VenturePORT Series - Do You Have the Money?
It can often take just as long to find the money to fund your business as it does to start the business itself. Unless you have family, friends, or contacts with money, strong professional credentials and contacts, or tremendous determination, your best shot is to sell yourself into business. That means, find a business that requires very little upfront money because you can pretty much pay for the products and services you provide when you get paid.
To get money, you have to convince someone to invest in your company by buying stock or lending to you under favorable repayment terms. Depending on how you're going to get the money, you may need a formal business plan and a prospectus with ample evidence you can deliver. This is often presented in the form of a PowerPoint Presentation for a polished, buttoned-up look. Once you've secured the money you'll pretty much have to go through the same process again with an outline communicating the plan for reaching the deliverables you've promised. So, unless you feel pretty confident you have the means to obtain financing from one of the options below, look for a concept that requires as little money as possible. If you can work without drawing a salary, and use independent contractors (freelancers) or suppliers who don't have to be paid until you get paid, you can pretty much sell your way into business.
Entrepreneurs driven by the desire for total control and the need to answer to as few people as possible usually prefer the model of selling themselves into business. Once you get investors, you have bosses. Even a very friendly angel investor, such as a father or mother, may still demand results and accountability.
We know of a successful doctor who raised nearly $1 million from friends and family for a dot-com concept that ended up going bust. He used to joke he'd have to flee the country if it failed. He didn't flee, but he felt enormous pain when it went down because he had to face his family and friends on a regular basis. Even if investors don't need the money, it's often a matter of pride that their money produces results. No one likes to lose, and if you lose money for someone, you can appear to be a loser in their eyes. All of this is a way of saying: Don't take lightly the concept of using someone else's money. There's rarely a free lunch.
When you raise money from outsiders, even if it's in the form of debt, you give up some control. If you have very little experience but a great idea, you might get the capital you need from investors, but they will insist on owning a controlling interest. That means you have a boss. In most cases, you can expect them to ask plenty of questions and expect regular reports.
That said, there's nothing like having access to cash. With sufficient cash, you can deploy the resources necessary to do it right — hire the right people and rapidly scale up if you experience solid demand. If you are able to find respectable investors to buy stock in your new company and leave you effective control, if you have properly managed the expectations of those investors so they don't expect miracles, and if you have the maturity to spend money wisely, that is of course the best of circumstances. Most entrepreneurs do not have such good fortune, and thankfully, it's not necessary.
There are six basic ways to finance your company. Here are details on the various options:
[ Return to Top ]
1. Selling Your Way into Business
As noted in Do You Have a Practical Idea?, the most viable concepts for entrepreneurs require relatively little money up front because you collect the money before you have to pay the bills. If founders are willing to draw no salary in order to limit the need to raise money, this concept can pay off in the long run. It might sound crazy, but it happens all of the time with start-ups built on "sweat equity."
This is often the most realistic means for young entrepreneurs, because they often lack the relationships and business knowledge needed to convince strangers to invest. The key is to have as little fixed overhead as possible — that means minimizing salaries, rent, and other expenses you have to pay even if no money flows in. This start-up mode calls for lean and mean, and it starts with selecting the type of business — outlined in Do You Have a Practical Idea? — that requires little in the way of upfront or fixed expenses. These include service companies that provide maintenance, repair, consulting, and other necessary services; distribution companies in which you sell someone else's products and services, or contract manufacturing in which you make the product based on getting orders using a third-party fabricator. This explains why many companies founded by young entrepreneurs are in software, maintenance and consulting services, food, travel, fashion, the Web, and publishing. If you do it right, and have the right relationships, you can launch with a good base of customers to get you going. You'll have much less trouble getting money from investors or lenders once you have a growing enterprise.
The key to selling yourself into business involves having a readily identifiable market, quick and direct access to the people in that market, and a business model that lets you hold off having to pay too much in the way of salaries or infrastructure until you get paid.
