Raising Capital
Raising capital is the second
step, after writing your business plan, for developing/expanding a successful
business venture. There are many types of investment capital, and many
firms/investors that specialize in investing in new and unproven business
concepts. However, there are far more entrepreneurs that are seeking capital
then there are investors that want to invest in early stage businesses or
startups. This guide will give you some insight as to how raising capital works,
alternatives to venture capitalists/angel investors, and the finer points of the
capital raising process.
First, of course, the legal disclaimer
Please note that the
information in this guide is not to be used as consulting, accounting, or legal
advice. The following information is provided with the understanding that this
article is not a substitute for professional advice, and is merely for
informational purposes. BusinessPlansLibrary.com com is not responsible for the
use of any information contained below or for the factual accuracy of any
statements made below.
Now for the Article
At this point, you should have
a well developed business plan, and an idea of how much money you need to
develop the business. Now it is time to market your business to people that have
money. There are many ways to go about this, but there are some things to
remember as you begin to send out your business plan to formal investors.
On a side note, this article
deals more with people seeking to raise capital from “arms-length investors”,
which essentially means people that you have or will have no other relationship
beyond the business investment. Many people initially seek to raise capital from
friends or family, and this is a perfectly acceptable (and easily accessible)
group of people that want to see you succeed. The benefits for raising capital
among family and friends are that you can negotiate terms of investment quickly;
family and friends are also more likely to give a loan rather than require an
equity investment. However, there are many drawbacks to this type of financing
as well, especially if 1) the business becomes very successful, and even though
you were given a loan, a family member/friend now wants more money, or 2) the
business does not work well, and you lose the money of a friend/family member.
Angel investors are typically
middle aged males that have a net worth of over $1,000,000. The average angel
investor in the
United States makes angel investments of
$400,000 per investment. Not only are angel investors an important source of
capital for your business, but they can provide you with a wealth of information
and business insight. Angel investors often seek to take a semi-active role in
the day to day operations of the business. Most of these investors like to
invest capital in businesses that are located within 200 miles of their primary
residence. This makes communication and visits with the investor much easier.
Typically, an angel investment is made into a business venture of industry that
is familiar to the investor. These people are very smart, experienced, and know
what makes a strong small business investment. 99% of the time, these investors
will seek a sizable equity stake in the business.
Venture Capitalists are another
very popular form of business investment, but these investors are far more
selective that their angel investor counterparts. Most venture capitalists
demand annual returns in excess of 30% per year, which is an extraordinary feat
to accomplish. These investors will also require up to 80% of your business. In
the
United States, the average venture capital
investment is $11,000,000. There are approximately 3,000 venture capital firms
that operate throughout the country.
The alternative to both of
these types of equity financing is to approach a Small Business Investment
Company. These firms are licensed by the Small Business Administration to
provide equity investments and loans to small businesses like yours. These SBICs
are very much like angel investors, but in a group capacity. Most SBICs make
investments of $500,000 to $1,000,000, and they make assist a portfolio company
with the raising of additional rounds of capital.
Private investment companies,
such as venture capital firms and SBICs, invest the money of their limited
partners (investors) into profitable projects. In many ways, their operations
are similar to that of a bank in that they take the investments of their
partners and reinvest in businesses, much in the same way as a bank takes
deposits and distributes money as loans to borrowers. However, these firms have
stringent investor requirements. Unlike banks, where you can just walk in and
make a deposit, these businesses have many restrictions regarding the raising of
capital.
Another method of financing
your business is to borrow the money. There are a number of programs
specifically designed for small business borrowers that have limited collateral
or cash flow. There is a popular misconception that the SBA is a direct lender
for business loans. However, this is not the case. The SBA acts as a guarantor
and provides the bank with the assurance that the event that a loan fails, the
federal government will reimburse the bank for the money that was lost. This is
why SBA lending programs have a myriad of paper work and forms to fill out
because the federal government wants to ensure that it is guaranteeing a
relatively safe investment.
Each bank has specific lending
protocols developed by the internal management of the bank, so in the event that
you are not approved by one bank, you may be able to get approval from another
one. There are a number of loan brokers out there that can help you obtain an
SBA loan, but you should be very careful when hiring a loan broker. There have
been a number of complaints filed against these professionals for their
exorbitant upfront and success fees. Loan packagers that ask you for large
upfront fees are most likely seeking to scam you. You should always confirm a
capital brokers license, state of jurisdiction, and reputation with the Better
Business Bureau before you engage any of these agents.
Banks also make traditional
bank loans to small businesses that intend to use their funds to purchase
tangible assets such as equipment, real estate, or vehicles. Banks like to know
that in the event that you cannot pay back the loan that they have a chance to
recoup their investment through repossession and sale. Banks do not like to make
large working capital loans for businesses that will not have large saleable
assets.
In conclusion, there are a
number of different methods for you to finance your business, and each one has
its different pros and cons. When starting a business and seeking financing, you
should consult a certified public accountant to determine which capital
structure makes most sense for your business.