Venturing out? Here’s how to find funding
Mark S. Long, Director of Incubation Services at the University of Florida
My mother used to tell me the magic words were “please” and “thank you.” But when you’re an entrepreneur, you learn the real magic words are “cash flow.” Period.
Many business publications tell us 8 of 10 entrepreneurs crash and burn within the first 12-18 months of starting their company, and most fail primarily due to becoming cash poor. Comprehending cash flow management, understanding where your cash has been spent, and knowing if spending that cash has moved you closer to market (or helped you better identify your market) are true keys to success.
But where does a company get money in the first place?
Many startup entrepreneurs feel they need to raise significant amounts of cash right from the start – especially from “venture capitalists.” This is what my mother used to call “bass ackwards” or what an entrepreneur should learn is “exactly wrong.”/p>
Typically, attempting to finance a new business with venture capitalists is a predictable path to failure. First, venture capital firms are usually large firms who invest large sums of money at the smallest possible risk. A typical venture firm will not invest $200,000 in a high-risk, early-stage startup.
In addition, the higher the risk profile, the larger the “piece” of the company the venture investors will want to take. Sometimes for a large investment, the venture firm will want control or majority ownership of the company.
This is not to suggest that all venture capital companies are bad or that their investments are not needed. Most venture investors provide a key role in company growth and development – although later in the life cycle of corporate growth.
Very early-stage startups should consider other sources of financing.
Of the many ways to finance a brand new venture, these are the most common:
- Roll your own: Be prepared to use your own funds and bootstrap your company. Many entrepreneurs get a second mortgage and/or line of credit; they use savings; they max out credit cards; they tap into retirement accounts. They find the money somehow. (I knew a founder who sold his car and biked to work for three years!)
Funding yourself is the most reliable source of funds – after all, you believe in your new venture, right? Putting your own funds into the business is a sure sign of your belief in the startup you founded, and as you need more money, self-financing can encourage others that you are, indeed, committed to the success of your company. This will motivate others to invest, since you obviously believe enough in the concept to put your own money to work in it.
- Friends, Family and Fools: These three groups of people are often called the “3 F’s,” when friends, family and fools become a source of investment capital. It represents your friends – people who know you well and believe in you always; your family – people who are related by blood or legalities (or people who feel obligated to support you since you’re a relative); and fools – people who are silly enough to believe in you, regardless of their knowledge or affiliation with you and your company.
These sources can be a significant early source of funds and enough to get the business going, since the average company starts with less than $35,000. Of course, this depends on your circle of family and friends – and the number of people you can fool!
- Bank loans: Although often you must provide collateral (i.e. home ownership, etc. and the self-financing mentioned in No. 1 above), a bank loan or line of credit can get a business through a rough patch or provide enough financing to sustain a company until it begins bringing in income from sales.
- Angel investment: “Angels” are high-net-worth individuals who invest in startups and who understand the risk profile for their investments. You often can find local or regional angel groups who invest both individually and as a group. Keep in mind, however, that not every angel investor has the qualifications you may need in an investor. It pays to evaluate your potential investor as much as they evaluate you.
Money is not the only angle for angels. (Say that three times fast!). You want money and expert advice and great connections through your angel investor’s network.
- Grants and special group funding: Besides venture capitalists (which is a pooled, organized group that invests larger portions of money and seeks a lower risk profile), you might find government grants (Small Business Innovation Research/Small Business Technology Transfer Research grants), SBA loans, state grants, minority business grants, private foundations, etc. that may be available to help finance your efforts.
Remember looking for scholarship and grant opportunities when you wanted funding to go to college? Do that for your business.
- Crowdfunding: Crowdfunding is popular today through sites such as Kickstarter and Indiegogo, where businesses can make appeals over the web to large audiences. Small individual contributions can add up.
- Customers and suppliers: A great source of funding can come from customers and suppliers. Customers can prepay for products or give you advance orders, and suppliers can provide extended terms on payment of invoices (such as 60 days or 90 days, instead of the usual 30 days), allowing you to stretch your cash and manage cash flow more efficiently.
- Factoring companies: Factoring companies help you manage cash flow and get paid sooner by providing financing for slow-pay invoices. In other words, if you book sales but customers don’t pay you immediately (meaning you have debt to manage), factoring companies can pay you instant cash for the unpaid invoices. You use these funds to continue operations, then you can settle with the factoring company once the invoice is paid (or some factoring companies just buy invoices outright, at a discount, and collect from customers themselves).
In addition to these common sources of funding, some businesses also barter for goods and services to conserve on cash, and some startups enter business accelerator programs, where they receive both financial and operational assistance to help them get off the ground.
Once a startup obtains some funding through one or more of the above methods, it can be stingy with cash flow and better manage the company financials a number of ways. These can include locating the early-stage company in a business incubator (a high-service, lower-cost location with tremendous amenities, assistance and support aimed at helping a new business thrive); minimizing travel and entertainment expenses by teleconferencing and videoconferencing; deferring capital purchases and exploring outsourcing; and hiring interns and students from colleges and universities.
After all, it’s not how much cash you have, it’s how you manage the cash you have. And remember to say “cash flow!” the next time someone asks you for the magic words!