Takes Money
We have all heard the phrase, “it takes money to make money.” In most—though not all—situations, this is very true. However, many people are unaware of one critical fact: the money it takes to get started does not necessarily have to be yours.
Lack of capital is one of the most common challenges that would-be entrepreneurs face when attempting to make their dreams reality. Most allow this obstacle to deter them from ever embarking on the journey toward wealth. Sadder still, there are many who tell themselves they must put their dreams on hold until they can afford it, only to discover that such a time never occurs, or when it does, everyone else has already profited from similar ideas, meaning a once-revolutionary vision is now old news
Rarely does a temporary postponement turn out to be temporary. We live in a competitive world. Successful business people are those who strike when the iron is hot, regardless of their personal circumstances at the time. Thankfully, there are numerous options for financing the start-up of a new business. In today’s information age, it is easier than ever before to gain information on the details of these various options, as well as the array of methods for utilizing them.
Your Own Money. The first option for funding the upstart of a venture is the most obvious: your own money. This is the cheapest and most convenient method of financing, as there is no interest to repay, no hoops to jump through, and no need to involve anyone else in your business. However, this option is not practical or possible for the majority of people.
People in Your Personal Network. One of the primary sources of funding for small-business entrepreneurs is from people within their own network. Unfortunately, many people do not realize how large their personal network is and how many opportunities it affords them. For this reason, it is advisable to make a list of the people with whom you interact or have interacted with in the past. This list may include, but is not limited to, friends, general acquaintances, business associates, family members and family friends, healthcare professionals, legal professionals, accountants, realtors, clients, members of clubs and groups of which you are also a member, people who attend your place of worship, neighbors, and present or former teachers, professors, religious leaders, coworkers, business partners, and classmates.
Over the years, many wise men and women have cautioned against merging the world of business with one’s personal life. It is certainly true that there are many pitfalls inherent in doing business with family and friends, though there are ways to minimize these dangers.
Great care must be taken and consideration given when asking a friend, associate, or family member to finance your endeavor. To determine whether or not this option is right for you, it is necessary to examine all aspects of this type of arrangement. Take into consideration the nature of your relationship with the person whom you are contemplating as a potential candidate. Would a business proposal cause you or that person discomfort? Would the nature of your relationship be altered as a result of their involvement? How confident are you in the ability of your business to make a profit? Would you feel uncomfortable interacting on a regular basis with this person if your business was ultimately unsuccessful, and how would such a setback affect his or her financial well-being? Would this person be a suitable choice for an investor if he or she was not a family member or friend? Are you confident in his or her ability to responsibly make a choice that could carry such potentially hefty consequences? Would your family or other friends disapprove of your involvement of this person and, if so, is that something you are willing and able to deal with?
As you can see, there are many factors to consider when one chooses this option for financing. Working with family members and friends requires extra care than is given to working with other lenders or investors. That being said, you should treat them just as you would any other investor when it comes to the standard of professionalism you apply.
Before mentioning your proposal to your prospect, it is vital to put together a business plan. Put the same effort into this plan as you would if you were presenting it to your banker. When you do approach your prospect, avoid springing anything on him or her at a family get-together or at any other inappropriate time and/or place. Plan your approach, and give adequate warning concerning your intended topic of discussion. Be one hundred percent open and honest, and encourage them to be just as honest with you concerning their feelings. Be confident when stating your case, but be on the lookout for any non-verbal cues that could indicate that your friend is uncomfortable or feels pressured, and respond accordingly.
Regardless of the answer you receive, within a week of your meeting, you should send a thank-you note expressing your appreciation of their time. If your request is denied, be understanding and gracious in your acceptance of their decision. Be sure to let the other person know that there are no hard feelings, and ask them if they have any feedback that you may find useful in learning from the experience. Should you receive a favorable response, be diligent about following up on the matter, and don’t count your chicks before they hatch, as there is always the possibility that your friend may have second thoughts or experience buyer’s remorse.
Lastly, get everything in writing. This simple step legitimizes your professional relationship and ensures that everyone fully understands the details and terms of the arrangement. Additionally, the law makes no special allowances when it comes to contracts or agreements between relatives or friends; cover all your bases and be sure you legally document everything.
Angel Investors. Angel investors are technically still amateur investors, meaning that they are unlikely to possess the same level of motivation and tenacity toward pursuing new investment opportunities as would a venture capitalist. This means the process is likely to be more drawn out, and you may encounter rejection numerous times. However, there are distinct advantages to working with an angel. Typically, you will not lose as much control over your business as you would when working with a venture capitalist, and there is also the possibility of enjoying greater flexibility in negotiating the terms of the deal. If the amount of money you need is more than what you can raise from friends and family, but less than an amount necessitating the involvement of a professional investor, lender, or financial institution, working with angel investors may be the right option for you. According to a study on angels conducted by MIT’s Entrepreneurship Center, there are four categories into which angels can be divided:
• Entrepreneurial angels made money starting their own companies and use that profit to invest in the fledgling businesses of others
• Guardian angels are value-added investors, often investing in companies in an industry in which they have some background or experience
• Operational angels not only contribute cash, but their operational and financial experience as well
• Financial angels invest primarily for the financial return
It is important to familiarize yourself with each of these categories of angel investors so you will be able to identify those angels who are more likely to be interested in working with you. Learning to do so will also allow you to tailor your proposal and presentation to appeal to the person you are meeting with, thus increasing your odds of receiving approval.
