How to Get Your Business Funded 38

Contrary to popular belief, business plans do not generate business financing. True, there are many kinds of financing options that require a business plan, but nobody invests in a business plan. Investors need a business plan as a document that communicates ideas and information, but they invest in a company, in a product, and in people.

Small business financing myths:

  • Venture capital is a growing opportunity for funding businesses. Actually, venture capital financing is very rare. I’ll explain more later, but assume that only a very few high-growth plans with high-power management teams are venture opportunities.
  • Bank loans are the most likely option for funding a new business. Actually, banks don’t finance business start-ups. I’ll have more on that later, too. Banks aren’t supposed to invest depositors’ money in new businesses.
  • Business plans sell investors. Actually, they don’t—a well-written and convincing business plan (and pitch) can sell investors on your business idea, but you’re also going to have convince those investors that you are worth investing in. When it comes to investment, it’s as much about whether you’re the right person to run your business as it is about the viability of your business idea.

I’m not saying you shouldn’t have a business plan. You should. Your business plan is an essential piece of the funding puzzle, explaining exactly how much money you need, and where it’s going to go, and how long it will take you to earn it back. Everyone you talk to is going to expect to see your business plan.

But, depending on what kind of business you have and what your market opportunities are, you should tailor your funding search and your approach. Don’t waste your time looking for the wrong kind of financing.

Where to look for money

The process of looking for money must match the needs of the company. Where you look for money, and how you look for money, depends on your company and the kind of money you need. There is an enormous difference, for example, between a high-growth Internet-related company looking for second-round venture funding and a local retail store looking to finance a second location. In the following sections of this article, I’ll talk more specifically about the types of investment and lending available.

Venture capital

The business of venture capital is frequently misunderstood. Many start-up companies resent venture capital companies for failing to invest in new ventures or risky ventures. People talk about venture capitalists as sharks—because of their supposedly predatory business practices—or sheep—because they supposedly think like a flock, all wanting the same kinds of deals.

This is not the case. The venture capital business is just that—a business. The people we call venture capitalists are business people who are charged with investing other people’s money. They have a professional responsibility to reduce risk as much as possible. They should not take more risk than is absolutely necessary to produce the risk/return ratios that the sources of their capital ask of them.

Venture capital shouldn’t be thought of as a source of funding for any but a very few exceptional start-up businesses. Venture capital can’t afford to invest in start-ups unless there is a rare combination of product opportunity, market opportunity, and proven management. A venture capital investment has to have a reasonable chance of producing a tenfold increase in business value within three years. It needs to focus on newer products and markets that can reasonably project increasing sales by huge multiples over a short period of time. It needs to work with proven managers who have dealt with successful start-ups in the past.

If you are a potential venture capital investment, you probably know it already. You have management team members who have been through that already. You can convince yourself and a room full of intelligent people that your company can grow ten times over in three years.

If you have to ask whether your new company is a possible venture capital opportunity, it probably isn’t. People in new growth industries, multimedia communications, biotechnology, or the far reaches of high-technology products, generally know about venture capital and venture capital opportunities.

If you are looking for names and addresses of venture capitalists, start with the internet.

The names and addresses of venture capitalists are also available in a couple of annual directories:

“Sort-of” venture capital: angels and others

Venture capital is not the only source of investment for start-up businesses or small businesses. Many companies are financed by smaller investors in what is called “private placement.” For example, in some areas there are groups of potential investors who meet occasionally to hear proposals. There are also wealthy individuals who occasionally invest in new companies. In the lore of business start-ups, groups of investors are often referred to as “doctors and dentists,” and individual investors are often called “angels.” Many entrepreneurs turn to friends and family for investment.

Your next question of course is how to find the “doctors, dentists, and angels” that might want to invest in your business. Some government agencies, business development centers, business incubators, and similar organizations that will be tied into the investment communities in your area. Turn first to the local Small Business Development Center (SBDC), which is most likely associated with your local community college.

Turn first to the local Small Business Development Center (SBDC), which is most likely associated with your local community college.

You can also post your business plan on sites that bring angel investors together. The two most reputable sites in this area are:

Important: Be careful dealing with anyone who offers to help you find financing as a service for money. These are shark-infested waters. I am aware of some legitimate providers of business plan consulting, but legitimate providers are harder to find than the sharks.

Commercial lenders

Banks are even less likely than venture capitalists to invest in, or loan money to, start-up businesses. They are, however, the most likely source of financing for most small businesses.

