If you've been complaining to friends and relations (and anyone who'll listen) that entrepreneurs just can't get access to capital, stop! There are more options for startup financing than ever before. From debt financing in the form of in-your-mailbox credit card offers to equity financing from business angels, the saavy entrepreneur is faced with numerous options.
What's not available, however, is "patient capital"--funding from people who don't expect immediate returns on their investment. Let me explain why this type of funding is so critical and where to find this form of investment to make your business a success.
The Importance of Patient Capital
Most businesses fail because they run out of time, not because they run out of clients. This sad reality first hit me when I saw a local entrepreneur close up his web-based printing business just after September 11, 2001. He was an honest, hard-working young man whom I'd met at a dinner party and instantly liked. He'd built his business with money from a small venture capital firm during the boom years in the late 1990s. The business had a great product, high gross margins and a loyal customer base. He was a smart entrepreneur, but he made the tragic mistake of getting business capital at an early stage from investors who were impatient to earn an above-market return on their investment. When he lost clients after September 11 and his financial projections to break even had to be delayed by a year, his investors stopped supporting him and forced him to close shop rather than dilute their investment.
While his story is nothing out of the ordinary, it's one of many cases in which patient capital could have saved the day.
There's a good reason why venture capital firms don't give you patient capital: They're greedy. And they have good reason to be greedy because that's how they've positioned themselves to their investors--also called "limited partners." Venture capital firms are high risk, high return investors, and their limited partners expect high returns quickly. To them, patience is not a virtue.
When it comes to small-business lending (particularly for loans under $50,000), banks and credit card companies are also greedy. Once again, for good reason, they cannot afford to be patient. They need to pay their investors--also called "depositors"--a fair return on their investment. Given how risky most business startups are, credit card companies and their issuing banks must charge high rates, often exceeding 20 percent, to earn a return. How many businesses do you know that can grow by 20 percent consistently, year over year?
Finding Patient Capital
So where are your best sources of patient capital? Here are the top three:
In previous columns, I've provided some advice about how to find and pitch to business angels who are typically wealthy individuals without an urgent need for a quick payback. At first glance, they might appear as focused on the short term as venture capital firms, but in practice, their motivations for investing are complex and go beyond financial returns.
Relatives and Friends
Money from friends and relatives is one of the best sources of patient financing available. Would your Uncle Joe force you to close shop for fear of diluting his investment? It's unlikely. In my experience, most companies that are running through difficult times can find ways to restructure their loans and investments from relatives and friends to create a financial cushion--for instance, with grace periods and deferred repayment. The challenge is to ensure that you treat these investors fairly and not take advantage of their generosity. According to the Global Entrepreneurship Monitor, an annual entrepreneurship activity research project, the vast majority of entrepreneurs around the world rely on these sources of capital, and the repayment expectations of these "informal investors" are more flexible and long-term. I'd definitely call this patient capital.
Personal savings from bank accounts, investment accounts and (gulp) your retirement assets are as patient as you are! But be careful: Don't be too generous with your own money. I've increasingly come to realize that the smart way to structure personal investments in your own business is in the form of loans. At CircleLending, we often see entrepreneurs give loans to their business and formalize them with proper paperwork and a payment schedule. Once business owners have invested a few months of sweat equity for no pay, it makes sense to structure subsequent cash infusions as debt rather than equity. This protects you and keeps your business and personal obligations separate. Structuring these transactions with proper paperwork helps put you in control of how patient you want to be.