What do you suppose is the most challenging aspect of building and growing an entrepreneurial business? Most entrepreneurs would probably agree it’s figuring out how to raise capital. It's a complex process, to say the least, but figuring out the best type of funding for your business is a great place to start, and knowing where to look for funds is just as important.
There are still essentially two types of traditional business financing, debt and equity. The good news is that both types have more variations and options available within each category than ever before. There is also the traditional hybrid model of debt that’s convertible to equity. Even with more available options, it is still not a slam-dunk to securing the funds you need to build and grow.
For startups, borrowing from friends and relatives can be an advantageous strategy that comes with a minimum amount of strings attached and possibly some of the cheapest money that you can find. Hopefully, you've had a good relationship and history of good behavior with these potential personal lenders and they perceive you to be mature and responsible enough to place their money in your good hands. To minimize the risk of hard feelings with personal financial deals, consider formalizing any significant size loan by suggesting the lender file a UCC financial statement. This is not common among family and friends, but it allows their loan to be secured and shows integrity on your part.
Another important thought to consider before borrowing from those close to you are the potential consequences if you can’t pay them back. Losing someone’s money can sure put a damper on personal relationships. You may not get a Christmas card the next year if things go awry.
Banks have become more structured than ever regarding debt financing, mainly due to regulations. Either you qualify under their guidelines, or you don’t. Chances are, to be successful in securing a loan from a traditional bank you’ll need to have the business and/or personal collateral to cover the amount borrowed. Often, you’ll need that collateral to be in the form of liquid assets and held by the bank itself. If you’re a small business, plan on personally guaranteeing any bank loan, unless you have a financially credible resource that will co-sign or guarantee on your behalf.
Online lending services appear to be a growing trend for small business debt financing. These services look to offer reasonably priced working capital to established companies (generally at least one year) with a history generating revenues. The loan qualification is based on the company performance instead of personal credit worthiness. The application process are completed online and decisions take only minutes. This type of financing is worthy of exploration if you're business fits the right profile, but, as with anything financially related, read the fine print.
There are plenty of reputable private finance companies that make loans to small businesses. These type firms offer a variety of solutions for working capital and have more flexibility on how lending terms are structured. Some firms have niche specialties such as purchase order or inventory financing, while others may lend against accounts receivables, also known as factoring or invoices advances. The loan qualification requirements are still stringent, and the cost of borrowing is proportional to the risk perceived by the lender. It is not uncommon to pledge your business and personal assets to secure a loan from a private finance company. A special word of advice, though: be certain to do your due diligence on any private finance company you entertain borrowing from. Get references and testimonials to help reduce your risk of getting involved with a less than scrupulous lender.
If equity financing is the path you choose to raise capital for your business, you’re essentially selling a securities interest in your company in exchange for the funds. For that, you now have partners in your business. In addition to the financial impact, the right partners (investors) can also be tremendous assets if they provide support, encouragement, contacts, or opportunities. On the other hand, partners that create friction or distractions can be a nightmare that takes away from the joy of being an entrepreneurial business owner. So, the advice here is don’t just go for the money. Vet your investors, just as they’ll vet you, and try to connect with people that have an adequate level of alignment with your vision.
Equity investors come in many shapes and sizes. Friends and relatives are, of course, probably one of the softer, gentler categories of investors. These are generally a good fit for smaller sized investments and occur more often at the startup phase. Just remember that friend or relative will become your business partner and may alter the dynamics of your relationship.
Crowd funding is an alternative approach to raising capital by soliciting contributions a large number of people, most often through Internet-based registries. There have been some excellent success stories using the crowd funding method, but there are also plenty of disappointing stories by companies that fell well short of their goals. To be successful, you must really connect with people and generate a buzz about what you have to offer. Easier said than done.
Sophisticated investors - including high net worth individuals, angel investors, or venture capitalists - are probably the most sought after and desired equity financing solutions. Each of these has different profiles of how they’re structured and who, what, where, when, and why they invest.
High net worth individuals are generally very private about their business affairs. They can be difficult to find, but a great option due to their flexibility in the size and type of deals. The complexity of debt or equity transactions with this type of funding source can vary, but it always wise to make sure all contractual terms and conditions are robust.
Angel investors typically like to invest in seed or early rounds of new ventures, generally up to a half million dollars. With the thriving entrepreneurial economy, competition for their investment dollars is tough. A business needs to stand above the rest if they expect the angel community to give them consideration. Some angel investors prefer to take a hands-on role with their investments, meaning, they may engage in business operations and decisions at some level.
Venture capital funds tend to align with large-scale equity investments in specific fields. They can be very niche players in the financial marketplace. For example, a venture fund may target opportunities in the life sciences field with investments between $5M-$20M. Regardless, they typically invest in companies that have some market traction and significant upside potential. Deal structures can be quite complex, and it’s a good idea to have a securities transaction lawyer on your side.
There are many detailed factors that funding sources consider for a financial transaction, but at the most basic level, your business type and financial needs must align with their funding profile. Finding the ideal funding source that’s a perfect fit for your business can be like finding a needle in a haystack.
You can greatly improve the chances by understanding where your business belongs in the financial marketplace. When you figure it out, fully commit to the financial segment that’s right for you and stay the course. Don't worry about what kind of funds may be down a different path, as it will only create distractions. The pursuit of your funding goals with a single market focus can improve your chances of success.
Now, most companies tend to stay close to home when seeking financial solutions for their business. This is understandable because it’s most likely where the strongest relationships are established, but depending on the type of financial solution your business needs, it may not be available in the local community. If this is the case, you may be forced to go outside the comfort of your established network.
Think in terms of what your business needs and less about where the solution might be located. Doing so can change your perceptions of boundaries and have you looking at the entire country as your neighborhood. You’ll find yourself thinking and acting without regard to geographic limitations, which opens vast opportunities to find money.
Of course, cultivating relationships with far away funding sources is absolute key. It requires an immense amount of time and effort to relentlessly network with new people and places. Follow every lead with professional yet aggressive persistence and be prepared to make your opportunity known with a compelling story again and again.
Go into it knowing that relationship rejection is very common with funding sources and know it’s generally due to opportunity misalignment and not a personal issue. Once you do get connected, developing deep relationships with your funding sources (and others that helped you get there) will pay long-term dividends, especially when you need it most.
Aside from a lucky few who fall into a great situation, there is no magic and not even any easy answers to finding the right funding solution for your business. Most important thing is to never give up on your quest. As the adage goes, “Winners never quit, and quitters never win.”