The pros of selling yourself into business:
- You skip a step. All of the work invested creating the materials you need to raise money can go into the work of getting customers, something you'll have to do one day or another no matter how much investment money you raise.
- You keep control. If you don't give up stock, you don't have anyone to answer to except your customers, your employees, and your family.
The cons:
- It's stressful. Details have to fall into place properly to make this work. You have to be upfront with anyone you owe money to, so they understand the payment terms. Building your business on integrity gives you a firm foundation to let you sleep a little better at night, so you can't mislead people.
- You might have to cut corners. You sometimes have to make tough calls when cash is tight between what you can do and what you can't do, or who you can pay and who you have to put off. Perfectionists beware: You may have to make choices that challenge your personal nature to precisely control the universe.
- It's not always sustainable. If you really hit pay-dirt with a great idea, you might experience so much growth you can no longer afford the hand-to-mouth approach. The good news: It's usually easier to get money when the business is growing fast.
[ Return to Top ]
2. Angel Investors
Another good way to start a business is to get angel financing. This means money from family, friends, or simply a business person impressed with your idea and you, who is willing to put up an initial sum to get you started. For many entrepreneurs, this is a father and/or mother, uncle or aunt, friend, schoolmate, boss, friend of a family member, or friend of a friend. This, again, is where relationships come into play.
Angels generally do it because they have the money, they like or respect you, and they believe in you. That could be because they are a loving parent or relative, or because they really do have reason to think you have a great future. Angels often are people who have made it themselves and who enjoy helping others succeed.
Most angels don't do it for a living. They are part of a huge, poorly documented economy of people informally funding businesses usually in the range of $10,000 to no more than $1 million.
Some angels go about it in a more formal way, and do it for the joy of making big money by discovering an early opportunity. These angels cast a wider net and are more likely to invest in complete strangers. They often have a small investment enterprise with a Web site, and they belong to angel networking organizations that bring together entrepreneurs and angels. Some city governments and other organizations sponsor angel meetings in which entrepreneurs can present business plans to angels as a competition. You have to put together a professional business plan and deck, and practice it well, because your presentation will surely take place in front of a crowd and you'll be stacked up against some pretty good competition. Once you're looking for angel money outside of your network of relationships, you're in the challenging business of selling an idea to strangers. The only difference is you're selling people to buy your company's stock instead of products and services.
Some entrepreneurs sell themselves into business and get angel money from a good customer who likes the product and service and believes in the company. The benefit of these types of investors is that often they will have a good understanding of your business and a more realistic idea of what to expect from it. The last thing you want is an investor with unrealistic growth or profit expectations.
[ Return to Top ]
3. Debt Financing
People who want total control over their companies might prefer debt to selling stock because you generally don't have to give up stock or voting rights to get the money. You just have to pay the money back, with interest. Debt is fine if you don't have too much of it, but it can become a fixed cost, just like rent, that hangs heavily around your neck unless the repayment plan represents a small portion of your sales and profits. Debt comes in many forms.
In order to borrow money, you will need a credit rating. That may seem like a challenge, but it's not as difficult as it appears. You can start the process of building your credit record when you're in college or right out of school by taking advantage of the credit card offers from leading companies trying to get your business. Accept one or two card offers, use them from time to time, and make sure you always pay at least the minimum on time. If you run up a small balance, make sure you make the payments, and run it back to zero from time to time. This will help you to get a good credit score. That's the number the leading credit rating agencies, including Experian, use to estimate your ability to repay a financial obligation. Borrowers of all sorts will use it to determine if they want to do business with you and, if so, how much they will charge you in interest. Unless you're very, very lucky, even a successful business will need to borrow a little money at one time or another, so you want to make sure you build up a good credit score.
There are a number of services you can easily find on the Web to get your credit score. You can get your credit reports and scores free annually from Experian and other companies.
Credit card debt. Many companies get founded on a couple of credit cards strung together. You have to already have credit to go this route, or have someone willing to co-sign. Usually, someone with a credit rating willing to co-sign can help you find a better way than credit card debt to start your business. The good news is the repayment plans are stretched out. The bad news is the interest rates are often high. Remember: If you have a good credit rating, or a co-signer with a good credit rating, you can almost always negotiate a better interest rate on finance charges.