Start-up entrepreneurs and small business owners are too quick to criticize banks for failing to finance new businesses. Banks are not supposed to invest in businesses, and are strictly limited in this respect by federal banking laws. The government prevents banks from investment in businesses because society, in general, doesn’t want banks taking savings from depositors and investing in risky business ventures; obviously when (and if) those business ventures fail, bank depositors’ money is at risk. Would you want your bank to invest in new businesses (other than your own, of course)?

Furthermore, banks should not loan money to start-up companies either, for many of the same reasons. Federal regulators want banks to keep money safe, in very conservative loans backed by solid collateral. Start-up businesses are not safe enough for bank regulators and they don’t have enough collateral.

Why then do I say that banks are the most likely source of small business financing? Because small business owners borrow from banks. A business that has been around for a few years generates enough stability and assets to serve as collateral. Banks commonly make loans to small businesses backed by the company’s inventory or accounts receivable. Normally there are formulas that determine how much can be loaned, depending on how much is in inventory and in accounts receivable.

A great deal of small business financing is accomplished through bank loans based on the business owner’s personal collateral, such as home ownership. Some would say that home equity is the greatest source of small business financing.

The Small Business Administration (SBA)

The SBA makes loans to small businesses and even to start-up businesses. SBA loans are almost always applied for and administered by local banks. You normally deal with a local bank throughout the process.

For start-up loans, the SBA will normally require that at least one third of the required capital be supplied by the new business owner. Furthermore, the rest of the amount must be guaranteed by reasonable business or personal assets.

The SBA works with “certified lenders,” which are banks. It takes a certified lender as little as one week to get approval from the SBA. If your own bank isn’t a certified lender, you should ask your banker to recommend a local bank that is.

Other lenders

Aside from standard bank loans, an established small business can also turn to accounts receivable specialists to borrow against its accounts receivables.

The most common accounts receivable financing is used to support cash flow when working capital is hung up in accounts receivable. For example, if your business sells to distributors that take 60 days to pay, and the outstanding invoices waiting for payment (but not late) come to $100,000, your company can probably borrow more than $50,000. Interest rates and fees may be relatively high, but this is still often a good source of small business financing. In most cases, the lender doesn’t take the risk of payment—if your customer doesn’t pay you, you have to pay the money back anyhow. These lenders will often review your debtors, and choose to finance some or all of the invoices outstanding.

Another related business practice is called factoring. So-called factors actually purchase obligations, so if a customer owes you $100,000 you can sell the related paperwork to the factor for some percentage of the total amount. In this case, the factor takes the risk of payment, so discounts are obviously quite steep. Ask your banker for additional information about factoring.

Friends and family funding

If I could make only one point with budding entrepreneurs, it would be that you should know what money you need, and understand that it is at risk. Don’t bet money you can’t afford to lose. Know how much you are betting.

I’ll always remember a talk I had with a man who had spent 15 years trying to make his sailboat manufacturing business work, achieving not much more than aging and more debt. “If I can tell you only one thing,” he said, “it is that you should never take money from friends and family. If you do, then you can never get out. Businesses sometimes fail, and you need to be able to close it down and walk away. I wasn’t able to do that.”

The story points out why the U.S. government securities laws discourage getting business investments from people who aren’t wealthy, sophisticated investors. They don’t fully understand how much risk there is. If your parents, siblings, good friends, cousins, and in-laws will invest in your business, they have paid you an enormous compliment. Please, in that case, make sure that you understand how easily this money can be lost, and that you make them understand as well.

Although you don’t want to rule out starting your company with investments from friends and family, don’t ignore some of the disadvantages. Go into this relationship with your eyes wide open.

Maybe, your idea and your situation is a better fit for crowdfunding—that is, creating a profile and pitching your business idea or product on a site like Kickstarter. In fact, this method of raising money has become so popular that here are dozens of crowdfunding sites to choose from, all offering different terms and benefits.

Words of warning

Don’t take private placement, angels, friends and family as good sources of investment capital just because they are described here or taken seriously in some other source of information. Some investors are a good source of capital, and some aren’t. These less established sources of investment should be handled with extreme caution.

Never, NEVER spend somebody else’s money without first doing the legal work properly. Have the papers done by professionals, and make sure they’re signed.

Never, NEVER spend money that has been promised but not delivered. Often companies get investment commitments and contract for expenses, and then the investment falls through. Avoid turning to friends and family for investment. The worst possible time to not have the support of friends and family is when your business is in trouble. You risk losing friends, family, and your business at the same time.

