Finding the Cash for Your Business, Part 2

How to approach investors and learn about alternative sources of financing

By Karen E. Klein

Where does an aspiring entrepreneur or a struggling small-business owner find the capital to fund a good idea or expand a mom-and-pop operation? That question is the top query in the Smart Answers mailbag. We posed it to several small-business experts and offer their advice in both this and the previous column. (See BW Online, 2/13/01, "Finding the Cash for Your Business, Part 1"

What if your idea is dynamite, the timing is good, you're networking your socks off -- but find that you still can't get capital? Many would-be entrepreneurs hit the wall when they're pitching to investors because they're thinking only about what they need, experts say, and not about what the investor wants. "Investors are not in the gift-giving business. They're making an investment and taking a risk, and they're expecting a rate of return that exceeds the risk-free return of 6% they can get by putting their money into a T-bill," says Bill Gartner, professor of entrepreneurship at USC's Marshall School of Business.

Experts suggest that you research different types of investors to learn what rules and criteria apply to each. For instance, banks have a very low risk tolerance and very strict guidelines on making loans. They want to make highly collateralized loans, and they don't want to lose any principal. Individual investors -- especially those who like you and catch a vision for your idea -- may be willing to take more risk in exchange for a lower return up front and a bigger payoff on the back end. The risk they take is substantial, however, and should be acknowledged: On average, 85% of startup and early-stage companies fail within their first five years, and 50% of the remaining outfits will survive while providing little or no return, says John B. Vinturella, a consultant and president of an Internet startup, Infotech-GNO, which is based in New Orleans.

What you need to do is approach possible investors with a solid business plan that shows you've done your market research, analyzed the competition, crunched the numbers, and -- perhaps most important of all -- come up with both a realistic exit strategy and a scenario that lays out how the investor will be paid back, with a nice return, in a specified time. "Few business plans include rate-of-return projections. You should include realistic annual earnings growth, and realistic gross and net operating margins. The annual return should be two to three times what the investor would realize in safer investments," Vinturella says.

There are specific missteps, so-called "deal killers," that you want to avoid at all costs when looking for investors:

Have some money or tangible assets in the business. Starting without any personal assets on the line will kill your credibility. Put in enough funds to cover prestartup costs, including market research, writing the business plan or prospectus, and marketing the deal in a less than desperate way.

Don't over-shop the deal. The serious investment community communicates internally, and few investors want to work on a proposal also being considered by a competitor.

Be realistic. Know what your idea is worth, and make realistic financial projections.

Provide accurate financial figures. They will have to withstand scrutiny, so have them reviewed by a CPA.

Listen and learn. Take the advice and input of prospective investors and put it to constructive use. No one wants to deal with an entrepreneur who knows it all.

If traditional investors -- angels, venture capitalists -- aren't responding to your efforts, you might pursue some nontraditional venues. For instance, you can take out "business opportunity ads" in local or national publications that allow you to state the amount of money requested, the type of business involved, and the kind of return being projected. You could also approach the occupational investment groups, ones that often involve medical or legal professionals. Next time you have an appointment with your doctor or dentist, give him or her a prospectus and explain your plan. You just might get an appointment with the investment-group manager.

Seek out nonprofit assistance in the form of local business-development groups whose goal is to assist in the establishment and growth of new businesses. Many offer money or facilities to help a new business get started. Or look for strategic partners, perhaps merging your startup with an established company that has facilities and interests compatible or related to your needs.

Finally, don't lose sight of the fact that starting a business takes time -- lots of it. Studies have shown that it will require a minimum of 100 hours just to find an idea that's worthy of pursuit and make sense of it. A study by the Federal Reserve Bank of Dallas found that companies with revenues of less than $2.5 million will spend up to about 600 manhours looking for funding, much of that time spent educating potential lenders. "It's an unfortunate aspect of our culture that we don't celebrate how long and how hard it is to do this," Gartner says. "But frankly, it probably shouldn't be easy."

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