Too Many Pieces of the Action?

How many stakes in his business should a startup's owner sell to raise capital? That depends on his goals -- and how many slices make a whole

By Karen E. Klein

Q: I started a consulting service five months ago with the financial backing of a private investor, but, with buying furniture and all the other work of getting a company started, I have yet to generate any income. My first investor is proposing another investor to help carry out our venture, but I'm hesitant. Is taking on another investor the best way to see this business through, or are there other alternatives?

---- S.F., Wilkes-Barre, Pa.

A: The real question you need to pose at this point, experts say, is why have you not generated any income after five months in business? If you started out with a solid business plan, a marketing program, and some expertise in your field, you should not need five months to get out of the box: A service business like consulting typically does not need the long development and startup time that a manufacturing or new-product company does.

"It sounds like there's been too much emphasis on things and not enough on marketing," says Paul Ratoff, an entrepreneurial consultant based in Placentia, Calif. "Definitely go to plan B -- which is to start to generate income to avoid the need of so much up-front capital. Start looking at family members for loans, which would be paid back once the business is on its feet."


  Why is your original investor unwilling to put more money into the firm? Is he unsure about your prospects for success? If the answer is no, why would he want to bring a friend in on the deal? Try to get by without additional capital, at least until you secure a few contracts and get some revenue coming in. Without revenue, venture capital will be your only alternative if you can't get by without additional financing. Traditional financing is out of the question until you begin to generate some receivables that can be financed, experts say, and new angel investors may be difficult to procure at this time unless there is a proprietary service you are offering.

The experts differ on the wisdom of bringing in several investors early in a startup's history. "If a company needs money, multiple investors can be advantageous -- deeper pockets, more collaboration and contacts, and, of course, more dynamics of personalities," says Peter Cowen, a Los Angeles-based investment banker.

You also are right to be hesitant about selling too much of your business for too little in return, says Kathleen Allen, a professor of entrepreneurship at the University of Southern California's Marshall School of Business. "A common problem that arises in early-stage development is taking on a lot of little investors, offering a chunk of the business or a piece of the profits to each, so that when the owner looks around, he or she is no longer the owner or has given away too much of the bottom line to recover," says Allen. "Similarly, if the owner gives away a lot at the front end (when, say, the idea is being developed), when it comes to the real need for money downstream -- e.g. manufacturing and/or marketing, the only thing she has left to bargain with is a piece of dwindling ownership."


  Your business plan should allow you to predict the economic feasibility of your consulting firm and give you a good idea how many months it will take to reach positive cash flow. If your plan does not do that -- or if you don't have a business plan -- work on that problem first. Calculate how long it will take you to break even and how much money you'll need in the interim, and then try to find alternative means -- friends and family, investing your own money, or taking out a personal loan -- to get you where you need to be financially.

Meanwhile, redouble your marketing efforts and put your energy into getting some contracts that will pay at least a portion of your fee at the front end of the consulting process. Keep your original investor in the loop on what you're doing, and if you do need to accept additional investment at this time, don't give away more of your company than you absolutely must. Best of luck.

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