What You Really Need to Know About Startup Financing

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For every thoroughly prepared entrepreneur like Payne, another fails to fully explore their options. "The only idea a lot of people have is that they need to go to the bank," says Michael Mykris, director of the Santa Fe Small Business Development Centerin New Mexico. "We plant the seed that there are other sources of funding."

Some start-ups may actually fare better because of their inability to access mainstream credit. Family members, for instance, are more forgiving than banks and provide flexible terms at a time when entrepreneurs need it most. You should consider a family loan not only an important first step in business ownership, but also a critical component of your credit history. Like other types of credit, family loans demonstrate that your business has handled credit responsibly, often a precursor to future funding from a bank or investor. In addition to hiring an attorney to authenticate a family loan, you should also document the payment history, including an amortization record.

Angel investors also offer advantages beyond funding, serving as mentors to the entrepreneur. Even so, many start-ups fail to include them in their funding search because they assume investors target only technology start-ups with vast growth potential. Not so, says veteran investor Hans Severiens, founder of the Band of Angelsin Silicon Valley. "The businesses we're interested in tend to be technology-based businesses that make a better widget or better software," he explains. "But that's only a small portion of the overall angel activities. The angel that invests in a restaurant is happy to put his money in and, in two or three years, get two or three times his money back. He's not looking for a restaurant to become the new McDonald's."

That's the good news. The bad news is that a start-up may need several angels because investments are typically $10,000 to $20,000 per angel. Says Severiens, "If you need to raise a million dollars, you have to talk to 50 people."

Persistence is paramount, not only because start-ups have to network extensively, but also because they should make repeated appeals to individual investors, says start-up manufacturer Edward Tucker. "I would strongly encourage people trying to raise money not to accept 'no' for an answer," he maintains. Tucker, 42, didn't veer from that advice when lining up funding for his company, Philadelphia-based Plasticoncentrates Inc., which manufactures components for coloring plastic. When he encountered resistance because of the technical nature of his presentation, he rewrote his business plan to make it more palatable. During meetings with socially conscious investors, he stressed that his manufacturing plant was located in a low-income area.

Tucker got additional dollars by highlighting his company's location and social objectives, which include $100,000 in "opportunity grants" from the state of Pennsylvania. Other states and localities offer programs to help new businesses, and some offer lower loan rates to start-ups in certain urban and rural areas.

A few entrepreneurs, however, find these government programs and local loan funds too restrictive. "A lot of times, they're for a specific purpose," says Vandell Hampton Jr., executive director of the Enterprise Center Capital Corp., a Philadelphia company that recruits, trains and grows start-ups in urban communities. His group funded Payne's business through its young entrepreneur program.

Before obtaining her SBA loan, Medell, who is part Chocktaw Indian, investigated a Bureau of Indian Affairs program. "The restrictions were so stringent," she recollects, "that you had to be on a pueblo or on native land."

Also, loan funds like Hampton's generally link training to financing. If a start-up needs credit quickly, it may have to forgo a business opportunity because of the funding delay. The loans are also more expensive, with interest rates as high as 14 percent. However, they still aren't as costly as many credit cards, which are not suitable for long-term financing, such as equipment purchases. "These assets are not going to produce significant revenue anytime soon, but the credit card bill comes in every month," Hampton emphasizes. "You need a term loan for longer-term working capital needs."

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This article was originally published in the October 2003 print edition of Entrepreneur's StartUps with the headline: Truth & Consequences.

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