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|Financing and the Risk of Business|
|Published Friday, May 6, 2016|
At one time I was an executive in a company that eventually sold for just south of $100 million. It was a big success, even more so when you hear about its financing path. Friends and family? Angel investment? Venture capital? None of the above. This successful company began its life financed by a stack of credit cards rubber banded together and carried everywhere in the founder’s briefcase. Have a bill to pay? “Wait one moment while I shuffle through these cards and figure out which one hasn’t been maxed out.”
It’s quite a success story, but the part of the story to focus on is the risk taken. In delving into the topic of financing a business, it’s critical to consider risk. If that company built on credit cards didn’t succeed, it would have meant financial ruin for the founder.
We’ve all heard statistics about the high failure rates of new businesses. Data doesn’t always show the same percentages, but the failure rates are always high. So let’s begin by accepting that many, perhaps even most, new businesses fail. Nevertheless, every entrepreneur starting a new business expects to succeed. If they didn’t believe this, then why even begin?
Loans are Personal
Whether you’re starting or already running a small business that you envision scaling to new heights, the early risks and sources of financing are often personal. Credit cards are tied to your credit rating, but just about any other loan is tied to the company’s and the owner’s assets. Without assets you’re unlikely to get a loan. If you have equity in a home and a high credit rating, you may be able to borrow money from traditional sources such as a bank. Otherwise, understand traditional lenders are not in the risk-taking business. If you do find a loan or use your credit cards, the risk is all yours. If things don’t go well your assets may be lost. Are you prepared for that?
Got Something to Sell?
If you don’t want to borrow funding, or you can’t, maybe you have something to sell. We’re again talking about assets. Do you own any stock or other investments that could be sold? Are you prepared to take the risk? Do you have other assets you’re prepared to part with to get your business off the ground, such as a car, real estate or boat? In what way, and at what risk, are you willing to invest in yourself? Keep this in mind if you look for funding from someone else, because whoever provides it will be taking that same risk on you.
Two Fs or Three?
Friends and family are often used as sources of funding for a business. A third “F” source is fools, a glib way of pointing out just how risky it is to invest in startups. That’s why transparency is critical where friends and family are concerned.
Our friends and family love and care about us. They want us to be successful, they want to support us and they want us to believe in ourselves. That’s why they often help finance startups. But understand that financial dealings among friends and family can easily fray, or even destroy, relationships. Avoiding this should be first and foremost in our minds if we’re going to take funding from them. Complete transparency is a big step toward better outcomes, especially when things don’t go as planned. Our friends and family must understand they could lose every penny they’re investing. If they are not completely comfortable with that potential, do them and yourself a favor. Do not take their money.
If they are comfortable with the risk of total loss, then you can think about what kind of investment they will make. Will they be lending you money, or will they be investing in your business and owning part of it?
These are not the only potential methods, but suffice it to say that structuring the financing and understanding what each party is getting is critical. Seek professional counsel.
An often-overlooked source of capital for your business is your customers, and there are a number of ways they may be helpful.
Your customers provide you with capital every time they make a purchase, so get them to buy something. Not only can it help capitalize your business, it also demonstrates you’ve done something right in providing them value at a price they’re willing to pay. That’s a great sign you’re on the right track. If you’re in a service business, you can sign them to a contract that pays you on an ongoing basis, providing steady income to the business. Perhaps they’ll put in a purchase order for delivery over time, which may allow you to get purchase order financing from a lender. Could you use a discount to induce them to make a deposit toward future purchases? Think creatively about your customers’ payments to you.
Another approach could be crowdfunding. Online platforms like Kickstarter and Indiegogo are vehicles for businesses to put products (not manufactured yet) in front of potential customers. Crowdfunding isn’t easy and many efforts fail to hit their goals, but the response will indicate how receptive the marketplace may be to your idea. High value, exciting products that are well presented on crowdfunding platforms can raise large sums. The funding is available for the company to use, making products for delivery at a later date. These are pre-orders that provide their own financing, a big win for a startup business.
No, you aren’t going to get a competition to completely fund your business. However, you may win a competition that will fund it. Here in NH entrepreneurs have access to a number of business plan competitions that award cash prizes and free services provided by lawyers, accountants, marketing firms and more. Generally the prizes aren’t loans or investments in your business. It’s free money. It doesn’t get any better than that. So if your business fits the parameters of a competition, don’t hesitate to go for it.
Angels & Venture Capital
Finally you’re thinking, he’s getting to where the real money is, angels and venture capital. Not really. Sure venture capital is big money, and the angel investor market has been getting lots of press, but the relevance to most businesses is nonexistent. We certainly have startups in NH pursuing and receiving angel investment and venture capital, which with successes will be good for the state’s economy.
These investors, however, only put their money to work in companies that offer a specific set of circumstances. The company has to have enormous revenue potential, with intellectual property or other barriers to entry, and a founder and management team who exhibit the ability to execute the visionary plan. These are just the early filters for an angel or VC. It is no wonder that VCs and angels make only a few investments each year, often after considering hundreds. This makes the odds low for most businesses receiving this type of capital. Be realistic about whether this is something to pursue at all.
If It Were Easy
Financing is a challenge, but so are all other aspects of being in business. Overcoming the hurdles and succeeding makes it rewarding. If it were easy, everyone would be doing it. It’s not. And it is risky. Know this, and assess it realistically. Start by taking a look at the Live Free and Start website (livefreeandstart.com).
Mark Kaplan is CEO of Alpha Loft, which incubates and accelerates start-ups and early-stage companies in NH through locations in Durham, Manchester and Portsmouth. For more information, visit alphaloft.org, email firstname.lastname@example.org or call 603-629-9511.
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