For those who were able to make it to Jason Pappas’ first of two workshops on “How to Finance Your Business” this past Friday know what a wealth of knowledge he has to share. He discussed some of the differences between bootstrapping a business, what Pappas refers to as “The Ramen Noodle Method,” and some of the more traditional methods of financing your startup.

Attached to this post you will find a PDF document that shows the flowchart discussed during the workshop.

Very basically, once you come up with your business idea, you have to figure out how to make it grow. One method is to bootstrap it. To bootstrap it, you can utilize credit cards or take profit earned and reinvest it into business development. Many companies have had success with this method, but many more have nothing but copious amounts of debt to show. Pappas notes that some businesses begin by bootstrapping and quickly move over to a more traditional financing method.

There are two simple methods of financing your business; you can finance through debt or through equity.

Relying on debt requires you to pay interest and put up some form of collateral should you default on the loan. Some forms of debt financing include: going to a bank, asking friends and family, or getting a Small Business Loan. Pappas recommended the SBA for low interest loans and even has financed a few of his businesses through this program.

The other method is to give equity in your company in exchange for funds and expertise. There is no need to provide collateral, which many entrepreneurs just starting out don’t have an asset to put on the line, most investors bring some expertise in a skill that could be beneficial, and the risk is shared in case of a failure. Yes you have to give up a portion of your company, but my philosophy is that “I would rather have a small piece of a large pie than a large piece of a small pie.”

Pappas discussed 4 types of equity: friends/family & fools, angel investors, venture capitalists, and private equity firms. Friends and family are often the first place many people turn to get started. There are some caveats to be aware of here. Be sure to accurately valuate your company before giving equity away to anyone. Also, Pappas recommends, “Never put non-delusion clauses in an equity agreement at this stage. The next stage investors simply won’t invest.” Dilution is the subsequent sale of shares of stock at a price per share less than that paid by the preceding investor. As an example you sell to your mom 10% of your business for $50,000, meaning that you value the company at $500,000. At your next stage, you sell 10% of your company for $250,000, meaning you a valuing the company at $2.5 Million. No investor is going to pay 5 times the amount your mom did for the same equity in the company and will therefore want to dilute her share to a more accurate 2%.

Angel investors are often the next stage people move into to find investors. Angels are people who have typically had some successes in the past and have money to invest in startup companies. This is the stage in which many incubators and accelerators are beneficial to companies starting out. They will help you get to the next stage.

Venture capitalists are often the third stage of investment and prefer to work with companies that have graduated from the startup stage and are now in the “Early Stage.” They have some success, some profits, and maybe a number of employees.

The final stage Pappas discussed was private equity firms. Private equity companies typically only invest in companies if they can become the majority shareholder, 51% or more. This is often a great opportunity for business owners to cash out and move on to their next company or retire altogether. Pappas’ company, Antson Capital Partners <http://antsoncapital.com/> is a private equity firm that buys out companies in the Baltimore and mid-Atlantic region.

Pappas has agreed to do a follow-up workshop on Financing Your Business on November 17 from Noon – 1pm in entreSpace. The focus of this workshop will be on valuating your company as well as what investors want to see at each stage of investment.

You can download the unedited audio of the workshop here. Make sure you download the attached pdf document illustrating the flow of investment.