During the first two months of traffic at the revised Entrepreneur.com site, the overwhelming majority of questions streaming into my editorial board have gone something like this, "I have this really great idea for launching a new company, so where do I go to get some money so I can get started?" The inquiries have come from high school teens assigned a small-business project, a retiree, a guy frustrated with working for someone else, a woman with the next great "franchisable" concept and two partners looking to remake the entire industrial deliveries industry. Having already covered "debt vs. equity" in a prior article, what I think most aspiring cyber entrepreneurs need is some frank coaching on the realities of looking for funds. The following are potential funding sources in ascending order from "easiest access" to "most difficult to secure":
1. personal savings
2. friends and family
3. credit cards
4. second mortgages
5. other businesses
6. trade credit
7. commercial bank loans
8. angel investors
9. venture capital
Small-business research consistently shows that most new companies get initial capital from one of the first four areas. Many new businesses purchase assets (machinery, office equipment, vehicles) and other start-up supplies and inventory with money from a savings account, loans or partnership shares from close friends or family, and/or from funds drawn against the equity in the entrepreneur's primary residence. Once launched, the new firm typically uses more of the same or credit cards to cover cash flow while building a core clientele.
Another place to go for funding is to an other successful business owner (perhaps a friend, a referral or an associate) whose firm has a tangible connection to your business. For example, your commercial painting venture might secure funds from a paint factory owner, wholesale distributor or real estate developer with related business in your target market. Or your appliance maintenance company could raise funds from a local building equipment supplier or a commercial repair parts supplier. In addition, they might be willing to extend 30, 60 or 90 days of payment terms to you as your principal (or exclusive) supplier, which buys you time on the front-end of your cash flow cycles before your customers pay you.
Commercial banks' lending practices aren't about "helping" new companies get off the ground. They make loans--plain and simple--to borrowers who can repay the principal with interest, and they'll often require collateral for upwards of 85 to 90 percent of the loan value. You'll need to demonstrate a track record of sales revenues to justify your ability to make periodic installments. Your fledgling business idea probably doesn't have either the sufficient assets or customer base to warrant serious consideration for a bank loan. But a personal second mortgage or home equity line of credit could be converted to a more competitive rate business loan if your firm can achieve sales benchmarks and cash flow cycles over time.
Angel investors are wealthy individuals who are actively looking for true "ground floor" investment opportunities. Like venture capitalists, they aren't listed in the Yellow Pages of your phone book but can be located through referrals from personal contacts you make among the leading business owners, trade group members, industrial associations or chamber of commerce activities in your local business community. Both angels and venture capitalists are looking for great ideas that can translate into highly profitable businesses. They'll want a large equity stake (25 to 40 percent or more), so this process can take significant time to arrange and a formal written business plan will be required for consideration.
I'll cover these categories in greater detail in future editorials so keep checking back, and remember, whoever funds your enterprise will have to be truly convinced you can really make your idea a reality, so be sure to have everything well thought out from A to Z.
David Newton is professor of entrepreneurial finance at Westmont College in Santa Barbara, California. He is the contributing editor on growth capital for Industry Week Growing Companies and a moderator on small-cap stocks for eRaider.com. His books include Entrepreneurial Ethics (Kendall-Hunt) and How To Be a Small-Cap Investor (McGraw-Hill), named November 1999 book-of-the-month by Money magazine and a 1999 Top 10 book by Forbes. His latest book is How To Be an Internet-Stock Investor (McGraw-Hill). He has written or contributed to more than 80 articles for publications including Entrepreneur, Your Money, Business Week and Solutions, and has been a consultant to emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.