 10 to 20 percent of the project cost. Personal guarantees from owners with real ownership are standard. This varies by lender and by program, so treat those numbers as the shape of the expectation, not a fixed rule.

Rung four is not a door that opens for good intentions. It opens for people who can point at the money that makes the payment. Rungs one through three are how you build that.

There is one more path most first time owners never think about. You can buy a business that already has the cash flow a lender wants to see. Loans for buying follow different rules, and we walk through them in How to Buy a Business With No Money Down.

Rung 5: Equity Investors

Angels and venture capital sit at the top of the ladder. For most small businesses they are not the goal. They are not even in the picture.

Equity investors buy a slice of a future payday. They need that payday to be huge and fairly fast. A profitable landscaping company with a good owner and steady margins is a wonderful business and a terrible venture bet. Nobody failed in that sentence. The two things just do not match.

If equity really does fit what you are building, the order still holds. Angel groups, accelerators, and warm introductions come first. Cold emailing venture firms with a business plan and no sales is not a plan. For how to get ready for those conversations, see How to Secure Funding for Your Startup.

Which Rung Are You On

Answer these in order. The first one you cannot answer is your rung.

• Has a stranger paid you for this yet? If not, you are on rung one.
• Do you have a business bank account with a year of deposits in it? If not, rung two.
• Can you name the person who would lend you a few thousand dollars tomorrow? That is rung three.
• Can you show a lender where next month's payment comes from? Until you can, rung four stays shut.
• Could this business be worth many times its size in five years? If not, skip rung five and stop reading about it.

Find your rung honestly. No amount of pitching moves you up one. Maybe you have sales and want to formalize, so you can open business accounts and sign real contracts. Our Launch 360 package handles the formation and the guidance around it.

If you are on rungs three through five, get the paperwork right before the money moves. A friends and family note, a loan or SBA term sheet with a personal guarantee in it, investment documents. Book a free consultation and we will tell you which rung you are on and what the next one takes.