{"id":22671,"date":"2011-07-27T09:40:36","date_gmt":"2011-07-27T13:40:36","guid":{"rendered":"http:\/\/countingpips.com\/fx\/?p=22671"},"modified":"2011-07-27T09:40:36","modified_gmt":"2011-07-27T13:40:36","slug":"the-best-way-to-get-funding-for-your-business","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2011\/07\/27\/the-best-way-to-get-funding-for-your-business\/","title":{"rendered":"The Best Way to Get Funding for Your Business"},"content":{"rendered":"

By Michael Masterson<\/a><\/span><\/strong><\/p>\n

Last week, I suggested that it takes more than an idea<\/a><\/span><\/strong> \u2013 even if it\u2019s a really fantastic idea \u2013 to attract potential investors. You need to prove that your idea has legs by turning it into a working model.<\/p>\n

But then what? Once you\u2019ve got a working model, where do you go for the money you need to turn it into a business?<\/p>\n

In general, there are four sources of capital: venture capital firms, government agencies, commercial banks, and private investors or partners.<\/p>\n

If you think your idea might be of interest to venture capitalists, check out the National Venture Capital Association (nvca.org). But for the average entrepreneur, venture capital isn\u2019t a possibility. As Paul Lawrence explained in his article “Raising Capital for Small Business Ventures<\/a><\/span><\/strong>“:<\/p>\n

“Yes, some venture capital firms will invest in new businesses, but such businesses are usually involved in technology or some other high-growth area. Frankly, for most small businesses, venture capital isn\u2019t even an option. It\u2019s rare for a small-business concept to have the kind of mammoth payoff venture capitalists look for.\u201d<\/p>\n

“Plus, the cost of doing business with these companies is high. It\u2019s basic economics. Their risk is high, so their reward must also be high. Even if you were to interest a venture capital company in your business, you\u2019d be aghast at what they\u2019d want in terms of their ownership position.”<\/p>\n

What about government grants? Tim Berry, author of Hurdle: The Book on Business Planning<\/a><\/span><\/em><\/strong>, points out that government funding agencies usually have “social” agendas. Grants and loans are available to minorities \u2013 especially minority businesses engaged in education, antidiscrimination projects, community services, fine arts, and other politically popular objectives.You can find out if your business idea might be a candidate for government money by checking into any of the government agencies whose purpose is to stimulate entrepreneurship. The best known is the Small Business Administration.<\/p>\n

I wouldn\u2019t advise taking this route, though. It requires too much bending to bureaucracy. Too much artificiality. Too much red tape. Getting these loans and grants takes months (or years) of filling out forms. And there are all sorts of reporting and regulatory requirements \u2013 enough to slow down even the most patient person. Plus, government-funded business projects have an extremely high failure rate once the funding is withdrawn. That\u2019s because they begin with an idea, not a working model. And the idea isn\u2019t good to begin with because it is based on social policy instead of being connected to profits \u2013 which is, after all, what fuels a business.<\/p>\n

As for getting money from a commercial bank, I can make this short: Forget about it. The only way a bank will lend you money these days is if (a) you have excellent credit and (b) you can collateralize your loan with assets. If you have good credit and tons of money, you don\u2019t need a bank loan. You can loan yourself the money.<\/p>\n

This brings us to the fourth and final option\u2026<\/p>\n

Finding a Private Investor or Partner <\/strong><\/p>\n

At first blush, private funding seems like the least likely way to go. You may not know anybody who has money. Or if you do, you may not be willing to risk damaging the relationship by mixing it with business.<\/p>\n

Some business experts advocate hitting up friends and family. I never did that, because my personal relationships were always more valuable than my desire for money. But I did ask business acquaintances to invest with me. My relationships with them were based on money, so I didn\u2019t think it was inappropriate.<\/p>\n

One of my first businesses, a house painting service I started with a buddy when we were still in high school, required a very modest investment. About $400 to pay for ladders and tools. We didn\u2019t have the money, so we got a job with a painting contractor and saved up to buy what we needed. It took six months \u2013 and during that time, we were making all sorts of good contacts. We were getting to know paint wholesalers and equipment rental providers and even future customers.<\/p>\n

