By Karen E. Klein Q: I founded my small business seven months ago and interest in my product has been remarkable. I have made a major investment in this company, but still lack funds. My personal debt has increased, and while my credit score isn't bad, my revolving debt is higher than most lending institutions like to see. Where can I seek funds? -- B.S., Texas.
A: Your problem is common to entrepreneurs starting product-oriented businesses. The founders pour their own money into developing prototypes and funding product development, but underestimate how much time and effort it will take to sell and market the product effectively. Thus, startup money dries up before revenues can be generated -- no matter how promising the product.
To sharpen your outfit's professionalism and greatly increase its chances of success, you need to take a step back and draw up a detailed business and financial plan that maps out how much money will be required to get it off the ground. You can buy software to help you create a business plan or download templates or guidelines for free online (start with the website of the U.S. Small Business Administration). In addition to making an educated estimate about how much cash you need to raise, the plan should also lay out where the funds will be used and what milestones you intend to achieve with the money over the next year (doing three- and five-year projections helps a lot).
A thorough, serious business plan will help greatly in your search for capital, says Channing Chen, managing partner of Fusion Strategy Parnters, a San Francisco-based venture consulting firm. You should also practice short- and long-form oral presentations about your background and the company's strategy and products, so that you will have a succinct pitch ready for investors and lenders.
KITH, KIN, AND CASH. Once you have the business plan, what funding sources do you approach? That depends on how much you need, as determined by your business plan. Entrepreneurs seeking to raise less than $100,000 typically try to get the money from friends and family, says Loren Busby, of Walden Capital Management in New York City.
Outfits looking for as much as $1 million might approach a local angel investors group, while those that need between $500,000 and $3 million could go to small-business investment companies (SBICs) that operate through the SBA. "For an amount greater than $3 million, [you] could approach a traditional venture capital firm. Start with local firms and branch out to other areas of the country after identifying a strong, regional sponsor," Busby recommends. "You can find a directory of venture capital firms at the local library or buy one from Venture Economics."
If you are just starting out and haven't raised friends and family money yet, that's where you should start. Your accountant can help you structure the contributions from friends and family as equity, debt, or convertible debt -- whichever method works best for you and your investors, says Chen.
HARD EVIDENCE. "For business owners pursuing this path, it is of utmost importance to demonstrate to would-be investors that there is unquestionable and sufficient demand for their products," says Chen. "This can be done by having potential buyers of the product act as references that the investors can contact or obtaining letters of intent (LOIs) to purchase the product." Include proof of demand for the product in your business plan, Chen recommends.
Here are some additional funding sources you might want to consider:
Companies that are or could be buyers of your product. These operations may have a vested interested in keeping your production line in business. Look for retailers or manufacturers who might see your products as important complements to their existing lines or as an integral part of their overall offerings. It is possible that these larger companies could provide capital to your fledgling operation, Chen says.
Firms exist that buy high-quality receivables from your business, usually at a substantial discount. These firms are called "factors" and they are especially prevalent in the apparel industry. "Using a factor is similar to having a revolving credit line at the bank, only more expensive," Busby says. "You can use the cash your company receives from the factor right away, while the factor takes on the credit risk and collects what is owed on your receivables directly. This type of financing is beneficial when you have short-term working capital needs, but is not a good solution for financing long-term growth."
Finally, don't give up on the idea of a bank loan. Greg Jelinek is the executive vice-president of National City Corp., where he heads up the Cleveland-based bank's small-business banking line. Having a relationship with a banker who specializes in entrepreneurship is crucial, he says. "Hook up with a bank that has a separate unit for small business and you'll get a lot of help and expertise as well as a full range of products, including SBA-guaranteed loans for small business and lines of credit," he says.
Relationship managers who work with entrepreneurs through National City Corp. consult with their customers about borrowing needs and credit lines. "A lot of entrepreneurs have short-term revolving credit debt that doesn't help when they need long-term capitalization for the business. We can often give them relief on cash flow by terming out that debt over a longer time period, like five years, so they can free up some money for working capital," Jelinek says. As the business grows, a savvy banker can help you manage your cash flow better and help you save a day or two in your collection cycle -- a day or two that might be crucial to your ability to put your company on the right track.
Have a question about your business? Ask our small-business experts. Send us an e-mail at Smart Answers, or write to Smart Answers, BW Online, 45th Floor, 1221 Avenue of the Americas, New York, N.Y. 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally. Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.