Entrepreneurs seeking funding often face a steep learning curve. If you’re brand new to the small business world — or it’s your first time putting together a funding stack — there’s a lot to take in.
But don’t let that stop you. SOAR Innovation is here to help simplify the process for you. We’ve recently put together a series of blog posts to help Eastern Kentucky’s small business community navigate their funding options.
While we’ve looked at specific funding types, we haven’t yet discussed the different strategies that consider how to put together a funding stack.
The best funding strategy is variety. There are a number of reasons why a diversified capital stack will yield the best results for your business and yourself.
Let’s take a look at each of your funding options — and explore why it makes sense to tap into multiple sources to get your business the cash it needs to grow.
What do you mean by a diversified capital stack?
Every company is unique. With each individual business comes a personalized set of growth objectives, goals, and considerations.
The funding process is just as unique.
Ask an investor who works with Eastern Kentucky entrepreneurs every day. They’ll tell you that every business faces its own set of opportunities and challenges when it comes to getting funded. No two are exactly alike.
When we refer to a diversified capital stack, we’re talking about which types of funding to go after, when, where, and why.
The tricky part is determining what the right sources are for you — when the right timing is — and how to implement it best.
First, let’s take a look at the types of funding available to you. Then, we’ll evaluate which questions to ask yourself to assemble a diversified capital stack that works for your growth plan.
Sources of capital for small businesses
SOAR Innovation recently created guides to the following types of funding. Review these if you haven’t already:
- Traditional small business loans
- CDFI loans
- Angel investments
- Opportunity Zone funds
- PACE funding
- NMTC funds
Alone, each of these different funding types can support unique business objectives. When put together into a well-designed capital stack, they can supercharge the opportunities available to your business.
There are 3 factors that you need to balance:
- Timing is a big consideration. If you need cash faster, loans may be your most accessible option. If you meet the bank’s criteria, which includes having reliable cash flow to pay back a loan, you could have your funds in a matter of weeks.
But loans can be expensive. Equity investments are a longer-term play for small businesses. They involve developing relationships with investors, pitching your ideas, and preparing for due diligence.
- Restrictions and covenants are other major factors. For example, you must comply with the rules for how you can spend certain forms of capital. This often applies to grants — and many equity investments as well.
- Finally, as you look at funding over the long term, assembling your capital stack includes building in options to access other types of capital in the future.
Let’s review some of the questions you should be asking yourself to help prepare your growing business for success.
Assembling a diversified capital stack
Step 1: Know your goals
Start by consulting your company’s roadmap. What are your goals for years 1, 3, and 5? And what sort of capital will you need to achieve them?
Let’s use a hypothetical business example to play out this scenario.
Say you’ve always wanted to own your own hardware store — one that sits at the heart of your community. Big box stores may have competitive prices, but you can offer your shoppers a more welcoming, friendly customer experience.
You also plan to launch workshops and classes out of the facility as an additional revenue stream down the line. Programming will further position your business at the center of your community.
Within your roadmap, this hypothetical business has a few goals:
- Open your hardware store (Year 1)
- Launch programming (Year 3)
- Expand to a new location (Year 5)
Let’s explore a funding stack that could support each step of the way.
Step 2: Match your early goals with funding
As a brand-new business owner, you need to seek out investors and institutions willing to work with you.
Your first goal is all about getting your hands on as much cheap cash as possible.
In this instance, you might consider pursuing options ideal for early-stage entrepreneurs:
- A CDFI loan, which will have more favorable terms than a traditional business loan.
- An Opportunity Zone investment, if your location qualifies for one.
- A small business grant, if you’re eligible.
You might even try for two or three of these options to receive the total amount of capital you need.
Balancing grants, investments, and loans is critical. If you skew too heavily towards loans, your balance sheet will take a hit, and it’ll be more challenging to access additional capital later on.
But you may be unable to launch your business on grants and early investments alone. Consider your options carefully. Weigh the pros and cons of taking more money now versus skating by until you can pursue a larger, more favorable investment after showing profitability.
Step 3: Set yourself up for success with institutional investors
Your second goal is a little more complicated. Programming a workspace out of your hardware shop is a promising idea, but it’s a brand new area for you. Your customers have expressed interest in leveling up their skills. And you think an afterschool program could be highly profitable.
It was smart of you to wait until the store was up, running, and profitable before tackling this concept.
Now that you’re ready to launch a more complex business model, this could be your moment to bring in an investor partner with complementary skills and experience.
Angel investors prefer to see that you’ve established relationships with other funders before putting up any of their own cash. So thankfully, you’ve been repaying your CDFI loan on time and won a small business grant from the USDA.
If you have a strong track record with your earliest sources of funding, it’ll lead to more favorable terms with angels.
But remember — they’ll ask to see your roadmap, financials, and complete business pitch. It will be pretty different from your early rounds of funding. You’ll be taking on a new partner, sharing decision-making, and collaborating to make this business successful.
Be prepared to make adjustments — but also continue growing in the direction of your dreams.
Step 4: Securing a bank loan for business expansion
Your long-term goal of expanding your business into a second location will require even more effort than the first. Once again, you’ll need to go after some new funding to make this growth opportunity a reality.
But this time is different. Several years in as a business owner, you have an advantage: many years’ worth of relationships, loan statements, and recommendations from investors.
Perhaps you’ll want to approach your CDFI with your business plan. But if they aren’t able to fund the loan amount you need, it may be time to pursue a relationship with a traditional bank.
If you’ve played your cards right, your cash flow projections indicate there’s a healthy margin to pay back a large loan. And your business credentials will inspire faith in these institutional lenders, too.
This is just one example of assembling a diversified capital stack to grow from a small hardware store into a multi-location business that offers programming and events. As you consider the options available to your business, the stack may look different, but the questions you ask yourself will be the same:
What type(s) of funding will empower my business today without causing issues tomorrow?
Partners in the funding process
- The US Economic Development Agency helps small businesses thrive by providing funding opportunities.
- Kentucky Area Development Districts help bridge the divide between government services and the business community.
- Several CDFIs, including the Kentucky Highlands Investment Corporation, are funding small businesses in our region.
- The Appalachian Investors Alliance and the Tri-State Angel Investment Group are helping clusters of entrepreneurial activity to form in our region.
- SOAR connects small business owners with funding opportunities and provides actionable resources.
Conclusion: Keep up the momentum for your small business
Download the Complete Guide to Entrepreneurship in Eastern Kentucky to learn how to transform a new business — from ideation through expansion.
Subscribe to the SOAR blog to stay up to date with the latest how-to guides and news about entrepreneurship in Eastern Kentucky.