Submitting a plan

The information you submit to investors depends a great deal on what your objective is. Sometimes you’ll submit a complete business plan, sometimes a Summary Memo. In most cases, even if you submit a short summary, you have to have the complete business plan ready to go as soon as the investors or lenders ask for it. If you’re looking for lease financing, receivables, or a bank loan, you’ll want to submit a loan support document to the lender.

When the search has provided you with a list of useful names, you can print your Summary Memo or loan support documents and send a copy to each of the investors, along with a brief cover letter.

Summary

Most businesses are financed by home equity or savings as they start. Only a few can attract outside investment. Venture capital deals are extremely rare. Borrowing will always depend on collateral and guarantees, not on business plans or ideas.

About the Author Tim Berry is the founder of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry. Follow Tim on Google+ Read more »

RATE THIS ARTICLE 1 Star2 Stars3 Stars4 Stars5 Stars
Loading ... Loading ...

How LivePlan makes your business more successful

LivePlan: Online Business Planning Software

If you're writing a business plan, you're in luck. Online business planning software makes it easier than ever before to put together a business plan for your business.

As you'll see in a moment, LivePlan is more than just business plan software, though. It's a knowledgable guide combined with a professional designer coupled with a financial wizard. It'll help you get over the three most common business hurdles with ease.

Let's take a look at those common hurdles, and see how producing a top-notch business plan sets your business up for success.

Click to continue
  • http://www.TapestryBiz.com Roxie Boyd

    Loved this article. I am very excited about the real possibility of opening a retail store by the end of this year, to complement my online eCommerce store, therefore I am reading articles such as this one, and just wanted to comment that I got a lot out of the article. Thanks and keep up the good work!!

  • Karen Brooks

    article was very informative, I have had a dream for many years and feel that this is the year to move ahead, reading this has opened my eyes to many possibilities in funding etc, thank you.

  • MERCEDES MAXEY

    I AM 21 YRS OLD I AM ANXIOUSLY RESEARCHING WHAT I NEED TO DO TO OPEN A NIGHTCLUB. I AM VERY OPTIMISTIC. I HAVE A GOOD FOUNDATION OF WHAT MY BUSINESS WILL ENTAIL BUT I GET KIND OF NERVOUS WHEN IT COMES TO FUNDS. ALL THIS MONEY TALK GIVES ME A HEADACHE..BUT IM READY.. DO YOU THINK THAT IT IS SMART TO PUT SOMEONE ELSE IN CHARGE OF THE FINANCE LIKE A CPA..PERSONAL ACCOUNTANT..AND GO WITH THEIR NUMBER OR THEIR WORD…BUT YOUR ARTICLE WAS VERY INFORMATIVE THANKS!!!

  • Roy Martinez

    I just joined, and I am finding lots of very interesting, and informative reading. I have been putting my venture together for five years, and I sure wish I knew about this then. I read the dont’s or try and avoid this or that, well I probably stepped on most of those land mines. You guys do know your stuff. I learned alot of it the hard way, but I am also going to avoid more land mines in the future Thanks so much

  • http://underconstruction pj

    thank you very helpful

  • CHRISTY

    I WANT TO THANK YOU FOR THE ENLIGHTMENT ON THE FUNDING CRITERA. I AM GOING TO DO MORE RESEARCHING ABOUT GET FUNDS FOR MY EMBROIDERY BUSINESS BEFORE I MAKE MY FINAL MOVE ON THIS. I REALLY DO NEED THE HELP BUT THE FAMILY AND FRIENDS THING I DON’T THINK THAT I WOULD GO WITH WITH THEM FOR THIS TYPE OF FUNDING. IF YOU KNOW ANY MORE INVESTORS THAT WILL INVEST INTO THIS TYPE OF BUSINESS PLEASE EMAIL ME AND KEEP ME POSTED. I WANT TO MAKE SURE THEY ARE LEGIT AND REAL. I AM LOOKING FOR SOME ONE WITH LOW OVERHEAD. THANKS AGAIN

  • Dan kenny

    Very good & informative site

  • Roy Herring, Jr.

    Your information is exactly right, even when some of the no no’s you speak of as investment sources are tempting, you have to think long and hard about it and as you say go into it with eyes wide open,especially when dealing with friends and family. So true! Thank you very good.

