Chapter 14 It Takes Money to Make Money In This Chapter Creating a funding plan for your company’s financial needs Obtaining first-stage or start-up capital Searching and planning for second-stage or expansion capital Employing other fundraising methods M oney does indeed make the world go ’round. Today, money is available for every type of business. In fact, there’s so much money floating around that the money managers are having a hard time; it seems there’s more money available than great deals to invest in! So, if you’re looking for money to fund a new venture, to support your current business’s growth, or to develop new products, the problem isn’t finding money; it’s coming up with a compelling reason for why the money managers should invest in your company. In other words, how do you tap into that money so your company can start growing? The market for deals involving private equity (an investment in a company in exchange for an ownership interest) is quite simply overheated and highly competitive.
In fact, the whole picture has flipped upside-down — at one time, entrepreneurs fought to stand out from the crowd of eager companies seeking funding; now the private-equity firms are battling to get ahead of the pack so they can secure deals to keep their investors happy. Who knows how long this will last, but for entrepreneurs seeking capital at any stage, this is a happy time (for more, on entrepreneurship, refer to Chapter 3). The bottom line: You can’t find money for any idea. Investors aren’t stupid.
A company that presents a great investment opportunity will get courted by the biggest of the big. If your company doesn’t have the potential to scale and tap a very large market; if you don’t have a “secret sauce” to keep com- petitors at bay; and if you don’t have a management team that knows how to grow a company, you’re out of luck. You need to go back to the drawing board and build something compelling that will get investors excited enough to invest. Not to worry though.
This chapter helps you determine your com- pany’s financial needs and explains how you can get your hands on some of the money available in the marketplace. 244 Part III: Money: What You Don’t Know Will Hurt You How Much Money Do You Really Need? Setting Up Your Funding Plan The term “plan” rears its ugly head when you start to figure out your financial needs. To successfully raise money for your business, you need to have a plan — as well as a backup plan and probably even a backup-backup plan in today’s business environment, because your chances of getting it right the first time (or two) are very slim. The goal is a funding plan that will guide your search and help you make wise financial decisions.
A funding plan is really quite simple. It has four steps: 1. Carefully determine exactly what your company needs to reach your goals. You have to plan for several stages of growth and financing.
Initially, you want to have enough cash to launch the business and survive until the company is generating enough revenues to cover expenses. Beyond that, you’ll establish some milestones such as multiple customer seg- ments, multiple products, and so forth. Target your potential sources for each stage of financing. Based on the needs you calculate for each stage, you can decide what kind of money you need and who could potentially be the supplier.
Recognize that some first-round money sources will want to be paid back or cashed out (get their investments back, in other words) before the next round of financing, so make sure that you plan for it. With the multi-stage plan defined, look at the various tasks you have to undertake to achieve your financing goals and get started before you need the money. Raising money takes time, so you shouldn’t wait until you need it, when it will be too late. For example, if you need private investors (called angels) for your second-round financing, you must start networking now.
Angels don’t just drop from the heavens when you need them. It takes time to build a business relationship so that you feel comfortable approaching the person about your financing needs and the person feels comfortable listening. Keep tabs on your progress against the timeline you set. If you’re significantly off from your projections, you may need to re-eval- uate your plan.
Perhaps you were a bit too aggressive in your expecta- tions. Keep in mind that you’re in a hurry; investors aren’t, so allow for some slack in your overall plan. Chapter 14: It Takes Money to Make Money 245 As you can see from the funding plan, the kind of money you need to raise and the sources you need to consider depend on where you are in the life cycle of your company. Every business goes through several stages, each with different financial requirements (see Figure 14-1).
Acquisition, Public Offering, Buyout Public Equity 2. Growth and Venture Capital Expansion Capital Private Equity Firms Angel Investors’ Networks Figure 14-1: Venture Capital 1. Seed and Start-up The stages Capital Strategic Partners Rapid Growth and of financial Customers Expansion or Exit Bootstrapping need Friends and Family throughout First Customer and Private Investors Proven Concept a company’s life cycle. Idea and Proof of Concept The following list explains the three stages of financial need: The first stage: This stage covers the period of time from the conception of the product/service through early start-up.
This is where the business concept is tested to make sure that customers want what you’re offering. The second stage: This stage takes over when the concept is proven and your company is ready to grow to the next level — by entering a new market, introducing new products, or developing multiple locations. The third stage: You reach the third stage when your company is looking for a liquidity event so investors can cash out, or you want to acquire another company or be acquired by another company. Each of these stages has different requirements and accomplishes different goals, which we cover in the following sections of this chapter.
