Raising Your First Outside Capital ($500K-$1M)

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Digital Library > Acquiring and Managing Finances > Alternative-funding sources"Raising Your First Outside Capital ($500K-$1M)"

Outside financing can help your company grow, but you may have to give up some control. How do you match the right investors to your needs? This Quick-Read shows you how to find the "smart" money.

OVERVIEW [top]

If you want exponential growth out of your company in the future, you probably won't be able to "boot strap" that growth. Without outside funding at some point, you will have to pass on great opportunities, such as the chance to buy a larger manufacturing facility or pursue a new product or market.

You shouldn't be going public until your annual earnings are greater than $1,000,000 and you are confident they will increase at least 20% for years to come.

Where should you go for money in the meantime?

If you have a track record of profitability, you might actually find the cash you need from your own banker, especially if you have a good relationship. If you are a young company, there are numerous other options for investor financing; but you will need to give up some equity to get it. That can be a good thing because you can get the investors' expertise as well as the money.

In this Quick-Read you will find:

  • The difference between smart and stupid money.
  • Options available for smart money investments.

SOLUTION [top]

Availability of funding from any given source will wax and wane with the investment climate. With that caveat in mind, here's what we know now about raising your first $500,000 to $1 million.

Before you begin to search for money, you need to determine how much you need. You don't want too much outside investment; you'll give up too much ownership or have to pay unnecessary interest. You don't want too little; once your collateral is committed to get part of what you need, it won't be available to justify more. The Quick-Read "How To Create the Financial Projections for Your Business Plan" provides a method for calculating a target amount.

It's a good idea to create an advisory group to help you sort out the smart money from what is sometimes called the "stupid" money. Smart money comes from investors who understand your business model, your industry, and the region of the country where you operate. These investors make reasonable requests about involvement in the management of your company, they invest once knowing you may need them to invest more in the future, and they don't make demands that will take you off course.

One topic to discuss with advisers: Should you select a different legal form for your business to attract particular types of investors? C Corporations, S corporations, limited partnerships, and limited liability companies all have their own strengths and weaknesses when you want to share ownership. Your state regulations will limit what amounts of equity may be sold to whom by each kind of business entity.

Stupid money comes from investors who know little or nothing about your industry, business, or region, and who have unrealistic expectations about returns on their investments. They may offer you money with onerous strings and be micromanagers as well. Most experts advise you to stay away from this kind of money, even if it is on the table and very tempting.

Sources for smart money

  1. Friends and family: Your family and friends are often a good source of funding because they know you and your company, and they trust you. Remember that you may lose their money, so don't take it if business failure will cause them great hardship. Make sure these investors have a very clear understanding of risks, rewards, and their opportunity to play a role in management.

  2. Employees: Who has more confidence in the business than the workers? You may even be able to pay a little less if you supplement compensation with an employee ownership plan.

  3. Key customers: If you sell your products or services to a big industry player, it may be interested in investing in you. Business consultant Kathy Long Holland says innovation is hard for big companies, and you can do it for them cheap. "It gives you a marquee name and credibility; you get a learning curve and long-term revenue," she says. Consider licensing the customer to provide your product in return for the investment, but be careful not to create a new competitor and be careful that you protect your intellectual property rights.

  4. Angel investors: Angels are individuals or organizations that are looking to invest small sums (in the tens or hundreds of thousands of dollars, not millions). They usually expect a minimum annual rate of return at 20%, and want their money back in about four years. Today's angels are more sophisticated than angels were a decade ago because they have more experience. Many have owned their own companies. Some angel investment groups are easy to find. If you have access to a business reference collection at a public or college library, look for angel listings among the venture capitalists in the Corporate Finance Sourcebook (National Register, annual). New economy companies are popular with angels, even though that sector has taken a hit. They like to invest there because that's what they know. They will have more questions about how "real" your company is than they may have had 18 months ago.

  5. Networking: Drill deep into your industry and region to meet as many players as you can. Join any business group you can find that touches your niche. During the recent boom, many relatively young executives left companies with good money, and are looking to put their savings to work and be involved with business again. Many aren't known in angel investor circles. Go seeking insight, and you might find money. You also may find business owners who will refer their angel investors to you.

REAL-LIFE EXAMPLE [top]

Teaching English for three years in Japan gave John Hayden and partner Miguel McKelvey a business idea in 1999. They wanted to provide content and a new way to teach English to the thousands of students attracted to Web sites and bent on learning English. Their company, "English, baby!" was born.

Hayden and McKelvey launched their own Web site and bootstrapped the development of content, while they simultaneously built a business plan. In January 2000, they showed it first to a professor, who introduced them to some out-of-state venture capitalists. The VCs wanted to invest $1 million, a small chunk at a time, but they refused to make a long-term commitment and wanted full control.

"They had no experience in our business," says Hayden. He and McKelvey decided not to take the money, something he calls a "very good decision" today.

Instead, they began networking and even formed their own startup support group called "Starve-ups." They met an investment adviser who introduced them to one of her clients who was quietly making investments. He came in with $100,000 and was able to provide office space for equity as well. Since then, networking has led them to another $150,000 angel investor. They hope to close their seed round soon at $300,000.

DO IT [top]

  1. Look at your capital needs over the next five years. Will you be able to do what you want with projected cash flow?

  2. Bring together a board of advisers. These should be more experienced business owners and managers who have raised equity financing themselves. The Quick-Read "Working with an Advisory Board" has tips for selecting and recruiting the kind of advisers who will impress potential investors. Advisers are potential investors as well.

  3. With your advisers, review the financing tactics in this Quick-Read. Considering your company's product and market, which options seem the most viable? If your family and friends network contains few high-wealth individuals, this may be a poor option. However, if your region is full of companies within your industry, networking might open doors.

  4. Before accepting any offer, clearly understand your investor's goals. Will the performance of your company meet his or her needs and expectations? Will you enjoy interacting with this person and feel comfortable with his or her advice?

  5. Follow changes in the habits of small investors by reading the business press regularly. Investment practices can change as rapidly as fashion statements.

  6. Watch the "Business Opportunities" section in the want-ads, both to spot potential investors and to see who else is looking for them.

RESOURCES [top]

Books

Angel Financing: How To Find and Invest in Private Equity, by Gerald A. Benjamin and Joel Margulis (Wiley, 2000). This one is more for seekers of funding than for investors, despite the subtitle.


Internet Sites

Associations

Vfinance.com. A directory of angels.

Corporate Finance. North American Securities Administration Association. Details about the SCOR (Small Company Offering Registration) program for local sale of equity.

Operating SBICs (Small Business Investment Companies). U.S. Small Business Administration. SBICs, licensed and regulated by the SBA, are privately owned and managed investment firms that use their own capital, plus funds borrowed at favorable rates with an SBA guarantee, to make venture capital investments in small businesses.

ACE-Net: The Angel Capital Electronic Network

Journal articles

"Raising Start-Up Capital," by Carole Matthews. Inc.com.


Article Contributors

Writer: Kathy Watson

Business consultant Kathy Long Holland

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