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|Finding the Right Funding Partners|
|Published Friday, December 22, 2017|
From left: Jeremie Clark, CTO; Matthew Guruge, CEO; Will Lynch, developer; Sarah Kasiske, product designer; and Tyler C. Hurst, COO of Awato in New Ipswich. Courtesy photo.
Matthew Guruge wanted more than money. The co-founder and CEO of Awato LLC, a career-counseling firm, was looking for investors for his New Ipswich-based business. Ultimately, he chose a syndicate of five angel investors who could provide key introductions and expert advice in addition to $300,000 in funding.
“We were really interested in getting people who could help us,” Guruge says of his now seven-person startup. “For us, [raising capital] was easy and fast. We were hoping to find mentors who could help the company grow and help us grow as entrepreneurs.”
Startups like Awato have more choices than ever for raising capital, but that doesn’t always mean it’s easy to find the right funding match or partners. Funding sources have expanded as federal regulations related to accredited investors have loosened and web-based crowd funding and financial technology, or fintech, have gained in popularity.
Basically, investment capital for businesses comes in three broad forms:
• Debt financing, which is based on a loan repaid with interest;
• Royalty financing, which is based on a loan repaid with interest; and
• Equity financing, which gives investors part ownership of the business.
However, selecting the best option can be complicated as there are various funding structures. Some of the options include: friends and family, angel investors, venture capital, banks and credit unions, fintech, crowd funding and federal grants.
The most salient question is, ‘How much money is needed?’ Because the answer will dictate the sources to be considered. Other factors include: Is the business selling something with large profit margins that could be more attractive to individual investors or a product with lower profit margins that will provide modest return rates? Is the business owner able to offer collateral to secure the loan or investment?
A strong rapport with the financier may be just as important as the loan or investment. An investment without solid, unwavering support or the investor’s firm grasp of the business strategy can spell trouble for entrepreneurs, says John Hamilton, managing director of Vested For Growth, a mezzanine funding program operated by the NH Community Loan Fund in Concord. “Business is about relationships, and raising capital is no different,” he says. “The first and most important is choosing a financier you relate to and you feel understands your business and can add value because it’s more than a money transaction.”
The friends and family option may be the most obvious for small amounts of capital, but it can also be treacherous. Since investors know the entrepreneur, they will listen to pitches. But they are also biased about the entrepreneur and his or her abilities compared with more objective investors. Tapping friends and family members also puts the entrepreneur at risk of permanently damaging important personal relationships.
While friends and family are more apt to be patient in seeking returns, it’s unlikely they can offer important introductions that an outside source could. And business contacts and introductions can be a crucial part of the financing process.
Venture capital is a high-risk, high-reward business. Because of that, VC firms are highly selective and take an equity stake and a board seat in portfolio companies. So, it’s definitely not the way to go for entrepreneurs seeking total control of the future of their business.
Business owners must also research prospective VC because firms often specialize in vertical sectors such as high tech or healthcare. Ask the VC firm about the companies in which it invests. If its portfolio consists of biotech firms, pitching a restaurant venture may not be the right fit. Firms also prefer businesses of specific sizes and stages of development. Entrepreneurs need those details and to establish an exit strategy before pitching a VC firm.
Business owners need to align their needs with the investor’s expectations, says Daniella Reichstetter, executive director of entrepreneurship at the Center for Private Equity and Entrepreneurship at Dartmouth College’s Tuck School of Business, and owner of Canoe Club in Hanover. “Introductions, advice, additional investors, customers, the ability to create a board and professionalize the company, etcetera, are key contributions that investors could make,” she says.
The University of NH’s Center for Venture Research created a list of VC resources for entrepreneurs seeking early-stage capital. It includes 12 Granite State sources, including VC groups, venture forums, matching networks and educational forums for entrepreneurs.
In 2016, venture-backed New England companies raised $5.3 billion in funding compared with $7.5 billion the previous year. The decline mirrored a national trend in which activity slumped last year to $52.4 billion from $77.3 billion in 2015, according to Dow Jones VentureSource.
But entrepreneurs should stay hopeful. Based on midyear investment stats, VC activity is projected to rebound and top $75 billion this year.
On Angels’ Wings
Angel investors—wealthy individuals that bankroll businesses for an equity stake—provide entrepreneurs with another source. Angels generate a moderate return on their investment while the entrepreneur gives up a small portion of ownership.