You should know that high-technology and Internet companies often com- press these three stages into very short time frames — sometimes months, and possibly even skipping the first stage altogether. What this illustrates is that to assess your financial needs, you need to understand the nature of the industry in which you’re operating, the type of business you have, and your attractiveness as a company to the capital markets. 246 Part III: Money: What You Don’t Know Will Hurt You Acquiring First-Stage Money You know that you’re in the first stage of starting your business when the eas- iest and most likely source of money comes from your own savings and “friends, family, and fools” — in other words, people who believe in you and your business plan. Entrepreneurs aren’t bootstrappers because they want to be; they do it because they have to.
Bootstrapping means finding money and resources (anything and everything they need) by any means possible, including begging, borrowing, and bartering. First-stage money is hard to come by for several reasons: New ventures don’t have a track record, so everything that investors and lenders see in the business plan is pure speculation on the part of the entrepreneur. New ventures often fail, so they represent perhaps the riskiest investment of all. Most new ventures have no intellectual property rights — proprietary assets or secrets that would give them a competitive advantage in the marketplace.
The founders of the venture themselves often don’t have a track record of successful business endeavors. Most start-ups are merely “me-too” ventures; in other words, they haven’t identified a significant unfair advantage that makes them valuable to customers and investors. For these reasons and more, entrepreneurs have to bootstrap — rely on their own resources and the kindness of friends and family, or anybody else who will listen to their stories. Bootstrapping for a new venture has three key principles: Hire as few employees as possible.
Employees are the single biggest expense of most businesses. Lease, share, and barter everything that you can. When you lease facil- ities and equipment, you avoid tying up precious capital that you could use to produce your product or service. Bartering also has become a popular way to acquire needed resources.
In a barter arrangement, you exchange a product or service that your company offers for something you need from another company. Use other people’s money. You can ethically use other people’s money in many ways. Getting customers to pay quickly is one way; convincing suppliers to give you more time to pay is another.
Chapter 14: It Takes Money to Make Money 247 The next sections give you an idea of what to think about when you’re con- sidering debt financing for your business or giving an investor an ownership interest in exchange for equity capital. Both are valuable financial resources, but you have to know when and how to use them. These sections help you do just that. Debt Debt is a financing source that is, unfortunately, near and dear to many an entrepreneur’s heart.
You know all those credit-card offers that you get in the mail? Many small businesses don’t throw them away; instead, they’ve started using credit cards as their credit line for quick cash. It’s an expensive route, but in a banking environment that isn’t always generous to small businesses, going into debt sometimes is the only route that owners can take. In this sec- tion, we look at some of the principal sources of debt capital for start-up and expansion. (You can find other types of debt financing to solve issues such as business cycles, cash-flow problems, and so forth.
We deal with those topics in Chapter 12.) Commercial banks Banks aren’t very favorable sources of first-stage money for new companies, which isn’t surprising when you consider that a banker’s first concern is how a borrower will pay back the loan or credit line. If a start-up company has little or no track record of sales (and most new companies don’t!), and it’s offering the bank only projected sales (in other words, blue sky), a banker won’t have much confidence that repayment is possible. Bankers operate under very strict guidelines, termed the “five Cs”: Character, capacity, capital, collateral, and conditions With no track record and only an estimate of expected sales, a new company has already violated at least two of the five Cs: capital and capacity. But what if you can show a track record from a previous business or from your personal financial status that’s strong enough to warrant a loan? Depending on how you negotiate the deal, you’ll receive either a secured or an unsecured note.
We’re betting that the note will be secured, meaning that getting the loan will require some form of collateral. Collateral is an asset of equivalent value that you pledge against the note, such as your house or a savings account. If you don’t repay the loan, the bank has the right to repos- sess or foreclose on the asset. But even if that happens, your financial obligations don’t stop.
Just because you’ve lost your collateral for defaulting on the loan doesn’t mean that you aren’t still liable for the loan amount. 248 Part III: Money: What You Don’t Know Will Hurt You Most bankers will ask you to personally guarantee any loan you take out, which means that in addition to any business assets, you’re also pledging your personal assets against the loan should you default. Try to avoid this situation if at all possible. Of course, savvy bankers want to cover themselves any way possible, and they’re holding all the cards when you really need the dough.