Raising Capital - What to Expect?
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.
TheFinanceResource.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
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
, 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
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.