We all have dreams of starting our own business, of bringing
to fruition that one great idea that is destined to make us enough money to leave
our families financially secure for generations to come.
If you are lucky, you may actually have developed your idea to the point where you feel you are ready to take a serious run with it. You may even have taken the time to draw up a business plan for your new venture. But what is the next step? Locating money, of course. Without financing, your business will never get off the ground.
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So, you ask for a loan at the local branch of your bank. That is when you may be surprised to learn that your banker, although friendly, may not be able to help you. Banks generally do not finance businesses until they are profitable, and they almost never provide loans to start-up companies.
Fortunately, there are alternatives. Unfortunately, the alternatives have costs. The first source of financing for your new business is typically your own savings. If you are not willing to stand behind your idea with your money, why should others? Financing a business personally often has limits — you may have other needs for your funds (education, food, clothing, etc.), you may be too young to have had time to build much in the way of savings, your spouse may put his or her foot down with respect to the level of risk that should be taken, etc.
Your second source, and the one that you will most likely need to rely upon if the business is to make it, is referred to as “friends and family” (no, this is not a hidden advertisement for a phone plan). As painful as it may be, founders of many new businesses have had to ask Mom and Dad, uncles and aunts, longtime next-door-neighbors or family friends to invest in a business that is, at this point, often only an idea. While they may be willing to lend you the funds you need, without a cash flow, it may be impossible for the new business to make loan payments. You may, therefore, want to offer the initial sponsors the opportunity to purchase a portion of your business. The amount you sell will depend on the size of the investment, but, in any event, you will want to keep the controlling interest in the business. The advantages of selling ownership as opposed to borrowing money are that (1) the business does not have to repay sale proceeds, (2) the investors, as part-owners, have the opportunity to share in the growth of the company, and (3) friends and family investors are likely to be easy on you and give you the leeway you may need from time to time.
Now your business is up and running, but you still need more cash to meet your business plan. You go back to the friends and family, but they are tapped out. The next source to consider is known as “angel” financing. Angels are usually strangers to you and your business who have funds available to invest in emerging companies. The goal of the angel is similar to yours: He or she wants to own a significant percentage of the next great company, or at least the next pretty good company. Angels are typically more aggressive and experienced investors than friends and family, and therefore will want more of the company for their money and may impose some restrictions on what you are allowed to do with the proceeds or on the decisions you can make without their consent. Still, they are typically fairly easy to work with and often do not get in the way (otherwise they would not be called “angels”!).
You have now hit the big time. The company is leasing space, you have employees and you are actually making a product or providing a service (but oftentimes is not making money). The next source of much needed cash is the venture capital market. This is often where the big money resides, but also the big costs. Venture capitalists, or VCs, as they are known, often acquire a controlling interest in a business in exchange for a significant investment. The VCs will control not only the ownership of the business but also the board of directors. This means that all important decisions will go through them. They can be your best friends, especially when the business is doing well, because they have money, contacts and business experience. If the business is not doing well, however, the VCs may well take over and replace you, leaving you without a business to run.
Finally, after having gone through all the trials and tribulations of securing financing from your own savings, friends and family, angel investors and venture capitalists, you have created a business which is running and profitable. It is only now that the banker you first visited may be able to discuss providing you with further financing.
James O. Reavis, a partner in the Technology Law, Securities and Corporate
Practice Groups at Hinckley, Allen & Snyder LLP, represents individuals and
businesses in connection with a variety of business and financing issues.
