Raising Capital
When attempting to raise capital for you business there are
certain things you must demonstrate to a potential investor.
These are called Money Keys, because they can unlock doors
to capital for you.
The first thing you must remember is that
investors invest in people, not in
ideas.
You must demonstrate that you want to make
money. This sounds rather elementary, but many entrepreneurs have actually
killed otherwise promising negotiations with a simple statement like "Im not interested in the money for
myself." or "I don't want
to make any money out of this deal." Why on earth would any investor want to invest with anyone who isn't interested
in making money?
You must know how to spend money and must
demonstrate your knowledge with a well though out business plan. Cash flow is
your life's blood. You must make every dollar work
like two. You must be careful of interest rates on debt, hire the right people
at the right time, know when to spend on inventory
and know when to spend on equipment.
You can finance your business with other
people's money. There are people who will invest in your business. But
remember, they are motivated by the desire to make money.
Investors
in small business EXPECT larger than normal
rewards because risk is higher.
They are really investing in YOU - not your
product or your business.
The Small Business Administration claims the
most common reason for small
business failure is under-capitalization. But most often this really means
UNDER-PLANNING. In other words
people have done a poor job was done
estimating initial capital requirements, a poor
job forecasting initial sales or a poor
job done using and conserving capital that was raised.
In order
to raise capital, especially venture capital, you have to know how much money
you need to start your business. You must isolate start up-cost and operating
expenses until sales reach above breakeven.
Where you get your money depends on various
factors: How much do you need and
what stage of business are you financing? There are three stages of business
financing. Initially, there is Seed capital. This is preliminary stage such as
prototype development, research, travel and so on. Seed capital is usually
financed through personal funds.
The next stage is actual Start-Up Financing.
How much is it going to take to get the doors
open? This is money needed for
equipment, initial supplies and inventory,
deposits, pre-opening marketing and operating short
falls until breakeven. Typically, this will also come from personal funds, or family loans. Occasionally, if you personal net worth is sufficient, you may be able to take out a
bank loan or an SBA loan or attract a private investor.
Growth Financing is the third stage. The
business has been in operation a while and has become profitable and has track
record. But now it needs to move to
larger facility, Needs to add to product line, add
equipment or it needs to increase
personnel or needs to increase
advertising and marketing. Now the banks are willing to talk to you because you
have a track record. So are more private investors
and venture capitalist.
There is certain documentation you need when
seeking capital. You must have a personal financial statement. You must also
have a written business plan. The business plan is the basic tool of investment
community. The business plan will answer the following:
- What is the business?
- Profitability of your product.
- Market analysis.
- Competition.
- Budget.
- Cash flow projections.
You will also need to
prepare a Loan proposal/summary. This document includes:
- Summary of your business, your product and your competition.
- History
of yourself and business to date.
- Include other financing.
- An explanation of the deal.
- How much you need.
- Terms YOU prefer.
- Repayment preference.
- Collateral.
Finally, you will need your
financial statements.
- Balance sheet.
- Income statement.
- Financial projections.
- Credit, personal and business references.
Remember. equity
financing is basically selling a piece of the business. Investors are gambling on you as a manager. Typically,
investors in small businesses are
looking for higher rate of return so
you must decide what you want to give up. This, of course, depends on how much
financial risk you are willing or
able to assume. Investors will want
some say in control of your operation.
Where can you borrow
money? Well, there are always family and friends., as
well as Commercial banks, Savings and loans and Credit unions. But there are
also Small Business Investment Centers which are privately owned and licenced by Small Business Administration. In some cases,
Insurance Companies or your
suppliers might assist you. There are, in some communities, City or County sponsored
Loan Funds for starting business.
There are certain Guidelines for seeking investors.
First and foremost, Say it straight,
be realistic and honest. You should now something about the investor as some investors
are only interested in certain types of deals. In other word,
match your proposal to the investor.
Never overstate your figures. Investors
and bankers can easily tell if your numbers are inflated. Write simply and
clearly and type your proposal.
There are Five
questions an investor will always
ask.
"How much can I
make?"
Investors
usually have a target of Return On Investment of 45%
to 60% per annum over 3 to 5 years. Typically, investors
will usually look at third year projected earnings. Using third year earnings,
investor will multiply by the Profit
to Earnings ratio of similar companies. Next, they will multiply the amount
invested by 4 or 5. 4 or 5 is usually the
expected turn on their money in a three year period. Then they divide to
determine what percentage of ownership it should yield. Credibility of revenue
projections is the key question. It cannot be assumed and must be based on
realistic, documented projections. Therefore
they rely on your research, that is, documented size of market and penetration
by similar companies.
"How much can I lose?"
Two factors
apply here. The structure of financing and the riskiness of deal. In assessing the risk of the deal
they will look at three major
inherent risks in early stage company.
- Production - can it be produced?
- Marketing - can it be sold?
- Management -can it be produced and sold at a profit?
For
a going concern operating at a profit, these three risks are minimized.
Management risk is most serious - people invest in people, not ideas.
"How do I get my money out?" (Exit Policy).
Your business plan should outline exit
policy. You could take the company public, sell company,
or re-purchase of shares at
pre-determined P/E ratio, which is most likely in start-up firms.
"Who else says it's a good
deal?"
Investors,
like anyone else, like reassurance. Investors
like endorsements and testimonials.
References, both personal and trade can come from customers, suppliers and
bankers. Your business plan should include :
- Letters from customers.
- Customer response to demonstrations.
- Focus group results.
- Trade show responses.
- Note: Investor
should be given hands-on demonstration of product or service.
"Who else is in the
deal?
How investors
and venture capitalist read a business plan? Basically, it is a six step
process. First, they will attempt to determine the characteristics of
the company and the industry from reading the Concept section. Next they will
determine the terms of the deal from reading the Ownership section. Then
they will typically read the balance sheet from the Financial
section. Next, they will examine the people in the deal from the
Organization section. Then they will determine what is different about the deal
from the Concept section. Only at this point will they give the entire plan a
brief reading if interested. This will give them a feel for
the characteristics of company and industry. You should know that most investors have a preferred area for
investment. Some will only invest in high tech deals, some only in deals that
involve a significant amount of real estate so it is very important to match your deal to investor.
If they are still interested at this point,
then and only then will the negotiations begin.
Links of Interest:
Note:The Business
Innovation Center
in no way endorses or certifies the information
offered on these various internet link. They are presented for informational
purposes only. ALWAYS CONSULT WITH YOUR LAWYER AND YOUR C.P.A. BEFORE ENTERING
INTO ANY FINANCIAL AGREEMENTS.
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