Talking Points
- Cater the financing to the type of company you have
- Venture Capitalists want billion dollar markets, hockey stick revenue growth with 10 x returns in 3-5 years.
- Strategic partners tend to want products out of the deal not necessary a financial return
- Bank loans work well if you have an established business with cash flow
- Most small businesses are financed by friends and family and need less than $50,000 to get going
Discussion
If there is one thing that gives every entrepreneur heartburn, it’s financing. For some reason, getting money is one of the hardest things most entrepreneur’s face. A lot of difficulty comes from the inherent value of money. It’s easy to value since everyone pretty much agrees on what’s it worth. When it comes to your business, that is a little more subjective. The risk is a lot higher since there are so many unknowns (including you). Don’t let this discourage you. There is money out there. You just need to figure out how to get it. Part of figuring that out is going to the right place for financing.
Type of Business You Have
Financing depends a lot on the type of business you have. A traditional small business that is quick to revenue (like 1-3 months) is far different than a startup that will take 1-3 years to even make a product. By no means are there hard and fast rules on where to go for money but there are some rules of thumb. For this post, I will break companies into two categories: Quick to Revenue and Capital Intensive.
Quick To Revenue
There are your businesses that do products or services that are in demand now and can start selling from almost day one. Things like restaurant, cafe, consulting firm or boutique. Quick to Revenue companies are typically lifestyle companies. What that means is that the “exit” or gain on capital invested takes a long time. This is why most of these business don’t typically get big investors (like Venture Capitalists).
Capital Intensive
These are your longer term projects or developments that take a lot (like over 5 million) of capital to make happen. They are also characterized by longer development times (thus the need for large amounts of capital). These types of companies are your Silicon Valley Startup working on breakthrough technology, construction projects (like office buildings) or leverage buyouts.
How Much Do You Need?
A big part of where to find financing revolves around how much you need. The average small business (typically the Quick to Revenue types) requires under $50,000 in funding to get going. This means that the places where these business would go for funding is limited to banks, friends and family, personal savings and business partners. The vast majority of businesses get funding by those four methods.
The Couple 100k Rule of Thumb
In general, if you need a couple of 100k to get going, your best bet (in order) is:
- Personal Savings: Most small business founders put their own money in to “bootstrap” themselves. This is the most common way to finance a small businesses. It’s risky since you can be fooled into thinking your idea is wonderful when it’s a dude.
- Friends And Family: The nice thing about friends and family money is that the biggest hurdle, trusting you with money, is easily overcome. The bad thing is that they may tell you how you should run your business. The terms of friends and family money should be defined (more later) and clear roles established.
- Business Partners: Pooling your money and talent does help reduce the risk of your new business. Like friends and family, the roles and responsibilities of each partner needs to be defined. More businesses have imploded due to partnership issues because the partners were not aligned on who does what and who contributed what.
- Micro-lenders: Are similar to banks but usually give out smaller loans (under $50k), to risker clients and have higher rates (due to the risk). There are also groups that lend to individuals (like Prosper. See link below).
- Banks: Tend to be conservative in their lending practices and want some sort of collateral that secures the loan. Banks are a good choice for established business or entrepreneurs with excellent credit.
If you notice, the list above does not include investors. Most investors don’t like to bother with small amounts of investment. The reason being that they have to keep track of it and want to place larger amounts of money to get bigger returns.
The Rest Rule of Thumb
If you don’t need a couple 100k, then you probably have a project that will require either a more savvy investor. These investors include:
- Angel Investors: These are high net worth people who find it thrilling to invest in new technologies and companies. They usually made their money via a startup exit.
- Strategic Partners: These are typically profitable companies that want to buy your product or service. They are typically in the investment for products and services. The investment exit is usually secondary for them. If you have investors that want an exit, then a strategics product focus will be in conflict with that.
- Venture Capitalists: They are all about the exit. The whole point of Venture Capital is to make a return on the invested money. These guys will always look for the exit and this may be in conflict with your development plans.
Use of Funds or Milestones
All investors will want to know what you will do with the requested funds. It’s best to set measurable milestones that will cost a certain amount of funds to achieve. This is important for a couple of reasons. The first is that you should know what you want the money for. Your financial models and budgets are where you will get this data from. The second is this gives the investor a gauge of your ability to manage the money you are given. They can also benchmark your plan against other ones they have funded to see how you measure up. Being overly aggressive or conservative will send up the red flags. To prevent this, run some scenarios where you assume everything goes perfect and when the goes wrong. That way, you can discuss your requested financing intelligently.
Types of Funding
Once you have all sorted out your funding needs, you now need to determine the type of financing to go after. There are basically two different types:
- Debt: This is basically a loan. You agree to pay some monthly payment (including interest) for some duration of time until the debt is paid off. Debt is usually secured by something (like a house, land, equipment or whatever). Debt can be the way to go if you have cash flow and don’t want to give up some ownership of the company.
- Equity: This is basically selling shares of your company to someone else. Equity financing is the preferred method for companies that are in the product development stages (e.g. Capital Intensive). When you finance with equity, you give up some control but don’t have to make payments to your debtor. The equity investor is looking to get a return by the company having a liquidity event (e.g. going public or being bought). VC’s always take equity.
Pulling It All Together
Fund raising can be frustrating. To make it less frustrating, have your story straight and approach the proper funding sources. Nothing will waste your time more than talking to uninterested investors. Do your homework and get some idea about the typical deals other companies like yours got. These compatibles will give you a great sanity check as to whether or not your funding requirements are reasonable.
Things To Ponder
- Determine the type of funding your current business idea needs. List the possible sources of funding and figure out what their criteria is.
- Pick a startup that recently got funded. Research who funded them (check out The Money Tree Report below). What types of firms put money in at each round? Is there a trend that emerges?
- Interview one of your local business owners. Ask them how they started their business and how they financed it. What were the barriers to financing and how did they over come them?
- If you are in business, talk to your bank to see what they offer in terms of loans. Do they offer lines of credit? What is required to secure one?
Exploring Further
- Check out The Funded for a ranking of Venture Capitalists as well as some Angel Groups.
- Business.com. Huge list of banks that do loans. I have not checked any of them out but some do offer SBA loans.
- SBA Loans. A detailed list of documents you need to submit to get an SBA loan.
- Prosper connects people who want to loan money to people who need it.
- The Daily MBA Sources of Money
- The Money Tree Report site
- Business Week has an excellent post on bootstrapping your startup.
Also published on Medium.
