How To Raise Money in a Recession
Here are eight ways to raise capital in a tight economy.
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There have been 11 recessions since 1948, occurring about once every six years. Periods of economic expansion are much more varied and have lasted as little as one year and as long as a decade. The average recession before 2007 lasted about 11 months. The Great Recession, which began in December 2007 and ended in June 2009, lasted 18 months and recorded the largest decline in output the country experienced since 1960 (IMF). The 2020 COVID recession lasted just two months but broke the record for longest expansion in U.S. history. Regardless of where we are in the economic cycle, we are either recovering from or headed to a recession. A constant during either period was that people were still starting new businesses. In fact, often the best new businesses get started when a smart, ambitious, and entrepreneurial person gets laid off from an existing business due to downsizing during economic contraction. If you’ve become part of this brave and bold crowd during an economic downturn, you are not alone. You represent the entrepreneurial American spirit that burns in the hearts of many. But to realize your dream, you need money. How do you get it? Below I discuss the top eight ways you can raise money in a recession (or any economy).
1. Bootstrapping This is probably the most obvious way to finance any new business. Bootstrapping is the process of funding your business yourself, without outside investment. In addition to your savings, there are other ways to get creative with your assets. If your new business will start out as a side hustle, a loan from your 401(k) may be an option. Be aware that every employer's plan has different rules for 401(k) loans, so find out what your plan allows. You could also take a direct withdrawal from your 401(k), but I don’t recommend this as it will trigger taxes and penalties making it a bad financial decision. If you have significant retirement assets in your IRA, you can look into getting a Rollover as Business Startup (ROBS). A ROBS is not a loan or a self-directed IRA, but allows you to access your money from your IRA penalty-free. The process involves setting up a C Corporation, then establishing a 410(k) retirement plan and rolling over existing retirement assets into the new retirement plan that then invests the money into the stock of the new C Corporation. This can be a complicated and tricky process, so it’s best to hire an expert if you are considering it as an option. You can also leverage your home’s equity. If you have owned your home for some time, there may be home equity that you can borrow to fund or invest in your new venture. You can do this through a Home Equity Line of Credit (HELOC). HELOCs are very common, and you can learn more by visiting your local bank branch or their website. In general, bootstrapping is a good option for businesses that have relatively low startup costs or that can generate revenue quickly.
2. Friends and Family Friends and family loans may be available when other types of financing aren’t, but they do require some precautions. Friends and family loans or direct investment by friends or family members has been used to launch many successful businesses including Walmart, Motown Records, and Amazon, to name just a few. Loans or investment into a business by friends and family can be a good source of early-stage funding, especially if you have a strong personal network. There are many pros and cons when looking to fund your business using money from your friends and family. On the pro side, such loans typically have no credit checks, can have low or no interest rates, and allow for flexible repayment terms. It all depends on what you can negotiate and the generosity of those funding. On the con side, the funding may be smaller than what you could get at a bank, and if things go south with your venture, it could damage relationships. It is hard to look Uncle Frank in the eyes at Thanksgiving dinner if you lost his money. If after weighing the pros and the cons you believe funding through your family and friends makes sense for your business, it is important to be clear about the terms and to have a written agreement in place.
3. Angel Investors Angel investors are individuals who invest their own money in your business. They are typically wealthy private investors focused on financing small business ventures in exchange for equity. Unlike a venture capital or private equity firm that raises money from other investors and then uses that capital to invest in a business, angel investors use their own net worth to invest in your business. Funding your business using an angel investor has some distinct advantages. They may be more patient with entrepreneurs and open to providing smaller dollar amounts for a longer time. For this flexibility and acceptance of increased risk, an angel Investor typically wants 10% to 50% of the business in exchange for the funding. That means business owners could lose control of their business if the angel investors determine the owner is keeping the company from succeeding. Angel investors are often looking for businesses with high growth potential and can be a good source of funding for businesses that have a clear business plan and a strong team.
4. Venture Capital (VC) Funds Like angel investors, VC funds tend to invest in startups and early-stage businesses. They are typically looking for businesses with a large addressable market and a clear competitive advantage. VC funds are professional investors who must earn a consistently superior return on investments in inherently risky businesses. More recently, VC funds have focused on certain industries or niches in which they can gain deep knowledge and expertise to help mitigate that risk. You will need to have a good business plan and be able to convey your value quickly. Make sure your business is ready, commercially viable, and preferably scalable, before approaching VC funds looking to raise capital. To find VC funds who may be interested in investing in your business, you can start on the internet looking for online platforms and investor databases. There are also venture capital associations located in various cities around the country. These are all good sources, but when looking to fund your business nothing beats networking at industry events and asking your social network for introductions.
5. Government Grants and Loans Believe it or not, the government wants to fund your new business. In fact, the Small Business Administration (SBA) is set up to do just that through different types of funding programs. Through its participating lender partners, the SBA offers loans for variant needs through its flagship 7(a) program that offers loans up to $5 million; 504 Loans for real estate, equipment, machinery, or other assets; and microloans for those needing less than $50 thousand to start their business. If you prefer equity funding for your business, the SBA has 300 Small Business Investment Companies (SBICs) licensed by the SBA who invest in small businesses in the form of debt and equity. For certain types of business such as those engaged in scientific research and development, they even offer grants. All the SBA’s programs provide their partners with a guarantee for the various types of funding. This can impact the cost of funding but is a good option for businesses who may have difficulty qualifying for traditional financing.
6. Crowdfunding Crowdfunding has grown in popularity over the past 20 years. Crowdfunding is done through platforms which allow you to raise money from many people, typically in exchange for rewards or equity in your business. Some of the more popular platforms include Kickstarter, Indiegogo, StartEngine and WeFunder. Different crowdfunding platforms have different market niches that they serve, so do some research to find the platform that works best for your business. Crowdfunding can be a good option for businesses with a strong social media presence or a compelling product or service.
7. Win A Business Competition Do you have a flair for presenting? A charismatic personality? If so, competing in a business competition to fund your business may be a good idea. There are many business competitions that offer prizes in the form of cash, mentorship, or other resources. These competitions can be a great way to raise money and get exposure for your business. Each competition has certain rules and focuses. For example, many are location-based, industry-focused, or university-led programs that are open to only certain types of businesses and founders. The good news about exclusivity is that it means you are only competing against others that meet the competition’s criteria, possibly making it easier to get exposure and funding even if you don’t win the competition.
8. Revenue Share Agreement A Revenue Share Agreement allows you to raise money from stakeholders in exchange for a share of future revenue over a period of time. Revenue Share Agreements can be a good option for businesses that are not yet profitable but have the potential to generate significant revenue in the future. The key to a successful Revenue Sharing Agreement lies in the structuring—not all revenue is equal. If different products and services have varying gross margins, the agreement should be structured to provide different share percentages based on product or product lines. A Revenue Share Agreement aligns stakeholders to work toward the same goal and offers a shared success. In raising funding for your business, approaching potential suppliers for funding will most likely be the best option, because your success means their success as well! Conclusion Raising money during a recession is no different than raising it during a period of economic growth—the only variation is the number of doors you will need to knock on will increase and, when you get the chance to pitch, the strength of your business case will matter even more.
Article by Ken Fick Freelance Writer Ken Fick is a CPA, and MBA with over 25 years of finance experience providing leading-edge solutions designed to improve forecasting, budgeting, planning, and decision-making to companies from $3 million to over $50 billion in revenue. He is a freelance writer that focuses on producing engaging content on all things business, accounting, finance and investment related. You can view a sampling of his published work at FPAexperts.com.