Bank debt. There's an old saying about banks: they only lend you money when you don't need it. In fact, that's not fair. We know of many small businesspeople grateful to their banks for the support they got in the early days. The challenge for young entrepreneurs: Banks do not give credit to people without a decent credit rating, and it's tough to get a good credit rating in college. That likely will involve someone co-signing for you if you don't have a credit rating.
Banks can often help you get Small Business Administration (SBA) loans, which are available for certain types of businesses, usually those with a very clear asset such as product inventory or machinery. Unfortunately, the Small Business Administration methods of qualifying businesses generally are not favorable for many service and high-tech companies, or for publishing firms, because these businesses often have no tangible assets at the outset, such as inventory or equipment. The SBA and many banks prefer either to lend to companies with an established business or to finance an asset, such as real estate or some form of inventory that could be sold for at least some cash in a worst case scenario. Of course, it never hurts to have a co-signer with a pristine credit score, no matter what type of loan you seek.
The amount of paperwork involved in getting a bank or SBA loan can be daunting. Expect hours of head-scratching aggravation as you try to piece together the answers to all of their questions. A word of advice: Once you've done so, put it in an electronic format to save for future purposes. It's easier to update an application than to start from scratch, and most banks ask the same sorts of questions.
In general, to get a bank loan, you have to have some kind of credit history, preferably some kind of asset such as a home, or a business that has a very clear and salable asset should you go out of business and the bank needs to recover some cash. The younger you are, the tougher it will be, unless you come from a family with means or have someone willing to co-sign. Nonetheless, if the basic conditions given above are met, you can usually get a bank loan in the range of $25,000 to $100,000 without much difficulty. Over that figure, scrutiny of your business goes much deeper.
Home equity line. Many older entrepreneurs finance their companies through a home equity line of credit. This is because banks often have a much friendlier attitude about lending money against a house, which to them is a real asset. The ability to get a home equity line assumes, of course, that you already own a home with enough equity to borrow against, and this is not often the case if you're in your 20s. In fact, if you're lucky enough to own a home, you might have enough assets and a good enough credit rating to get an entry level bank loan.
Home equity lines allow you to borrow money on the difference between your mortgage and the amount of total value in the house. Generally, if you have a good credit rating, you can borrow at near prime rate and only have to pay interest for an extended period, sometimes up to ten years, depending on the nature of the loan. After ten years, assuming you still have good credit, you can refinance, if the company has not generated sufficient cash to repay both the interest and the principal of the debt during that period.
People with children should seriously reflect before using a home equity line to finance a business. As a parent, you have a responsibility to make sure you properly shelter your kids. Putting your house on the line in a business startup is indeed a gamble, especially if you have to sell your house to pay off a debt. At the very least, borrowing against your house can raise the stress level with your significant other, who may or may not share your confidence in the success of your business.
Receivables loans/factors. Depending on the industry and the type of lender, there are a variety of loans you can get against receivables (money owed to you by your customers). In the fashion and textile industry, these lenders are known as factors. These companies will lend you a percentage of the money you are owed by customers at any given time, so that you can pay your suppliers or employees before you collect the money from customers. Over the years, many companies have depended upon receivables lenders because they couldn't get loans anywhere else.
Generally, under these arrangements, you turn over your invoices to the lender, who advances you a percentage of the total amount due, and then collects the money directly on your behalf. For this, they get a nice cut. Make sure you carefully calculate the cost of these loans. Annualized, the cost can be very high indeed.
There's a variation on this type of company that lends money to companies with a regular flow of payments by credit card. These types of loans also come with high costs, and aren't available to companies unless they are already up and running with customers paying by credit card.
