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Business Funding

You'll find numerous sources of financing for your new venture. The key variables you'll encounter include:

      •  how much control of your company you'll be expected to
          give up

      •  the interest rate

      •  how much time you have before you have to repay.

Before we launch the list of startup business funding options, let's deal with the jargon. The world of business finance has four basic definitions you should know:

Investment horizon: This is nothing more than the duration of a loan or other financing option. To the investors, it's the amount of time they're willing to wait before raking in their profits.

ROI: The acronym stands for "return on investment." This is the percentage of profit that investors hope to see. For example, if an investor expects an ROI of 30 to 50% over five years on a $100,000 investment in your company, then he or she expects to collect $130,000 to $150,000 from you (or from the sale of his or her share in your company) in five years.

Due diligence: Due diligence is a thorough investigation or inspection of your company, including its personnel, current finances and other documentation. The investor is simply trying to verify information that you've supplied, probably in a business plan. The process may include background checks, verification of outstanding debt, your legal status and the state of your company's assets. It usually involves a visit by a team of investigators and can take a few days.

Valuation: This is the process of assigning a dollar value to your company. It's used to establish your equity (value versus debt) when investors assess their financial risk. A third party accountant often performs the valuation.


Self-Financing for Startup
In a perfect world, you'd have all the capital you need to finance your own business. Then again, if you were that wealthy, you probably wouldn't have to work for a living.

Although self-financing doesn't imply that you have every penny you'll need up front, you should have enough to start business. After less than a year, your income should be sufficient to fund your business. In a self-financing scheme, you might be acquiring indirect financing. Suppliers, for example, might give you thirty days to pay bills. In some cases, you may even decide to negotiate a 45-day payment delay.

Self-financing requires exceptional cash flow management. The good news is that online businesses typically receive credit card payments without delay and have fewer collection issues that accrue from bad checks and installment plans.

Keep in mind that most financing schemes require that you invest personal funds to finance at least some portion of your business. If you're in business with several partners, you can expect the majority of your funding to come from within.

Insider Funding
For small startup businesses, insider funds usually originate with family and friends. You've probably all heard the cautions about doing business with family and close friends. The disadvantage is that your loved ones may have no idea of the risks involved.

To protect all parties, formalize the arrangement. If the funds are an outright gift, make sure your relatives or friends know the tax implications. If the funds are a loan, sign a promissory note. This will also be useful at tax time.

Loans from your family and friends can be secured with equity in your company. That is, by investing an amount equal to a specific portion of the company, they can expect profit sharing and a corresponding percentage of the sale value of the company after a period of time.

Equity Funding
Individual investors are also interested in equity funding. This works almost exactly like an equity loan against your mortgage. Equity is established by subtracting any amount you owe from the value of your business. Lenders agree to advancing money in amounts equal to a specific percentage of your equity.

Since equity funding is a type of shared ownership, some equity lenders will impose conditions on you. For example, they may want some management control.

Angel Investors
Angels are individuals or small groups with money to invest. Typically, they either have an individual net worth of one million dollars or more or can show income over $200,000 in each of the last few years.

Although angel investors can contribute advice, they're not usually interested in helping to run your company. They'll specify their expectations (usually three to five times their investment over a five-year period) and an exit strategy. For example, you might repay them with an equity interest in your company or shares when you decide to go public in an IPO (initial public offering).

You can expect to borrow between $100,000 and $500,000 from an angel. Prior to investing, angels tend to conduct due diligence.

Angels can be business acquaintances, community members or individuals you've met in the course of networking. If you can't find an angel, check with the Small Business Administration (SBA), a branch of the federal government. They have a list of angel investors.

Venture Capital
Small business startups don't usually acquire their funding from venture capital companies. Venture capitalists have large amounts of funding from private sources and can't afford the time to keep tabs on numerous small operations. While they're willing to work with high risk, they expect high returns.

If your startup is a medium to large business and you're looking for an exceptionally large outlay, a venture capital firm may be interested in finding funding for you. You can check the directory that's sold by the National Venture Capital Association.

Banks
Another source of funding for your small business is a small business loan from your community bank, credit union, saving and loan or finance company.

Traditional commercial banks aren't a good source of funding, as they're not really prepared to assume risk. Credit unions and small community banks are more suitable. Because they are eager for your business, they often provide useful support benefits for small businesses. Visit the loan officer well in advance to discuss funding. They prefer to work with you when they know something about you in advance.

The financing can be a loan or a line of equity. The line of equity saves you money, since you withdraw the money you need only when it's time to pay the bills. Interest accrues only after you start withdrawing and only on the funds you withdraw.

Expect to pay a fairly high interest rate. You might compare rates with a business credit card that works a lot like a line of equity.

Small Business Administration Loans
Some small businesses are able to receive loans negotiated through the U.S. Small Business Administration. Like student loans, commercial lending institutions actually process the loans. The federal government provides incentives for them to lend smaller amounts to small businesses.

According to the federal government, a small business is defined as one with fewer than 100 employees and sales under $5 million over the past three fiscal years.

The SBA has several programs, one of which is the "LowDoc" program. This is a program in which the paperwork has been streamlined to a one-page application form. Before you leap for joy, check out the list of documents you have to submit along with the application. It includes a personal financial statements, some repayment guarantees by all owners and proof that you were denied funding by a conventional lender.

Loans over $50,000 require additional documentation under the LowDoc program. You can borrow up the $150,000. About ninety percent of applicants actually receive funding.

You can also apply for a microloan from the SBA. These are six-year loans of less than $35,000 (the average is $10,500) for furniture, equipment and other tangible assets. The administration of the loan is usually structured as a line of credit.

Other Sources of Startup Funding
If your bank or credit union turns you down, you might ask them to suggest sources of creative funding. The more creative the source, though, the harder the funding is to get. Likely, you'll also have to pay a higher price in application time or interest rates. Here are a few of the more unusual sources for funds:

• Grants from private foundations, the federal government or your state government are difficult to get, but they don't involve repayment in cash. The catch is that your business has to be directly involved in some mission that's congruent with their priorities. So if you're working on a cure for cancer, you can expect federal money after a lengthy application process. If you just want to make lots of money, your state government probably won't consider your business to be a priority for them.
• Leasing some of your equipment, furniture and space is a way to delay capital expenditures. In fact, the rate may be low enough that you can put off purchases on items you don't need right away. You can also buy on an installment plan with low interest.
• Combinations of loans, equity lines and self-funding are realistic ways to approach the funding of your startup.
• Home equity loans can be used to launch a business. Be aware of the financial risks to your family.
• Owner financing may be possible if you're buying a business from someone else.

Don't be discouraged by all the work you have to do to acquire funding. If you have a good business plan and have filed all supporting documents carefully, you probably already have all the information you need to fill out the forms.

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