  • george

    I am in ghana and I have bein doing retail business for thirteen years until I decided to invest in this hotel business.even though the hotel is doing very well I can not pay my dept easily becauce of the kind of finance I had. I seriously agree agree with you that you have to be slow when looking for finance . I have done two years in the hotel business and maid some good money but because of the nature of finance I had am still owing I sold my mercedes and some personal stuf but its going to take me about two years to pay every one

  • Ibrahum Simon

    I like the subject, becouse i had been graduete in business Administratin last year, and now im working as Regional Trade Officer in Shinyanga Region,TANZANIA.
    i BELIAVE AND TRUSTING IN In this session will develop my mind and knowledge which i had not acquire wen was at college,Thanks very much and you mad my life better.

  • samuel owen

    this site is etremely useful, i have searched for funding for some time, but i have found help when i was almost giving up,thanks alot bplan site for helping entreprenuers globally,

  • chelise

    Good info …. thanks!

  • dr suprith

    good article , thanks

  • Loretta

    This advice, was so detailed and structured to suite the needs of many. I am in the pre-startup of my company, and we focus on startup, which entails all of the foundation needed. I love every bit of what I have learned, it also lets me know if I am up to par with the big dogs. I am, but you can never stop learning. Thanks

  • Tina Jorgensen

    I so much agree with you, when it comes to borrowing from family and friends . One of my family members did that and now that the business failed the lender no longer owns her house(after owning it for 30 years)the bank does. It’s really sad, because it tore the whole family apart! You give good advice, keep up the good work.

  • Marcia H.

    I was watching Larry King tonight and heard about this site, for small business funding. I am so glad that I took the sujjection visit. I want to start my business with ex-offenders. I would like to have a transitional facility. This facility will help men and women with the transition to re-enter society as positive productive members after completion of their prison terms. This site has clearied up many questions for me and given me a clear view of safety first, when searching for funding, and for start-up cost. Thanks so much for the detailed information and the comments from others. If there are more or any other sites I can visit for the type of funding I seek please forward an e-mail address(s) to me. Thanks sooooooooooooo much!

  • Ivana

    I am in the process of opening a business, that will be dealing with handyman service, etched glass, jewlery and various arts and crafts, you name it we will do it.

  • Natalie

    What kind of return do most investors look for?
    We have had people approach us asking to invest in our company – and frankly, we need it to expand. (And, SB Loans are hard to come by these days!) What is fair? Want this to be a win-win for both sides. We get the capital we need – but, don’t have to pay out big that it practically closes the company when an investor pulls out. But, realize that we do need to compensate generously for the $ that someone invests.

    HELP! :)

  • Dev

    This is an Informative topic. I would like to start up a business. How would I get to know, what amount is best for my business and what are the risk aligned to it and what could be expected profit. Is there any topics which mostly help me analyzing the above I have mentioned. Thank you.

  • http://www.BoxerDRILLZ.com Ricky Ray Taylor

    Is it true that owning a house (for collateral purposes) is the only way to obtain a small Business loan?

    ———————–

    Hi Ricky,

    I would suggest getting in touch with SCORE or your local Small Business Development Center for a list of resources for small business loans.

  • Steve F.

    This article is very informative. The business I am planning to start is service based and can operate strictly out of my home office. Therefore, my start-up costs are very minimal (a little over $10,000). Are there investor’s out there willing to invest so little for fear that the risk vs reward is not there? This is a very lucrative business according to market analysis and there is very little competition in my area but much need. How do I find private investors to present my business plan to?

  • T. Allen

    I’ve read everyone’s reply’s, I live in MI and I find it very hard to get funding, because of no collateral nor good credit so it is very difficult to get funding. But now I have to rely on my employment to fund myself a little at a time, but I will be persistant and get it done by myself. This article is right, because no banks will fund you, and no one will help you until they see you grow dramatically, then everyone and their mother wants to invest, i’m just keeping it real.

  • Pingback: 5 Non-Traditional Ways to Get Startup Money

  • Ilya Bodner

    This is a great article and keeps us all “engaged” the entire time.

    Sincerely,

    Ilya Bodner
    Small Business Owner

  • Chas Brown

    This article was so helpful! I am a bartender and have recently decided to use my skills and knowledge to train others while also working as a mobile bartender at private parties. Everything is set up out of my house but in order to really take the business up a notch, I would need assistance. Because the startup cost is small, I’ve been using my current employment as a means to make the business work. Should I seek funding elsewhere to separate my personal funds from funds for the business?