Leasing. This is a highly desirable solution for many enterprises that require technology, equipment, vehicles, machinery, etc. Similar to car leasing, a third-party company in effect buys the equipment on your behalf, and you pay them back with interest, usually over a three- to five-year period. Because the product presumably has some residual value at the end of the lease, your payments are based on the current price minus what the equipment's worth at the end of the lease, theoretically saving you money. Because of interest charges, leases usually cost more than an outright purchase, but they help cash flow because they spread out the payments over multiple years. You will need to have a credit record, or a co-signer, to get a lease.
Note: There are numerous types of leases with much fine print and often hefty interest payments hidden in confusing terminology. Make sure you understand the effective interest rate of your lease and what happens if you need to get out of the lease. Usually you will be liable for the payments unless you can find someone to buy the equipment.
[ Return to Top ]
4. Early Stage Venture Capitalists
Venture capitalists get investors to put money into funds they use to invest in new companies. Generally, venture capitalists look for companies well on their way and showing substantial growth, with sales approaching $10 million or more. The due diligence necessary for them to evaluate and close a deal alone can cost hundreds of thousands of dollars. They rarely take chances on early stage companies.
A certain breed of venture capitalists specifically focuses on early-stage companies to get a higher return and because they can often get a much higher interest than in a company that is further along. These early stage venture capitalists look for companies already up and running with what's called an impressive "run" rate, or growth of new customers. It's always best when venture capitalists find you by reading or hearing about you. If you feel you can show a good growth record, early stage venture capitalists are a potential source of equity. Generally speaking, these companies focus on specific sectors, with a focus on energy conservation, any ground-breaking technology, or bio-medical getting particularly high interest right now. For most entrepreneurs starting out on their first venture, even early stage venture capitalists are an unlikely source of funding.
Once again, going after funding is a sales effort in and of itself. The process inevitably will take your eye off the ball of selling customers, so you had better make sure you have someone keeping the sales process going and the business running while you or a colleague focuses time on all of the e-mails, calls, phone presentations, face-to-face meetings, and all of the preparation involved in going after investors.
[ Return to Top ]
5. Investment Bankers
If you're even thinking about investment bankers, you have probably already entered the big leagues. These are the people who make the big deals happen, fund or engineer acquisitions, mergers, or rapidly growing businesses. Generally, these companies want to see even more in the way of sales and growth than the early stage venture capitalists. You'd better be looking at $10 million or more. But, the best of these organizations have incredible contacts to help you open doors and find other investors. If your company is really hot, you might even be able to retain a controlling interest.
Few and far between are the young entrepreneurs who deal with these folks. Most entrepreneurs make a perfectly good living without ever getting to that level. Of course it happens. Everybody knows about Sergy Brin and Larry Page of Google, Howard Schwartz of Starbucks, Jeff Bezos of Amazon — but the odds for any single entrepreneur to do the same are long indeed. What does it take to get to this stage early in your business? An incredible combination of contacts, brilliance, angel money, scrappiness, and more. The founders of Google, YouTube, Facebook, and MySpace didn't just do it with a good idea — they had access to early sources of money and expertise to help them get to the next level.
[ Return to Top ]
6. Going Public
You're no longer an entrepreneur in the strict sense of the word when you're talking about going public. This is the process of selling shares of your company to the public through one of the stock markets. This can produce tremendous wealth for founders, because presumably they invested mostly their hard work in the business rather than paying a price per share when they launched, so whatever they get for their shares is pure profit. Of course, it isn't nearly that simple. With a few exceptions, a company has to be very far along in the growth process, usually in the tens of millions of dollars in sales, before it can consider public financing. The legal and accounting costs of filing for a public offering alone are far beyond the means of all but a relatively few companies — and there are fewer than 10,000 publicly held companies in the United States, out of over 2 million enterprises of one kind or another.
You can dare to dream of going public, but remember that many a successful entrepreneur leads a wonderful life largely in obscurity, with enough means to raise a family, enjoy the fruits of his or her labors, and indeed enjoy having one less aggravation — a boss and a job to worry about losing.
[ Return to Top ]
