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The $48,000 Question

Where, exactly, do startups get their money? The answer may surprise you.

Finding money to start a business isn't easy. It never has been, and let's face it, it never will be.

I know, because I've been on one side or the other of debt and equity transactions for more than 30 years. As a banker, I sat between the money and the companies that wanted it. Later, as a consultant, I helped entrepreneurs raise millions of dollars from angels, venture capitalists, government lenders and grant programs. Then, as a business owner, I bootstrapped, begged and borrowed my way from startup to cash-out on three different occasions.

Along the way, I bet my sweet assets, pledged my house and even offered my spouse as collateral on a terrifying level of debt. I fretted about payroll on an all-too-frequent basis. And I survived three recessions. All of which is to say, don't expect textbook narratives on capital structure or myths about pennies from heaven from me. I'm about practical, real-world strategies for financing everyday businesses.

So for this, my first column, I thought it would be useful to look at how the millions of businesses that spring to life every year are actually funded. Certainly among the mass of data Uncle Sam collects about small businesses, there are facts about how they're funded.

Or not.

"I know it's hard to fathom," says William Dunkelberg, chief economist for the National Federation of Independent Business, "but the government simply doesn't track where small business--the engine that drives the nation's economy--gets its steam."

The First Six Years

The University of Michigan's Panel Study of Entrepreneurial Dynamics II has followed 1,200 startups since 2005. The study continues through next March but is already yielding some interesting tidbits:

• Each year about 12 million people try to start about 7 million ventures--that means more businesses than babies are conceived every year.

• At the end of two years, there was no correlation between the amount of startup capital and success.

• More than six years in, fewer than two in five startups report initial profits--worth noting if you're thinking about quitting your day job.

The last official study of startup financing was conducted in 2002--three years before YouTube made it possible to broadcast your most embarrassing moments to the world. Results from the Census Bureau's newest small-business study will be available any day now. Unfortunately, the "new" data was collected in 2007--before the recession, before the credit crunch, practically before the iPhone. It hasn't even hit the street and it's already past its sell-by date.

Aside from timeliness, there are two fundamental problems with government data on startups.

The first lies in the definition of startup. Should it include those that haven't yet filed a tax return? Should part-time and hobby businesses be counted? Should sole proprietorships, partnerships and corporations be part of the same count? Depending on the definition, estimates of the number of new businesses started each year can range from 600,000 to 6 million.

The second problem is the definition of small. In government terms, a company with as many as 500 employees is a small business. That's almost two-thirds of all U.S. firms. Can Doggie Daycare Inc. really base its financing strategy on statistics and averages that include companies more than a hundred times its size?

Luckily, some private researchers are working to fill the knowledge gap. In 2005, a University of Michigan project managed by Paul Reynolds and Richard Curtin identified a group of 1,200 startups and tracked their progress annually, continuing through 2011. Here's what they've found so far:

  • More than 80 percent of new ventures were funded by owner savings, personal loans and credit cards. In short, owner financing exceeded all other sources by a wide margin.
  • About 17 percent of entrepreneurs received financial help from the folks who knew them, loved them or liked them.
  • The average startup kitty was about $48,000 (though the median was less than $4,300).

So, while a quick man-on-the-street poll would likely point to the SBA, venture capital and angels as common sources of startup financing, they rarely are. Collectively, those sources fund less than 5 percent of the nation's budding businesses.

In short, look no farther than the mirror for your most likely source of startup money. Good, old-fashioned bootstrapping--that's what kick-starts this nation's entrepreneurial engine.



Kate Lister is a former banker, small-business investor and veteran entrepreneur. Her books and websites include
Finding Money: The Small Business Guide to Financing and Undress For Success: The Naked Truth About Making Money at Home.

Kate Lister is a former banker, small-business investor and veteran entrepreneur. Her books and websites include Finding Money: The Small Business Guide to Financing and Undress For Success: The Naked Truth About Making Money at Home.

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This article was originally published in the June 2010 print edition of Entrepreneur with the headline: The $48,000 Question.

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