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Should You Raise Money from Small Investors?

Should you raise money for your company a little bit at a time?

Shortly after she launched Better Batter Gluten-Free Flour in Altoona, Penn., in 2006, Naomi Poe saw that to grow her business she needed an infusion of cash, as well as some wise counsel from experienced business owners. She asked two acquaintances whether they would be on her board of directors.

"At the time, I didn't know that, generally speaking, you don't ask people to be on the board unless they're vested in the company," she says.

But her prospective board members forked over $20,000 and $10,000, respectively, and they agreed to work with her to grow her fledgling business. That began a pattern of small cash infusions--ranging from $1,200 to $30,000 each--that helped her launch her company. Private companies can offer equity to as many as 35 private investors without their having to pass wealth or investment knowledge litmus tests, according to U.S. Securities and Exchange Commission guidelines.

But Daniel Shaffer, president and CEO of Shaffer Asset Management in Harrison, N.Y., and author of Profiting in Economic Storms, says the strategy has benefits and drawbacks. Raising larger amounts from fewer investors means you spend less time on selling your business to prospective investors, who may have deeper pockets, better contacts and vast business knowledge, he says. However, niche businesses like Poe's might be a hard sell to VCs.

At the same time, smaller, private investors--who are often family, friends or other personal acquaintances--may be more likely to invest in your venture, but they need to realize that the investment comes with risk and they might lose their money, he says. That personal connection can negatively affect relationships with investors, but it also allows you to retain more equity in your business for a longer period of time, he says.

Objective analysis (and a gut check) will help you determine whether you will work better with, as Shaffer says, "hawks who are going to be on top of you every step of the way to make sure you're performing versus finding individuals who believe in you and may have a little bit more patience if things don't go according to plan."

As for Poe, she likes the control that working with smaller investors gives her and says her investors are more tolerant of slower strategic growth than what she would expect from a venture capital firm. As of the beginning of January, Poe has raised from 26 investors nearly all of the $500,000 she originally estimated she'd need to take her through 2012. 

Gwen Moran is a freelance writer and co-author of The Complete Idiot's Guide to Business Plans (Alpha, 2010).

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This article was originally published in the February 2011 print edition of Entrepreneur with the headline: Pocket Change.

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