Small businesses today have access to more funds than ever, not to mention a wider array of financing resources. Venture capital firms invested a record $36 billion in 1999--more than double their 1998 investments--and are on track to exceed that figure this year.
Angel investors, fattened by lucrative undertakings over the past decade, are eager to share their wealth and expertise with fledgling entrepreneurs. More than $16 billion in SBA loan and venture capital programs helped launch or expand 50,000-plus businesses in 1999. And banks, finance companies, credit card issuers, leasing companies, factoring firms and a host of Net enterprises are tripping over one another to participate in the $170 billion small-business financing market.
But don't submit your loan application just yet. Despite the proliferation of financing sources, funding remains problematic for most start-ups. "If you're starting a new venture with only an idea, you'll probably have to start with only your money," says Charles Cocotas, the veteran entrepreneur who helped transform single-unit Boston Market into a national franchise chain. "Securing a loan or investors is easier once you have a successful track record. Otherwise, it's extremely difficult--unless you're a dotcom."
There's the rub. Dotcom: the obsession of virtually every investor. The nemesis of virtually every non-dotcom entrepreneur competing for funds. Indeed, PricewaterhouseCoopers estimates that of the $36 billion invested by VCs last year, nearly 90 percent went to high-tech companies; fully 56 percent went to Internet-related ventures. "Money going into non-high-tech companies declined for the first time in five years," reports Kirk Walden, national director of venture capital research for PricewaterhouseCoopers in Austin, Texas.
Of course, not all VCs are on the same page, adds Walden. "Some specialize in narrow segments, such as retailing or health care. They understand those brick-and-mortar businesses and know they won't realize returns of 100 percent a year, but they also know there's value and less risk in those investments."
On the other hand, venture capital provides only 7 percent of funding for private companies, according to OffRoad Capital Corp. in San Francisco, an online financial services company. This means that the number-one source of money for start-ups is family and friends. But that's just the tip of the iceberg when it comes to financing options. You also have these alternatives:
Angels are individuals who seek out new businesses to mentor and invest in (usually $25,000 to $500,000) in return for equity ownership. Not as demanding as VC firms, angels nevertheless expect high returns (25 percent). They generally favor businesses with which they are familiar and that are located nearby. They're best found through friends and angel networks.
Banks offer the least expensive route (about 2 percent above prime), but they take the least risk. Consequently, bank loans are difficult to come by for start-ups that lack assets and/or profitable histories.
Commercial finance companies take on higher-risk loans than banks; therefore, they're good if your company is high-growth and will continually need its loan ceiling raised, if your credit history is spotty, or if your company has a high debt-to-worth ratio with a strong cash flow. Interest rates and fees are about 2 to 10 percent higher than banks.
|Need an angel to help you? Check out From Zero To 60 to get hooked up.|
Credit cards are used by nearly one-third of start-ups. If you carry a balance, using credit cards is an expensive alternative (12 to 21 percent in annual interest), but they're easy to get and use, and they ease the bookkeeping burden.
Factoring is a practice whereby you sell your receivables for a discount before they are due. Widely used in most industries, factoring is relatively expensive (10 to 20 percent), inasmuch as you are paying for the cost of the capital, the extra risk and the paperwork.
Lease financing works well if you need funds for business equipment. Finance companies, banks and many vendors will arrange lease financing.
A line of credit is a revolving bank account that allows you to draw funds against a given total established by your bank. These accounts are usually secured with accounts receivable and/or inventory as collateral.
Personal assets include savings, stocks, bonds, pension plans, life insurance policies and real estate. Many entrepreneurs who own homes secure equity loans and use the proceeds to start a business--in which case, technically, you are financing your business, not the bank. Keep in mind that you could forfeit your house if you default on the loan.
The SBA guarantees loans to small businesses made through authorized lenders. There is no set maximum or minimum, but funds typically range from $25,000 to $1 million. The money may not be used to pay off creditors, cash out investors or invest in real estate, among other restrictions.
|Find out more about the SBA and check out the article, SBA Loans From A To Z.|
Venture capital firms invest in high-risk businesses with the potential for rapid growth and high returns in a short time. Typically, they expect to exit in three to seven years with annual returns of 25 to 40 percent or more.
Determining Your Best Option
Baby, I Got Yo Money
Unlike venture capital firms, banks are not influenced by astronomical profit potential when evaluating a borrower's credit worthiness. Their first consideration is risk aversion; their second is the borrower's ability to cover the principle and pay the interest. Consequently, banks prefer that business owners secure loans with hard assets--a home, equipment, real estate. Some will lend against a small business's receivables and inventory but at steep discounts. Furthermore, most banks are reluctant to make loans to a business if the owner is not heavily invested.
