Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
How can you improve your chances of getting the capital you need to make your business successful? Tied very closely to that question is another concern that focuses on the current status of the venture's development. So putting these two together, the "stage" of your firm's life cycle definitely matters when it comes to raising funds, and understanding this becomes one of the best ways to improve your chances of securing a funding deal. Here's how it works.
Think of your venture as having four distinct stages in its development:
2. The launch. The enterprise has completed both aspects of the pre-launch and is now open for business. Production has begun, product/service demos are starting to happen, customers are in the pipeline, and invoices are ready for signing. During this stage, costs switch from R&D and market testing to production, sales, shipping, accounting/billing, customer support and front-office administration. The business is simply trying to establish some distinct traction among potential end users. The key funding question is now, "What is the venture's 'time to revenue?' " Cash flow remains negative while initial sales trickle in the door.
3. The ramp-up stage. During this time frame, sales growth is dramatic on a month-to-month, quarter-to-quarter basis, as the enterprise establishes a foothold in the target market. The business model has been validated by end users. The main funding question is now, "What is the venture's 'time to profitability?' " Negative cash flow is more a matter of timing on payments and receipts, but generally speaking, sales volume is approaching a clear point where the firm will pass break-even and show a profit.
4. The viability stage. There are now enough regular customers in the normal sales cycle, and sustainable growth in new inquiries from a large target market, to qualify the business as reasonably "viable" for the foreseeable intermediate term. Profits are consistent, and the main funding question is now, "What is the venture's long-term strategic position"?
If your firm is in either of the two phases at stage one, funding from outside sources is very difficult to come by. The vast majority of these deals are supported through friends and family, personal savings, a second mortgage on the house, and/or credit card debt and are generally a labor of love. Because the risk of ultimate success is great, only a select few pre-launch deals can attract outside investors. That's why it's so important to understand your firm's development stage.
A stage two deal is much easier to capitalize than a stage one, because the business model has received preliminary validation in the market, and risk is significantly lower. And a stage three deal provides an even more solid track record of prior success from which to attract investors. Not only is the model valid, but there is identifiable growth in sales and a reasonable timeframe to profitability. Finally, a stage-four deal is the easiest to attract funding partners, as the venture can look to either expand internal infrastructure, acquire additional capabilities, create a formal alliance with another firm, or approach potential buyers about purchasing the firm.
So remember, the further along your venture stage, the more likely it is that you'll be able to attract funding. Early-stage proposals carry tremendous risk, but those risks can be reduced as the business develops and matures over time.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 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.