Funding Strategies for New Businesses

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Business Plan Competitions: Many universities and associations organize business plan competitions. The prize is often funding in the form of a grant or award. These competitions have a number of benefits. The first is that they force the team to finely hone their value proposition and translate it into a professionally drawn business plan. A second is that it brings the team into contact with other, competing teams. This gives them direct experience with the dedication, resourcefulness and professionalism of other teams. A third benefit is that the competition is generally judged by people very experienced in the start-up game. Some may be investors who will take the time to help the team perfect its business plan and value proposition.

Micro-loans: There are financial organizations that specialize in making small loans to start-up companies. They are specialized banks. The loans are generally small but can be very useful in developing prototypes or bringing key team members on board. For the most part, these organizations recognize that they are making relatively high-risk loans. Their purpose is to support entrepreneurial activity.

These and other funding sources can be very useful in getting a company through the early-stage. The objective of the founders should be to use them to develop the product or service to the point that the company will be of interest to investors who will look at it from a return on investment perspective. Investors will require a clear demonstration that the value proposition can be monetized and that the team is capable of managing that monetization. They will also look for indications that the team is very good at getting the most out of limited financial resources. Once a company gets to this stage, they are ready to start the hunt for larger amounts of funding. They have a number of options.

Funding a Going Concern

The good news is that the funding approaches for going concerns is much more organized than the early-stage sources. The bad news is that they are much more competitive and challenging. Here are just a few options:

• Angel Investors: Angel investors are generally high net worth individuals who have decided to make early-stage investment in emerging companies. Sometimes they operate individually and at other times they form angel investment associations. Many of these either organize or support forums which allow early-stage teams to present. Angel investors tend to participate in companies in specific spaces. Most of the groups have websites which list their portfolio companies and outline their investment approach. It is important to make sure that you are presenting to a group or individual that is interested in your space. Angels approach each company as business decision and expect a return on their investment. This tends to be a real challenge to early-stage teams as it may be the first time they will be forced to see their company in that light. A benefit of angel investors is that they will often consider smaller investments.
• Venture Capital Funds: These funds tend to be more organized than angel groups. For the most part, they are investing money provided by institutional investors like pension funds. As fund managers, they are responsible to those institutional sources for generating a substantial return on the money. Because the cost of diligence can be very high, these funds tend to prefer larger investments. That may seem like good news, but the bad news is that they will want a company to be much more advanced in the process of monetizing the value proposition. In addition to a good product or service, you will need a growing, referencable customer base and very good profit margins in order to attract their attention. Venture funds tend to look at a company from an investment perspective and within a fairly short time-line to a future liquidity event. Entrepreneurs who have eschewed venture funding for self-funding do so in order to avoid this pressure. Keep in mind that the venture fund makes its profit when you sell the business, take it public or bring in additional funding. None of these options may have a positive impact on your long-term strategies. Also, venture funds will almost certainly require either a seat on your board of directors or the right to appoint an outside director. They generally push hard for more professional governance and oversight.
• Customer Financing: If you have been successful in getting potential customers to fund your early-stage, you may be in particularly strong position when your company begins to turn a profit. This may be some of the least expensive funding you can access. If you have carefully built a relationship with a range of customers, they may provide additional funding in the form of advance orders or forward-looking commitments. The good news here is that the obligations to them will disappear when you deliver on your commitments.
• Bank Credit Lines: At some point, if you are good at growing your business, your company will become ‘bankable’. That means that it will qualify for a credit line. Initially this line may be used to financing receivables. The bank may loan against purchase orders and give you the working capital necessary to deliver on those orders. If you mange the line well, they may eventually let you use some of it for working capital to make forward investments in expanding the business. A word of caution about bankers; they expect to be paid back on time and with interest. Failure to do so will quickly sour the relationship. So, be careful and prudent when it comes to such credit lines.
• Business Credit Cards: A word of caution first. It is very important to keep business credit separate from personal credit. You may be offered business credit cards rather casually. It is important that you treat them as business credit. Credit cards can be used to fund travel expenses and short-term purchases. It is important to pay them off in a timely fashion. Failure to do so will negatively impact the credit rating of the company and may cause you problems with other sources of credit or funding. A good payment history will improve your access to those other sources.

Prudence, Professionalism and Proportion

The first rule in funding a business is prudence. Do not waste time and energy chasing funding sources that are highly unlikely to fund your business. The second is professionalism. Approach each funding stage in an organized and professional manner. This becomes more important as your company grows but it is essential to take a professional approach from the very beginning. The third rule is proportion. Make sure that you are working to access levels and types of funding that match the stage and condition of your company. Funding a company from start-up through profitability is a major challenge that all founders face. It makes little sense to make the process more difficult by ignoring these simple rules.

© Dr. Earl R. Smith II

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Related Articles:

• Angel Investors to Avoid

• Angel Investors – The Good, Bad and Very Ugly

• Presentations from the Investor’s Perspective

• Protecting Investor Interests: Quick Assessment, the Short List

• Moving the Ball

• Lack of Accountability – The Core of Failure

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Contact Dr. Smith

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The Federal Circle provides advisory services to companies working in the federal contracting space. Its core team and network of advisers has a deep understanding of the government contracting space. Together they represent a rich resource for companies trying to generate traction in these very competitive markets. Contact us for a free initial consultation.

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