Sources of Start-Up Capital
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Q: I'm starting a music company that will be both online and offline. What's the best way to find and secure venture capital?
A: You'd never think it from the media hype, but most businesses aren't funded by venture capitalists. Most entrepreneurs find money through banks, private investors (friends, family and business associates), suppliers, customers or professional angel investors. The source you choose determines how you raise the money as well as how you pay it back. Here's a breakdown of your options:
- Banks are a straightforward source of funds. Many offer small-business loans if you've already started your business. You'll need a business plan and perhaps a personal guarantee. The funds are a loan, so you must generate enough cash to cover loan payments. You can find banks via the phone book, the Web and TV as well as Entrepreneur.com's listing Best Banks for Small Businesslisting. Banks seem to be desperate for customers these days.
- The government can also help. The SBAcan point you toward many different funding sources as well as give you assistance with the legal and administrative aspects of starting your business.
- Entrepreneurs often raise funds from friends and family. Treat these investors as real business relationships, however. Demonstrate how you will use the money and how you will repay it. Will you pay with interest over time? Will you issue stock and return the investment through an IPO or acquisition? Issuing stock is complicated--you may need a prospectus and SEC registrations, depending on how much you're raising. Note that if you're promising an IPO, the odds are not on your side. Very, very few companies go public. Acquisition or a stock buy-back are more likely strategies. (I recently got a return from my very first start-up investment--20 years later. Original dreams of an IPO gradually gave way to decades of collecting cash to buy back investors' stock!)
- Finding friends and family who will invest in your start-up is straightforward: Start calling. You're after high-net-worth investors who take personal referrals seriously. The best way to find them is through personal networking.
- Suppliers and customers may also back you. If your product complements a supplier's, they might invest--for example, if you distribute its music, a record label might want to invest. Be careful, though: Taking money from a supplier may prevent you from using that supplier's competitors. Strategic investors get their return in many forms: increased sales of their own products, stock sale of your company, advertising through your distribution channels, etc. These arrangements are rarely made just for a cash return, so the payback can take many forms.
- Private angel investors invest much like professional VC firms. You pitch them with a business plan and financing pitch. They invest for equity and expect a return--IPO, acquisition or stock buy-back--in three to seven years. Angels can be found through professional services like Garage.com, through angel groups like CommonAngels.comor via networking. I usually recommend starting with a lawyer or accountant who works with a lot of small businesses. They often meet professional angels while working with their client companies.
Whichever sources you choose, decide in advance how much money you want from them and how you intend to repay it. And be realistic! I've seen entrepreneurs make up a story to get the money, only to be surprised four years later when the investors start demanding a return. Professional investors rarely walk away from an investment, so if you write the deal knowing how you'll provide the return, you're much more likely to reach a happy ending.
As an entrepreneur, technologist, advisor and coach, Stever Robbins seeks out and identifies high-potential start-ups to help them develop the skills, attitudes and capabilities they need to succeed. He has been involved with start-up companies since 1978 and is currently an investor or advisor to several technology and Internet companies including ZEFER Corp., University Access Inc., RenalTech, Crimson Soutions and PrimeSource. He has been using the Internet since 1977, was a co-founder of FTP Software in 1986, and worked on the design team of Harvard Business School's "Foundations" program. Stever holds an MBA from Harvard Business School and a computer science degree from MIT. His Web site is a http://www.venturecoach.com.
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.