Venture Capitalists. A venture capitalist is a professional investor who contributes financially to your business in expectation of receiving a high return on his or her investment. Utilizing this option opens up many more opportunities due to the large amount of funding available, as well as the access to the investor’s vast network of professionals. In contrast to the amateur investor, you might expect a venture capitalist to take on quite an active role in most aspects of your business in exchange for the funding he or she provides. While enormous benefits can be reaped from the experience and expertise this type of investor can contribute, many find it difficult to share the reins of their company with someone else, and may find the terms of such an arrangement to be stifling and tedious. You may also face higher expenses due to an increase in legal, accounting, and other fees, and you are also subject to a higher rate of return.
As true professionals, venture capitalists are also more likely to conduct business under a strict code of practice to which they rigidly adhere. While this certainly has its benefits—particularly for the investor—it makes proper planning even more crucial, as venture capitalists have an established system for screening candidates. You must do your research in order to come up with a business plan that appeals to an individual investor. Practice your pitch until you are comfortable and appear poised and confident, and be sure that you are clear about your plans, needs, wants, goals, and, perhaps most importantly, your plans for their money. Sell yourself, your business, and your team. Remember to dream big! When constructing your business plan, ask yourself what ultimate success would look like for you; create a plan to work toward that vision, and do not be shy about sharing that vision during your meeting! Your entire presentation should take under an hour, so make every minute count.
Banks, Financial Institutions, and Lender Financing. While some may make use of this option by choosing to use their credit cards to fund their venture, most will do so by applying for a loan. There are two types of traditional bank loans: secured loans and unsecured loans. The truth of the matter is that very few people qualify for unsecured loans; therefore, we will focus on secured loans. A secured loan is one that demands collateral in exchange for capital. Collateral may include your home, automobiles, equipment, stock in your business, and any other property, both tangible and intangible. A lender may also require a personal guaranty, which is a contract stating that its signatory will assume the burden of repayment for the borrower’s debt in the event that they become unable or unwilling to meet that obligation. If, for example, your corporation is applying for a loan, you may be required to submit a personal financial statement and sign a personal guaranty. If your business fails, you will personally be responsible for repayment of the debt, thereby placing in jeopardy your finances and all your personal assets. There may be additional stipulations and conditions, or covenants, in the terms of the loan. For example, you may be required to regularly submit all accounting records to your lender, and these statements must show that you are maintaining a certain debt-to-equity ratio at all times.
Once the terms of the loan have been set forth, your loan will be subject to review. Your credit report, preexisting relationship with the lender, business plan, and your business profit and loss reports and Dun & Bradstreet report will all be subjected to scrutiny before the lender makes a final decision to either approve or deny your loan. To improve your chances of approval, check your credit report prior to submitting your loan application and address any areas of concern, fine-tune and polish your business plan until it is of the highest quality, and research the options available to you concerning the backing of the Small Business Administration (SBA). The SBA offers two types of loans to small business owners: direct loans and guaranteed loans. Whereas direct loans are extremely difficult to qualify for, you just may meet the requirements of an SBA guaranty. Receiving this type of backing can make you far more likely to receive a loan from a third-party lender, since the SBA is guaranteeing repayment of the loan, thus reducing the risk to the lender by up to 75-85 percent.
While these are the most commonly used sources of funding for business owners, there are other options which merit consideration, such as private and government grants, factoring, leasing options, the sale of intellectual property, and so on. It is important to bear in mind that anytime a business owner brings outside money into his business that is not given in exchange for a product or service and/or does not come from someone who is actively involved in the operations and/or management of the business, the transaction is considered to involve investing in securities. There are laws at both the state and federal levels that set forth a multitude of restrictions on requirements for transactions of this nature. These laws are both broad and vague, and encompass almost any type of investing arrangement. The complexity of these statutes and the penalties for unwittingly violating them necessitate consulting with a knowledgeable, reputable attorney with experience in securities law. Please take this crucial step before attempting to recruit anyone to invest in your business. The importance of this cannot be overstated.
For more information on these and other sources of funding, how to write a business plan, securities laws, and much more, refer to the Rich Dad’s Advisors® book OPM: Other People’s Money, written by Michael A. Lechter, Esq.