201510.16
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The Pros and Cons of Self-Funding a Silicon Valley Business

Starting a business in the San Francisco Bay Area can be the fulfillment of a lifelong dream. There are numerous potential rewards for those who are willing to put the time and effort into getting a business off the ground. During the startup phase, there are many important decisions to make. Among the most critical is how to fund the new business.

Many people wanting to start a new business (particularly here in Silicon Valley) look for investors or venture capitalists to fund their startup. Others choose to fund themselves. Here is an overview of the various options for self-funding, and the advantages and disadvantages of going this route.

Self-Funding Options

There are several approaches for funding a business with personal assets. The approach you choose will depend largely on your specific circumstances.

Savings

Money you have in personal savings may, under some circumstances, be the best source of funding for your Bay Area startup. Though depleting long-held savings should always be done cautiously, with savings accounts currently paying very low interest rates, there is little to lose in the way of opportunity costs using money from your personal savings to fund your business. However, if you do utilize this option, make sure to leave enough in your account to get you through an emergency.

Other Personal Assets

Personal assets, such as IRAs, 401Ks, other types of retirement accounts, stock investments, and real estate can be another source of personal funds for your startup. Tapping these types of personal assets, however, can have significant tax consequences and may, under certain circumstances also be riskier than withdrawing funds from a savings account.  Using these kinds of assets will require consultations with your tax advisor and/or financial planner and you will need to review all your available options to decide whether and/or how to proceed.

Family or Friends

If your savings and/or other personal assets are not enough, you may have a family member or friend you can ask to either lend you the money or become a collaborator/investor in your business. Collaborating with someone close may be an option  but there are a number of legal issues that arise under these circumstances (e.g., which kind of legal entity, rights and obligations of the respective parties, what to do in the case of deadlock or disagreement) and consulting with an experienced business attorney as early as possible is absolutely essential.  Moreover, on a personal level, this route  could also put an added strain on the relationship, particularly if things do not work out as planned.

Personal Debt

In today’s lending climate, business loans can be difficult to secure. For this reason, many Silicon Valley new business owners use personal loans to start their business. Personal financing options may include home equity lines of credit, credit cards, or unsecured loans. If you have a high credit score and relatively low existing debt, this might be a viable option. Just be cautious about which source you choose; many credit cards carry high interest rates, and it may become difficult to pay the finance charges if your business revenues are not as high as projected.

Cash Flow from the Business

Reinvesting cash flow is a relatively low-risk way of funding the growth of your business. This strategy can be combined with one of the other self-funding methods to grow your company without having to solicit outside investors.

The Pros of Self-Funding

There are several potential advantages to self-funding your Bay Area startup. These include:

Full Ownership: When you start your own business, you are the one putting in all the hard work and long hours to make it work. And if you are self-funding, you also receive 100% of the rewards for your efforts.

Full Control of the Company: Perhaps just as importantly as full ownership, self-funding gives you full control over the business. This means you have the ability to make faster decisions when opportunities arise, without having to call a meeting and gain approval from your investors.

Proof of Concept: There are many Silicon Valley new business owners that have a hard time obtaining funding from investors or banks because they have a new and unproven idea or a track record that is not long enough to demonstrate to a bank that the business will be a good lending risk. Self-funding (at least in the early phases) gives you the ability to prove that your business concept works, providing greater certainty for investors who may want to participate down the road.

Greater Spending Discipline: When working with your own money, you are far less prone to developing wasteful spending habits. Setting a precedent of strong spending discipline will prove to be a major benefit for your company when it begins to enter the growth phase.

The Cons of Self-Funding

There are some possible drawbacks to using personal funds to start your business, such as:

Risking Personal Assets: Clearly, one of the major disadvantages of self-funding your startup is putting your personal assets at risk. If the business works, you receive all the rewards. However, if things go wrong, it can exact a significant toll on your personal finances.

Slower Growth: In almost any industry, the ability to grow and expand is largely dependent on having enough capital. If you self-fund, you are limiting your growth potential to your available capital and business cash flow. In Silicon Valley, there are many businesses that are in rapidly evolving industries such as technology and the Internet. Often, the lack of capital can cause such businesses to quickly fall behind the competition.

Fewer Connections: Bay Area venture capitalists and investors provide far more than just a capital infusion. Often, their rolodex of business contacts can be just as important.  If you have already been involved with several previous startups, you may already have the connections you need. But if this is your first new business venture, your ability to form strategic partnerships to help build your business may be limited.

Self-funding your startup venture can be a good option, especially in the beginning stages. There are some disadvantages, however; and in some industries, it may make sense to seek outside funding. Before proceeding, it is best to speak with an experienced business attorney who can help you fully understand the risks and put your new business in the best possible position to succeed.

Jeffrey Miller is a Palo Alto business attorney and member of the Palo Alto Area Bar Association (PAABA). He provides skilled guidance on all types of legal matters for businesses. If you need any kind of assistance with your Silicon Valley startup, call attorney Jeff Miller today at (650) 321-0410 or email him at jeff@jeffmillerlaw.com.