Such investors are typically experienced enough to lend guidance and provide crucial contacts. However, the high level of involvement may not suit everyone.
The Center for Venture Research at the University of NH, which tracks U.S. angel investing trends, reported in June a 13.5 percent decline in angel investment during 2016 compared with 2015.
The contraction was a reaction to “the overheated public equity markets where prices have increased quite consistently, and some would say unrealistically, since 2008,” says Center Director Jeffrey Sohl.
Software companies accounted for 25 percent of last year’s deals, and Sohl says angel investing is still most popular with technology startups.
Funding with Fintech
Fintech refers to online financial services and includes tools such as PayPal and Square. But it has also fueled the creation of online lending platforms like Kickstarter, GoFundMe and Indiegogo, which are designed for small business owners and inventors seeking capital.
Such crowdfunding platforms are based on a reward system in which investors are typically provided discounts, or early versions or expanded versions of the products they back. However, federal regulations have loosened in recent years to enable equity crowdfunding, meaning investors can also get an ownership stake of the startups they bankroll.
Crowdfunding platforms generate profits by taking a small percentage, usually 4 percent or 5 percent, of the money raised on their websites. They sometimes specialize in specific categories.
For example, Kickstarter is favored by artists, musicians and other creative entrepreneurs. GoFundMe is not so specialized and frequently used for charitable causes as well as business ventures. MedStartr Inc. specializes in health- and medical-related startups.
The Web-based tools have proven so popular that banks have started launching fintech-like tools to serve their customers. Though fintech platforms appear to provide fledgling businesses with easy money, the terms of some loans have caused problems for entrepreneurs because they are higher and more demanding than anticipated.
Interest rates of some fintech platforms have risen higher than rates on credit cards, making it difficult to pay off principals, says Richard Grogan, director of the Small Business Development Center in Durham.
Many business owners simply head to the banks or the U.S. Small Business Administration for funding. SBA loans, which averaged about $375,000 in 2016, are issued through approved lenders such as banks and guaranteed by the agency.
When a business borrows from a local bank through an SBA loan, the SBA guarantees a percentage of the loan will be paid back to the bank if the business goes belly up. The guarantee percentage depends on the loan type and amount.
SBA Regular 7(a) loans of $150,000 or less have an 85 percent guarantee, while loans of more than $150,000 have a guarantee of 75 percent, says NH District Director Greta Johansson.
SBA Express loans are another type of 7(a) loan that maxes out at $350,000 and comes with a 50 percent guarantee.
The SBA also provides products specifically for exporting that can have a 90 percent guarantee. Loans top out at $5 million. It also offers a 504 loan product for fixed asset acquisition.
The SBA sponsors microloans of less than $50,000 to small businesses. It also sponsors disaster recovery loans. The agency also oversees the Small Business Innovation Research program and the Small Business Technology Transfer program.
Last year, the SBA supported loans of $111.7 million to NH businesses versus $99.5 million in 2013. The volume of SBA real estate and long-term equipment loans increased more than 41 percent during the most recent fiscal year compared with the previous year. Johansson attributes the rise to the low unemployment rate and confidence in the market.
This year, SBA lender activity has remained robust across a variety of verticals. The volume and value of loans has risen, she says.
Since the selection of a funding source can be a byzantine process, Hamilton invokes Steven Covey’s mantra of beginning with the end in mind. Establish the business’s end goal and the role capital would play in reaching that goal to narrow down choices.
The NH Business Finance Authority operates a Live Free and Start program designed to support startups in NH and expose them to the ecosystem that is here to help them.
It includes a website that explains its initiatives and the resources that connect entrepreneurs with prospective investors.
Capital Compass is another online tool that can help entrepreneurs in selecting the right financing options. Created in early 2014 by the Community Loan Fund, Capital Compass offers a questionnaire that helps business owners eliminate funding options based on their needs.
The multiple-choice questionnaire asks a series of questions in four categories: the business, its future, the market and the owner’s risk tolerance. Questions range from “What is your primary purpose for raising capital?” and “What is your gross profit market?” to a question related to the amount of advice the business is seeking from its financier.
And the organization says 413 people have completed the questionnaire since it launched more than three years ago.
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