Many clients start the entrepreneurial process asking the age-old question, “How do I raise money?” Unfortunately, beginning a business is a process that involves fulfilling a number of requirements before one can even think about raising money. The requirements for financing a business I am referring to may seem obvious, but they are critical to actually raising money:
Financing an Ongoing Profitable Venture
Let’s start with the easiest situation just to understand the parameters.
You have a growing and profitable business with a history of success and little personal or business debt. You have a specific plan to buy physical assets which you can then use as collateral which can be paid back from profits over a specified period. You also have an excellent relationship and history with your bank. Together, these aforementioned facts meet all the simple criteria necessary to obtain a loan for financing a business.[pullquote]Before raising money make sure you have answered these questions:
- How much do you need?
- How and when will you pay it back?
- Why should someone have the faith to invest money in your venture?
- What is the expected risk and return?
- What are the resources you have or plan to have to support the request?[/pullquote]
In simple terms you have:
- Credit Score of 700 or above.
- Cash flow sufficient to make required interest and principal payments.
- Sufficient capital and collateral to cover the entire loan.
- A specific plan, history, and experience to develop confidence in the lender to make the loan.
Financing For a Startup
Now, let’s look at a more typical situation of a startup company. You have a great idea, a little experience but no history, and minimal assets. You (your venture) needs money for development and startup costs before you even really begin.
Tech companies, service companies and many retail businesses, are perfect examples. Before describing the options for financing a business open to you, let’s review some general tips you must consider in your efforts to procure financing.
- It is absolutely critical you have a credible plan to convince investors you will succeed and pay the money back. The plan, when laid out properly, should build confidence and trust by the investor in you and your business.
- You must know your numbers and facts cold.
- Make sure to understand your assumptions, calculations, and forecasts and be able to answer all related questions. You need the energy, commitment and enthusiasm to obtain financing but it needs to be supported by real facts.
- Be sure to have an accountant you are comfortable with and financial statements you understand and can explain.
Where to Look for Funding
[pullquote]Essential Considerations to Assist in the Procurement of Financing
- Develop a credible plan.
- Know your numbers and facts.
- Have an accountant for guidance.
[/pullquote]There are several potential sources of funds for start-up businesses that should be considered when financing a business. Each potential source should be evaluated on the basis of probability, costs, long-term viability, risk, and business constraints.
Equity – Personal, Friends and Family
Equity is the amount of money you can put into the business on your own:
- Money you don’t have to borrow or pay back.
- Equity may also include effort (sweat equity) put into the business for it to get underway.
In general, it is difficult to start a business without any of your own, a friend’s or family’s equity to show commitment. Keep in mind it is much easier to obtain other investors if you are contributing 10% – 50% of the financing depending the project in question.
Investor Equity can come in a variety of different forms. Depending on the type, they can provide significant funds especially for businesses such as services which traditionally have little assets or collateral. These investor equity sources typically expect more risk but in return correspondingly expect returns. As a general rule, they require agreements that place a number of constraints on the business, e.g. salaries to you and how expansion might be made and carried out. As part of the equity investor formula, the more you give up, the less is left for you and the less control you have, particularly, if you have to give up more than 50% of your equity.
Equity investors vary but can include:
- venture capitalists,
- private equity dealers,
- private offerings,
- private investors, and
- Angel investors.
Traditional Banks and Loan Institutions
It is important to remember that banks need to balance their goals particularly when viewed in relation to loaning money. Banks reduce risks and make certain they get paid back. Understanding and acknowledging these factors can help reduce some of the stress one feels when dealing with bank bureaucracy, requirements, paperwork, etc. As stated earlier, the better your history, relationship, collateral, ability to repay loans, plans, etc., the higher the probability of getting a loan. Keep in mind that obtaining a traditional bank loan for financing a business startup is a more and more difficult undertaking than it was decades ago.
Additional Sources to Help Find Money and/or Guarantee Loans.
Community Based Lenders
Non-profit, independently financed, private or public organizations, which often make loans to small businesses or entrepreneurs who do not qualify for traditional commercial bank loans. These loans are often referred to as “Character Loans.” They do not require strict credit, cash flow or collateral requirements. They still require, however, character, a business plan and location in/or near the local community.
Finding a Guarantor or Co-Borrower for Obtaining a Loan.
