Understanding the Early Stages of Financing for Your Startup

Last week’s blog covered the different funding options that exist for startup businesses. In this blog, I discuss the funding available for the initial stages of your venture. Many aspiring entrepreneurs become discouraged when looking for financing. The SBA and financial analysts speak about the importance of the small business to the community. The number of small businesses even serves as an indicator of economic health. Yet, funding seems to be as real as the tooth fairy. I hope by sharing the technicalities of funding for your startup venture, you will be encouraged to know where to look for financial support. Of course, no matter what stage of financing you are in, your chances of getting financed are virtually nonexistent if you do not have a business plan.

Your business undoubtedly goes through different stages of financing. During the early stages, you can expect financing to come from your own resources. But as your business progresses, you should work to separate your personal finances from the business. Understanding these early stages will enable you to plan for each stage and ease your personal financial risks from those incurred from your business.

We can divide the various stages of financing into three categories:

• Early Stage—the period from concept to the initial production of your product or service
• Expansion Stage—the phase that includes revenue generation, profitability and the period right before going public
• Harvest Stage—the phase where financing comes through a public offering, merger or an exit strategy

I will focus my conversation on the stages comprising the early stage of finance.

Seed Stage. The seed stage is the proof of concept phase of your business. During this phase, you are likely developing your product or service and defining your market through extensive research. At this point, you have a business plan that is still hit or miss. Do not get discourage because at this stage, I would argue that if nothing changes, something is wrong. Financing. Expect most of the financing to come from your personal resources—savings, 401(K), home equity line of credit or a private loan, for example. Your personal equity is at risk since your funds are still married to your business funds. Also, if you were affected by downsizing and were fortunate enough to get a severance package, consider using it to fund your startup. External funding may be family, friends or possibly an angel investor. If you are developing a new product (i.e., a new technology), then you might qualify for government funding, possibly even a grant. Although there are government grants to fund innovations that fill a need in our society, no grants exist to fund the commercial startup of that innovation. Government grants will cover up to the period to make a prototype: the proof of concept. Recommendation. Unless you are manufacturing some unique invention, I recommend that you fund your endeavor during the proof of concept stage. This stage is very risky for investors and it can be for you as well. If you find an external investor, you risk losing management control. If loved ones invest and the concept fails, you risk losing personal relationships.

Startup Stage. At this stage, you might be on the verge of opening your business or if you have already launched, your business is no more than a year old. Your business usually has not started selling the product yet. Your business plan is fully developed and your management team is in place. If you need financing, it is for product development and market studies. Financing. At this stage, you might be able to reach beyond your own pocket. If you are denied a commercial loan, then consider acquiring the loan with a government guarantee on a portion of the loan. This stage of investment is still considered risky. You might be able to find an angel investor; however, venture capitalists are usually not interested at this time. Recommendation. Discipline and ingenuity will help you during your startup stage. Find ways to bootstrap! Minimize expenses and find creative ways to market your business on a shoestring budget. Conserve your cash. Another option is financing your equipment. Some companies offer deferred payments. Although I will tell you to tread carefully, now might be the time to give loved ones a chance to invest. Just be sure they know the difference between equity financing and debt financing. If they are offering you equity finance, that means if the business fails, they lose their money. If they loan you the money, then you must pay it back even if the company is not thriving. You can also introduce a loan at this point. Your credit must be favorable. Still, only apply to SBA-approved commercial lenders because there is a chance the SBA might back your loan. You might want to solicit an angel investor. With an impressive business plan, you could land the investor you need. But be sure you understand what you are agreeing to—get a lawyer!

First Stage. At this stage, you are selling but you might not be generating profits. At most, you could break even. Your focus is on production and sales. Financing. At this point, you might have exhausted your funds and would need to raise funds to produce and sell your goods. Usually at this point, you have proven your product and options for funding your business are broader. Have the right management in place to understand financing decisions. For instance, if you are considering debt financing, reduce your risk by financing your fixed costs (i.e., property and equipment) on a longer term and consider short-term financing for your variable costs since you will be able to cover that cost with each unit sold. External investors might be interested; however, your business is still at a vulnerable stage and you will definitely want to understand the cost of acquiring investors. Recommendation. It is important that you understand your business plan and that you have forecasted the various rounds of investment you need during this early stage. If you are in a reactive mode, you could make decisions that you might regret. At this stage, introduce a mix in investments, possibly both debt and equity financing. Ensure you have a management team that understands the intricacies of all the fundraising options you have at this stage. If you are considering investors, be sure your business consultant ensures your plan includes your proposed offering to potential investors.

Starting a business takes plenty of hard work, discipline and perseverance. Believe all the clichés: Nothing ventured nothing gained; nothing worth having comes easy; there is no such thing as a free lunch … and so on. According to the SBA’s 2008 “Report to the President,” a study showed that on average, only 17.31% of startups are actually implemented four years after conception and 68.1% are still in the startup stage. Furthermore, an average of over 1,400 hours is spent preparing the startup for implementation—it takes plenty of elbow grease to get a great plan around your endeavor. Creating a business plan is easier said than done, so do not be afraid to get assistance in building a solid plan. Organizations like SBA and SCORE offer free or low-cost resources. There are also small business consultants and coaches who can guide you through the process or even write one for you. Many resources are eager to help you mind your business.