  • Karim Cisse

    Someone asked me this question: What will you do to grow business in a lounge or hotel? give me three ways to generate revenue in my hotel?
    Please help me answer this question!

    • http://profile.yahoo.com/TMVSLFJ6ZK33NXEGEMCPPVNYG4 Christiana Writes

      In a hotel, one can make some type of food available via either a kitchen that takes short orders, room service or vending machines in the hall if you are not into hiring staff and buying food. You could also rent space to a food concern and have them provide food for the customers.

      There could be sandwiches, fruit, packaged snacks and non alcoholic beverages available in the vending machines.

      You could provide entertainment via a ‘jukebox’ or live performers in a lounge and it too can have food of some sort.

      Vending machines in the bathrooms of both types of establishments dispensing condums (male and female), perfumes, sanitary products and/or other novelty items.
      There could be magazine or newspaper sales in the lobby.

      Pictures can be taken by a photographer or a booth and you could rent space for conferences or speaking engagements.

  • Pingback: Banks No Longer the Answer to Commercial Business Financing Needs | Westshore Mortgage & Investments Co., Inc.

  • http://www.tasteofjamaicainternational.com Sherron

    Thanks so much for this info.

  • mrfixit

    With all due respect I appreciate most of this article but I’m not buying it. The reality as history shows since 2000 is that 95% of venture capital companies have invested in outrageously poor concepts and business plans, startups with unrealistic business models, whereas they will ignore more conservative businesses that have actual stability, profit, and realistic business models. Most of these companies have all gone bust and one only has to glance over to the dot com graveyard to acknowledge any lack of prejudice. You’ll see one or two that only become extremely lucrative and popular simply because they are overhyped and others perceive its false value and buy them out. Meanwhile there are hordes of talented engineers and creatives who actually have skin in the game and are desperate for funding, they are creating innovative products burning 14 hours a day working while over-hyped businesses that barely anyone ever uses, (see Groupon) is generating tens of millions of dollars of investments.

    As far as banks need collateral I also think this is mostly nonsense. Banks do and will take on high risk companies so long as the company they are investing in is very proficient at fraud, or selling them a story and has some old buy who graduated from West Pont. Much of the time the collateral is worthless, because it cant be sold or used practically, and if there are buyers they end up paying pennies on the dollar for these assets because the bank wants to dump all their toxic assets.

  • M Shoaib

    it was a very informative articles for those who start a business and have a financing issues and in a stage to financing to start the company,i appreciate for this article and keep it up and God bless you and give you more knowledge and success and courage to do more valuable work for professionals.

  • Pingback: 5 Non-Traditional Ways to Get Startup Money | FirstChoicePractice Sales

  • Kyalo

    That was a good pointer!!!
    Have you ever had a bad investment???

  • http://www.securebordersk9.com M. Wade

    Superb article that is written with complete honesty and knowledge.

  • http://www.finlandiagroup.blogspot.com/ Arri Pekka

    What a article.For me its all in one most informative article i ever read.

  • Pingback: 20 businesses you can start with little or no money | My Click to earn

  • Looking4ward

    what should be a return-on-investment for “friends and family” offering? is there a legal template that I can use to get started? Thank you.

    • Jmorg_123

      I checked with my bank and attorney. Both entities had different opinions. The gentlemen at my local SCORE office suggested (strongly) that family and business do NOT mix. I am taking that into consideration at this point, but sometimes it is the least troublesome avenue to take, at least in the beginning.

  • Vijay

    I appreciate that the blog covers all the requirements and very helpful for a beginner.

  • Stephensenyo

    the world is full of people who don’t like taken risk,how can you convince people to be involve in VENTURE CAPITAL. Any body there who has an idea

  • Rachael

    Thank you, i enjoyed that – always wondered how to approach investors!

  • Matthew Flanagan

    The last paragraph when you say borrowing will always depend on collateral and guarantees is true with having collateral because the only guarantees in life are death and taxes.Love the article as it is very informative and was wanting to start a locale painting (interior/exterior homes) business and as of now i have everything to start or say get by to run it. i was looking for advice on how to get it up and going (advertising ect.)so far all i can think of besides referrals, and word of mouth, craigslist ect. is maybe to pay for a web site and have someone run it for me.if anyone can help me out by pointing me in the right direction would be much appreciated.
    Aloha and happy thanksgiving to everyone,MAtt