Often time a family member or close friend is reluctant to give you cash upfront but they think you have a good idea for a business and a good chance to succeed. They may be willing to either guarantee a loan or co-sign for a loan.
Small Business Administration (SBA) Loans
The SBA does not lend money, rather it provides guarantees to a bank. The guarantee means, if a person does not repay a loan, the SBA will pay a major percentage of the loan back to the bank. All banks can make SBA guaranteed loans, but most have restrictions on what types of loans they are willing to make. Just as with most traditional banks, the SBA only wants to guarantee loans to people who are likely to repay the loan. All SBA loans are made to individuals for a business. The individual is personally liable to repay the loan.
Financing Outside the Box – Guerrilla Financing
To find money to finance your business you must consider every possible choice available. Going outside the box to find financing is often referred to as, “Guerrilla Financing.” The more you know about your business, the more options are available. Remember, both lenders and investors look for the same thing in a business – VALUE. Projected earnings and even management skills are considered part of this value proposition.
If money is the only thing stopping you from doing something good in the world, stop waiting and start doing some good! Nothing better symbolizes entrepreneurship than fundraising. Social entrepreneurs are no different. Today, there are a host of online resources for what today has become known as crowdfunding.
Crowdfunding was initially used by “social entrepreneurs” who turned to this method as a way to fund their projects, films, books, and social ventures.
Today, one of the best know crowdfunding sites is Kickstarter.com. Kickstarter is the 800 pound gorilla in crowdfunding, originally designed and built for creative arts, many technology entrepreneurs now use the site, some reporting to have raised millions of dollars. The Kickstarter funding model is an all-or-nothing model. You set a goal for your raise; if your raise exceeds the goal, you keep all the money, otherwise, your supporters don’t pay and you don’t get anything. This protects supporters from some of the risk of you running out of money before your project is completed. There are a now a number of her crowdfunding sites to consider: Indiego, Crowdfunder, Rockethub, Somolend, and more.
Free Financing Through Operational Belt Tightening
We frequently worry about financing a business but often fail to pursue strategies that might help avoid the need.
There are numerous activities that companies can do to reduce investment costs and lower overall expenses. The most common include:
- rent instead of purchasing,
- deferring payable terms,
- shipping direct to consumers,
- outsourcing etc.
Making these changes can have real impact on an organization as it relates to costs and investment. Putting these changes into place can make investors happier. These opportunities need to be considered as critical operational components. As an example, many start-ups are required to prepay expenses due to a lack of credit experience. Similarly, borrowing on credit cards is usually discouraged because of the associated high interest rates. Despite these problems, businesses can use credit cards to avoid pre-payments. All they have to do, for example, is to pay credit card charges on time which could translate to 10-30 day free money.
Finding Investors needs to be a two way street. Clearly you want to avoid loan sharks, etc. However, there are real considerations businesses need to consider when seeking investors:
- Evaluate the bank by finding out what it has to offer that will fit your needs and your capability for assuming the debt.
- Many entrepreneurs use smaller financial institutions which don’t provide the type of loans or products a business needs for growth:
- Letters of credit,
- wire transfers, and
- credit cards
Above are examples of services that may be required.
- Don’t be afraid to ask for references of other clients and talk to higher level executives in the organizations you are seeking funds.
- Determine the process, time, and requirements from the organization where you are seeking financing. Assume there will be delays, more information requests and mistakes. For example, when you send information be sure it is received.
- If possible, encourage efforts to understand your investors, site visits, introductions to you and their participants, etc… For example, in my bank, I have a customer rep who has been there for years. He warns, guides, and facilitates, and even sometimes breaks rules, to expedite my needs.
- Share changes in the business that may affect your needs or the investor’s prospects. This can be accomplished formally or informally depending on the issue. For example, if you may need letters of credit, make sure to plan ahead instead of waiting for the supplier demand?
I learned a simple rule in raising money several years ago. If you are doing well and providing investors with expected returns and little risk, the relationship is great and they may even encourage you to grow faster than you should. On the other hand, if you are missing plans and affecting investors’ returns, the relationships can sour quickly. This result has some simple tips that summarize the process of finding investors:
- It is a two way street that requires honesty, understanding and communication.
- Don’t overestimate what is needed to meet your plans.
- Understand your needs and risks to find the right kind and type of investors.
- Develop plans, measure results, and satisfy investor requirements to monitor investor potential concerns.