About Author

Jowanna Parris-Daley owns and operates jowanna inc™, a small business consulting company that offers business plan writing, website design and technology consulting services.

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Startup Funding Options

 

So you want to start a business? Are you willing to risk everything … or at least something for it? Most lenders and investors want to see what you have put on the line for your dreams, before they invest in your business. In this blog, I discuss the different sources of funding for your business. I will dive into each of the different startup funding options in subsequent blogs.

Your Money. Most entrepreneurs use their own money to start a new venture. This funding might come from savings, 401(K), home-equity loans, credit cards, etc. In an ideal world, you protect your personal worth and get funding from an outside source. However, if you are not a proven entrepreneur, you will more than likely have to self-fund at least a portion of your venture. While a compelling business plan might get you some suitors, you also risk losing control of some or all of your business.

Your Rich Uncle Bob and Aunt Sue. A relationship-based investor (or what I call an emotional loan) is another alternative. Family and friends are logically the next place to seek funding for your business. How great! Not only does Aunt Sue have the money, but you are also her favorite and seeing you succeed will be repayment enough. Although borrowing from a family member or a friend is a viable option, things can also get pretty uncomfortable on the home front. Can you imagine? You have presented an impressive plan to family and friends and you have personally invested $2,000 in your business. Uncle Bob and Aunt Sue invested $1,500 each. Cousin Roy throws $200 in the pot because he feels that you are onto something and wants to get a piece of the pie. One year later, business is booming! To show your gratitude to Cousin Roy, you pay him back $1,000—$500 more than he was expecting. Yet, the relationship was still damaged: he no longer speaks to you because you refused to buy him a BMW after your company opened up its third location. (We will spend more time on mixing money and family in a later blog.)

Commercial Lending. You can also get a business loan to fund your business. The most important factor to a bank is your credit worthiness. Banks will not become enamored with your business idea. All they want to know is your likelihood of paying back the loan and if the numbers on your financial statements are realistic and in alignment with each other.

Small Business Administration (SBA)/Government-Backed Loan. The SBA is a government-run organization that offers resources to small business owners to either start a business or expand an existing business. The SBA does NOT make loans; it guarantees loans for small businesses. You must first try to secure a loan before the SBA will back a loan.

Local Government. Your state and local government have entities known as the Offices of Economic Development that provide funding and information of other sources of funding for small businesses. If you live in an area with high unemployment, you can often find funding. The government knows the importance of small business ownership to the economic stability of communities.

Financing Companies. There are financing companies that­ loan money to start your business or to buy equipment. Furthermore, companies like Microsoft, Dell or HP can offer you financing and/or leasing for your equipment. However, be aware that the rates and fees are often higher than a bank.

Venture Capitalists. Venture capitalists are usually companies that buy ownership into your company. These investors not only buy stake in your company, but they also get input on how your company is managed. Venture capitalists have stringent requirements. They are usually interested in seasoned entrepreneurs with a unique idea that shows extreme growth potential.

Angel Investors. Angel investors, like venture capitalists, are looking for a high return rate on their investment. They are usually wealthy individuals who reside in your backyard! Angels usually want to invest close to home. Networking is the key to finding Angel investors. These investors usually want to get their money in and out in a couple of years. Their experience can work in your favor. They impart their experience to help you build a profitable business. It is important to include an investment offering along with a payback schedule in your business plan.

Grants. I am sure you noticed the late-night ads or an invasive pop-up while browsing the Internet telling you there are secret government grants for your venture. The truth is that grants are almost always reserved for non-profit companies. The exception to this rule is grants to create products that will benefit the public or our government—especially in the technology arena. Even in this case, funding is usually limited for the proof-of-concept and prototype stages.

Small Business Contests. There are a growing number of entrepreneurial contests available from organizations trying to tap into the lucrative small business market. While these contests present many small business owners visibility, it is certainly not without risks and hassles. The requirements are often cumbersome and there are risks associated with sharing your idea.

Small business funding is a subject ingrained in the mind of most business owners. Even though the economy is rebounding slower than expected, there is funding out there for small ventures. Approximately 50% of employment comes from small businesses. However, you must have a solid business plan and you must be willing to risk your own neck in the game.

Jowanna Parris-Daley, MCP, MCSD, PMP, MBA (Entrepreneurship)
 

References

Sherman, A. J. Raising capital. Get the money you need to grow your business. 2d ed. New York: AMACOM, 2005.

Additional Resources

Small Business Administration – Financial Assistance for Borrowers

Small Business Administration – Venture Capital

Small Business Administration – Finance Startup

About Author

Jowanna Parris-Daley owns and operates jowanna inc™, a small business consulting company that offers business plan writing, website design and technology consulting services.

 

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