So you’ve decided to take the plunge! You’re going to start a small business, a type of small business that will involve some start-up costs.
Oh, and you don’t have all the money you’ll need to get started.
Unless you’re independently wealthy and you’ve got a lot of “extra” cash, or you’re willing to spend your personal savings and put some or all your retirement funds at risk (which is usually not a wise idea), you’re probably going to need to get some financial help with your small business.
Don’t let this economic reality extinguish the fires of your dreams. Fortunately, there are lots of people who understand that many potentially great small businesses often need financial assistance at the start. And believe it or not, even in this sluggish economy there are people willing to lend you money for small business start-ups.
Your first task is to figure out what sort of individuals, or organizations, would be the most suitable to approach for start-up capital. Then you’ll want to get to busy preparing to “make your pitch.”
There are several different sources of start-up capital for small businesses. See which of these categories best fit your situation:
“The 3 F’s” – This may seem rather sarcastic or flippant. But in the world of small business, we often speak (only half-jokingly) of “the 3 F’s” of small business investment– Family, Friends, and Fools! This is not to suggest that anybody would necessarily be a “fool” for investing in your business. There is, however, a reason for throwing these three “categories” together.
The simple and obvious truth is that we all enjoy an especially “close” relationship with our friends and relatives. Presumably, our friends and relatives know us like other people do not. In most cases they get to observe us over many years, and they get to learn a few things about our character, our work ethic, and so forth. For these and other reasons, family and friends will sometimes be willing to help finance our business venture with a very minimal “screening process” (relative to the other finance options), and with very flexible repayment arrangements.
The downside to obtaining start-up capital from friends and relatives is that the “closeness” in the relationship that helps get you the money, could become the “closeness” that drives you crazy as you operate your business. This is to say that friends and relatives who invest in your business may think that they’re obligated to offer direction on how you manage things, or that you’re obligated to follow their direction.
Another thing to consider if friends and relatives help capitalize your business is what happens if your business struggles, or even fails. One of the greatest problems with small businesses, and one of the biggest reasons they go bankrupt, is “undercapitalization.” Whether it happens because of poor planning, or because of unforeseen circumstances (the very nature of business is risky and uncertain), small businesses can often times just simply run out of money.
If you’re going to consider friends or relatives as a source of start-up capital, make sure to have a written agreement between you and the other parties involved. Make sure it is spelled out- in writing- what involvement your investors will have in the operation of your business, if any at all. And make sure everybody involved understands that there is no guarantee of success with your business, and that there is an understanding of the “risks” involved.
If a person who is neither a friend nor relative is still willing to offer you these kinds of “easy terms” on start-up capital, be very cautious and don’t let yourself become the “fool.” If they don’t know you very well, chances are you don’t know them very well either – and you could end up financially indebted to a seriously problematic person.
Small Business Loans: One way to finance your new business venture is to simply “borrow” money from a lending institution. In this case, a “lending institution” is probably going to be a bank or a credit union, but could also be a governmental agency. Sometimes a city will set-up a small business loan program and lend “government money” (tax revenues) to small business start-ups, for the purposes of expanding the business sector of the local economy. Sometimes a city will partner with a privately owned lending institution (like a bank), to make business loans available. Currently the city of New York, under the direction of Mayor Michael Bloomberg, has a city business loan program in place.
Typically, small business loans are issued for amounts under $200,000. Some institutions will issue what are called “micro-loans” for amounts as small as $15,000 to $35,000. But regardless of the amount, getting qualified for a small business loan is usually going to require that you pass some very stringent scrutiny, and adhere to some very specific repayment requirements.
If you’ve ever bought a house before, then you know the scrutiny that lending institutions place on borrowers. In the case of a mortgage loan, a lender will require that you verify two methods of repayment. That is, the lender essentially “owns” your house while you’re making your loan payments (and the lender can take the house away from you if you get behind on your payments), but the lender will also require you to verify that you have sufficient funds (and that your income is sufficient) to be able to make the monthly payments in the first place.
A small business loan will come with similar scrutiny and requirements as does a mortgage loan. The lending institution is in business to make money on your loan, but will want to do so with minimal risk to them – just like a mortgage lender.
The “Angel Investor”: An Angel Investor (which is sometimes referred to as simply a “business angel” or an “informal investor”) is typically an affluent person who has money to lend, and will provide capital for a business start-up in exchange for some kind of equity or ownership in the business. Sometimes multiple “Angels” will come together and form an “Angel Group” or “Angel Network,” where they share research on prospective new businesses, and then pool their money together to make “group investments.”
An “Angel” who invests in a business start-up usually spends his or her own money on the investment, as opposed to managing somebody else’s money and investing it for them. And an Angel will typically be willing to assume much more risk than a bank or lending institution will with a small business loan. This is why an Angel will require some ownership in the business, and will demand a fairly high “return on investment.” Interestingly, a study published at the Harvard Business School in 2010 indicated that despite the risks that Angel investors are willing to assume, businesses that are financed with Angels have some of the highest success rates of any businesses in America.
There is no “set range” of money that an Angel will typically extend for a business start-up. In recent years, it was common for Angels to invest anywhere from $200,000 to $400,000 in to a new venture. Yet in the current economic environment, the “rules” have changed somewhat, and today Angels are often willing to invest in smaller amounts. That said, the Angel Investor is often regarded as a “middle ground” approach to business financing, falling somewhere in between the “3 F’s” or the Small Business Loan approach, and the typically larger-sum Venture Capital approach.
Venture Capital: Venture Capital is investment money provided to early stage start-up businesses that demonstrate a high potential for growth. Typically, a “VC” firm will pool the money of individual investors and place it into a fund, and the firm will then invest the money on the individuals’ behalf, in exchange for ownership and equity in the business.
VC investment usually occurs in varying stages of business development. Some VC investors will help get a business started and provide an original round of “seed capital,” whereas other VC investors might prefer to invest in a business that has already been started, and is looking for capital in order to help the business grow.
Most VC investors are typically looking for businesses that are introducing some kind of new technology or an innovative business model. Such investors usually look for businesses that are producing new products and services and new intellectual property in the areas of computer software, biotechnology, or information technology.
One big difference between VC investors, and other business investment options, is that Venture Capitalists will often take a fairly “hands on” approach with the business and want to exercise some level of control over what the business does. Venture Capitalists will often want more involvement with the decision making processes involved in the business, and will frequently want to grow the business as quickly as possible, and then get the business sold to another investor.
Venture Capital investments have historically amounted to several millions of dollars at a time. However, given present economic conditions, some Venture Capital firms have been willing to invest in much smaller amounts, and adjust their usual timelines and strategies for managing those investments.
Depending on what kind of small business you’re planning to build, you may be able to find capital to help get you started by searching these different kinds of financing options. The United States of America is a wealthy nation, with lots of wealth within it. And wealthy people usually are looking ways in which to grow their wealth, and put it to good use.