Alan Fellheimer, president of Pennsylvania Business Bank in Philadelphia, gives start-up loans to almost any type of business, but only if the owner also makes a substantial investment. He encourages start-ups to approach banks, particularly his bank. "Many think they won't qualify for a bank loan, but we often can work with entrepreneurs to structure a deal that makes sense. Maybe a combination of [the owner's] assets, help from friends or family, someone who will guarantee the loan. As long as it's not an SBA loan--they require too much paperwork."
Most entrepreneurs now take advantage of the SBA's Low Doc program, not only because it reduces paperwork to one page, but also because it cuts response time. The streamlined program expedites the review process on loans under $100,000, relying heavily on the strength of the borrower's character and credit history, according to Mike Stamler of the SBA. Start-ups must submit comprehensive business plans with Low Doc applications; existing businesses should, but need not. A variety of SBA loans--including the 7(a) Loan Guaranty Program, are available through banks, business development agencies and other lenders for conventional start-ups, new franchises and existing businesses.
turning to friends and family?|
Check out Investor Next Door for the inside scoop.
Despite the popularity of government-backed loans, the overwhelming majority of start-up entrepreneurs rely on personal savings, residential mortgages, consumer and credit card loans, as well as money from people they know. When Greg Brophy started Shred-it Inc. in Mississauga, Ontario, in 1998, the then-26-year-old entrepreneur asked a dozen family members for money. "Most could only come up with four or five thousand each, but put together, it makes a difference," says Brophy, now 37. Still, it wasn't enough to get his shredding business ripping. Needing $125,000, Brophy refinanced his house and arranged equipment leasing.
If you decide to approach friends and family, Brophy warns, "recognize that it can be a double-edged sword: [you've got] low-cost financing but potential misunderstandings that could damage relationships and the business."
To reduce the likelihood of such problems, "keep it professional," advises Lori King, founder, president and CEO of private equity investment firm NVST.com Inc. in Bellevue, Washington. "Don't approach it as a 'trust me' situation just because it's family. Prepare a business plan, do all necessary research and present an honest picture of the risks and rewards."
No matter what you do, find a way to stand apart from the crowd when you approach investors. Do that, and you're bound to find the money you need--dotcom or not.
Brain Food: Financing Reference Books
Before venturing out into the cold world of financing, consider the warm guidance of these books:
Where's the Money? Sure Fire Financing Solutions For Your Small Business (Entrepreneur Media Inc., $19.95, www.entrepreneur.com) by Art Beroff and Dwayne Moyers
Where To Go When The Bank Says No: Alternatives For Financing Your Business (Bloomberg Press, $24.95, www.amazon.com) by David R. Evanson
Finding Your Wings: How to Locate Private Investors to Fund Your Venture (John Wiley & Sons, $34.95, www.wiley.com) by Gerald A. Benjamin and Joel Margulis
2000 Financing Start-Ups (Harcourt Brace, $139, 800-831-7799) by attorneys Robert Brown and Alan S. Gutterman
Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Dearborn Trade, $16.95, www.dearborn.com), by George M. Dawson
Pratt's Guide to Venture Capital Sources (Thompson Financial, $385, www.ventureeconomics.com) edited by David Kwateng
Start Up Financing: Hundreds of Ways to Get the Cash You Need to Start or Expand Your Business (Career Press, $16.99, www.careerpress.com) by William J. Stolze
Free Money for Small Businesses and Entrepreneurs (John Wiley & Sons, $16.95, 800-225-5945) by Laurie Blum
The Insider's Guide to Small Business Loans (Oasis, $19.95, 800-228-2275) by Dan M. Koehler
Directory of Venture Capital (John Wiley & Sons, $42.95, 800-225-5945)
Business Plan Tips
Put It In Writing
A thoughtful, convincing business plan is key to any funding search, stress Dee Power and Brian Hill, coauthors of The Quest For Capital: A Financing Guide For Entrepreneurs (Javelina House, $26.95, www.capital-connection.com). Power and Hill offer the following tips for preparing a professional business plan:
Smaller bites are more digestible. Start with an outline. Break the large task into smaller components or sections and the task will not seem as daunting. A business plan can be viewed simply as the answers to a series of questions.
Competition counts. Every product and company has competitors. Systematically gather information on your competitors so that you can make a credible case for why your product or service will be better.
Marketing matters. Hone your market research and analysis skills. Define your customers and how you are going to reach them.
Keep it exciting. Put together a clear, concise, realistic business plan that gets the reader excited about the opportunity your company presents. The plan must cover not only what you are going to do, but also how you are going to do it.
Proof and proof again. Have experienced business-people read and critique your plan, testing it for clarity and reasonableness. Never send out a first draft. When you're certain it's perfect, proofread it again.