When we were ready to go off on our own, we spent a few weeks knocking on doors and offering discounted service. Before we knew it, we had all the work we could handle.<\/p>\n

Years later, I funded an idea I had for a new publication by asking my boss if he wanted to invest in it. When he found out I had no money of my own, he took 75 percent of the deal and made me sign notes to repay him the 25 percent (about $10,000 or $15,000) that I was liable for. I was a little unhappy with the arrangement at the time \u2013 but eventually I realized he was being very generous.<\/p>\n

Once I recognized that when it comes to funding “good ideas,” money talks, I switched strategies. I decided I\u2019d never attempt to sell an idea again. Instead, I\u2019d sell a working model. Nowadays, when I\u2019m looking for capital, I wait until some version of my idea has already proven itself to be profitable. At that point, I can go to any good businessperson and show him the numbers. Sales and cash flow can persuade in a way that market research and computer charts can\u2019t.<\/p>\n

The Difference Between Getting a Loan and Taking On a Partner<\/strong><\/p>\n

Let\u2019s say you have proven your idea in the marketplace with a working model. The next step is to figure out whether you want an investor or a partner.<\/p>\n

The advantage of taking on debt (getting a loan from an investor) is that you do not give up equity in your business. It can still be 100 percent yours. The disadvantage is that you will owe the money even if the business fails.<\/p>\n

The advantage of accepting investment capital (taking on a partner) is that you don\u2019t have to pay the investor if your model doesn\u2019t work out in the bigger world. A second, often overlooked, advantage is that you will have someone to bounce ideas off. (The best investors are successful people in the industry you are entering.)<\/p>\n

In between getting a loan and taking on a partner, there\u2019s room to play. You might be able to structure a deal that has the best of both worlds \u2013 a loan that gives the lender a limited (though significant) upside if the business takes off. To get that, you would have to make some concessions. You may have to pay back some of the loan if the business fails, for example. Or you might take, say, 50 percent of the salary the business intends to pay you and use that to pay down the loan over time.<\/p>\n

Ultimately, the guy with the money decides what the deal is. You\u2019ll do better negotiating your stake if you present a very exciting and trustworthy picture of the business\u2019s potential. And that will depend on having detailed financial reports on costs and cash flow and profits, if there are any.<\/p>\n

Prepare to Make the Pitch<\/strong><\/p>\n

Before you can contact prospective investors or partners, you need to figure out how much money you need. Come up with three scenarios: ideal, less ideal, and minimum. Of course, there will be advantages in having the ideal amount of capital \u2013 but don\u2019t get your heart set on that. Chances are you will get option two or three. Be prepared to work with either.<\/p>\n

In making the pitch, follow Paul Lawrence\u2019s SIPE process \u2013 Solicit, Interest, Persuade, Execute:<\/p>\n

1. Solicit<\/strong><\/p>\n

Begin informally. Casually ask your prospect, “If I happened to come across an interesting business opportunity, would you like to hear about it?”<\/p>\n

It\u2019s important to note that you\u2019re not asking him if he would invest in a business, but if he\u2019d like to hear about potential opportunities. Since he won\u2019t feel that he\u2019s being pressured, it\u2019s more likely that he will give you a positive response.<\/p>\n

You also immediately rule out people who have no interest in any business proposals\u2026 without putting them (or you) in an uncomfortable position.<\/p>\n

2. Interest<\/strong><\/p>\n

Give your prospect a one-sentence description of your business. A long-winded explanation can sound like you don\u2019t have confidence in your business idea or that you don\u2019t really know what you\u2019re talking about. You then follow up with an estimate of the business\u2019s profit potential and a couple of supporting statements that provide strong reasons to believe it is viable.<\/p>\n

3. Persuade<\/strong><\/p>\n

If the person you are pitching seems interested, set up a second meeting to present him with a written proposal.<\/p>\n

Make it short and to the point, no more than eight pages. If you are presenting it to the right person \u2013 someone already successful in the industry \u2013 he will not need more than that.<\/p>\n

The proposal should have two goals:<\/p>\n