Venture capital is a growing opportunity for funding businesses. Actually, venture capital financing is very rare. I’ll explain more later, but assume that only a very few high-growth plans with high-power management teams are venture opportunities.
The process of looking for money must match the needs of the company. Where you look for money, and how you look for money, depends on your company and the kind of money you need. There is an enormous difference, for example, between a high-growth internet-related company looking for second-round venture funding and a local retail store looking to finance a second location.
Pratt’s Guide to Venture Capital Sources is an annual directory available online or in print format.
Your next question of course is how to find the “doctors, dentists, and angels” that might want to invest in your business. Some government agencies, business development centers, business incubators, and similar organizations that will be tied into the investment communities in your area. Turn first to the local Small Business Development Center (SBDC), which is most likely associated with your local community college.
Turn first to the local Small Business Development Center (SBDC), which is most likely associated with your local community college.
You can also post your business plan on sites that bring angel investors together. The two most reputable sites in this area are:
- Gust Angel Network
- AngelList
Important: Be careful dealing with anyone who offers to help you find financing as a service for money. These are shark-infested waters. I am aware of some legitimate providers of business plan consulting, but legitimate providers are harder to find than the sharks.
3. Commercial lenders
Banks are even less likely than venture capitalists to invest in, or loan money to, startup businesses. They are, however, the most likely source of financing for most small businesses.
Startup entrepreneurs and small business owners are too quick to criticize banks for failing to finance new businesses. Banks are not supposed to invest in businesses, and are strictly limited in this respect by federal banking laws. The government prevents banks from investment in businesses because society, in general, doesn’t want banks taking savings from depositors and investing in risky business ventures; obviously when (and if) those business ventures fail, bank depositors’ money is at risk. Would you want your bank to invest in new businesses (other than your own, of course)?
Furthermore, banks should not loan money to startup companies either, for many of the same reasons. Federal regulators want banks to keep money safe, in very conservative loans backed by solid collateral. Startup businesses are not safe enough for bank regulators and they don’t have enough collateral.
Why then do I say that banks are the most likely source of small business financing? Because small business owners borrow from banks. A business that has been around for a few years generates enough stability and assets to serve as collateral. Banks commonly make loans to small businesses backed by the company’s inventory or accounts receivable. Normally there are formulas that determine how much can be loaned, depending on how much is in inventory and in accounts receivable.
A great deal of small business financing is accomplished through bank loans based on the business owner’s personal collateral, such as home ownership. Some would say that home equity is the greatest source of small business financing.
4. The Small Business Administration (SBA)
The SBA makes loans to small businesses and even to startup businesses. SBA loans are almost always applied for and administered by local banks. You normally deal with a local bank throughout the process.
For startup loans, the SBA will normally require that at least one third of the required capital be supplied by the new business owner. Furthermore, the rest of the amount must be guaranteed by reasonable business or personal assets.
The SBA works with “certified lenders,” which are banks. It takes a certified lender as little as one week to get approval from the SBA. If your own bank isn’t a certified lender, you should ask your banker to recommend a local bank that is.
Need help finding a business loan? Find available small business loan options with the Bplans Loan Finder.
5. Other lenders
Aside from standard bank loans, an established small business can also turn to accounts receivable specialists to borrow against its accounts receivables.
The most common accounts receivable financing is used to support cash flow when working capital is hung up in accounts receivable. For example, if your business sells to distributors that take 60 days to pay, and the outstanding invoices waiting for payment (but not late) come to $100,000, your company can probably borrow more than $50,000. Interest rates and fees may be relatively high, but this is still often a good source of small business financing. In most cases, the lender doesn’t take the risk of payment—if your customer doesn’t pay you, you have to pay the money back anyhow. These lenders will often review your debtors, and choose to finance some or all of the invoices outstanding.
Another related business practice is called factoring. So-called factors actually purchase obligations, so if a customer owes you $100,000 you can sell the related paperwork to the factor for some percentage of the total amount. In this case, the factor takes the risk of payment, so discounts are obviously quite steep. Ask your banker for additional information about factoring.
6. Friends and family funding
If I could make only one point with budding entrepreneurs, it would be that you should know what money you need, and understand that it is at risk. Don’t bet money you can’t afford to lose. Know how much you are betting.
I’ll always remember a talk I had with a man who had spent 15 years trying to make his sailboat manufacturing business work, achieving not much more than aging and more debt. “If I can tell you only one thing,” he said, “it is that you should never take money from friends and family. If you do, then you can never get out. Businesses sometimes fail, and you need to be able to close it down and walk away. I wasn’t able to do that.”
The story points out why the U.S. government securities laws discourage getting business investments from people who aren’t wealthy, sophisticated investors. They don’t fully understand how much risk there is. If your parents, siblings, good friends, cousins, and in-laws will invest in your business, they have paid you an enormous compliment. Please, in that case, make sure that you understand how easily this money can be lost, and that you make them understand as well.
Although you don’t want to rule out starting your company with investments from friends and family, don’t ignore some of the disadvantages. Go into this relationship with your eyes wide open.
Maybe, your idea and your situation is a better fit for crowdfunding—that is, creating a profile and pitching your business idea or product on a site like Kickstarter. In fact, this method of raising money has become so popular that here are dozens of crowdfunding sites to choose from, all offering different terms and benefits.
source – bplan
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