You are here to find out how start-ups get money. We won’t waste your time with banter. Let’s get started…
And the place to start is a sober warning: Getting money for a small business is a real bitch. You are competing against every other small business and start-up for a very limited pool of capital, and the competition is really hungry for that money, just like you are. So you should expect to spend a lot of time hunting for money at first, and a lot of time hunting for more money to help you remain in business. In this financial section, we will briefly describe the different sources of money that you should consider. Some sources are more likely to pan out than others, and some sources are probably entirely inappropriate for what you want to do (i.e., expecting a venture capital firm to offer money to help you open a sports bar).
When starting a business, most people (rightly or wrongly) go to a bank first. This section is, therefore, quite large. So we put it on its own set of pages. Click here to go to information on obtaining business loans from your local bank.
Friends and Family
If you are like many small start-up business ventures, you will look to friends and family for some of your money to get the business started. This money allows you to buy whatever you needed to get started, hire professionals, or any of the other initial requirements. Whether you have already done this or are contemplating it, please keep two important ideas in mind as you look for this type of funding:
Do not sell stock at this point! Debt can and should be given wherever possible at the initial stages, preferably debt that is not signed by you but that is unlikely to happen. In the beginning, you will probably have to sign off on any loan to your business, even if the person giving you money is a friend or relative. This is actually preferable in many ways to giving the person a piece of the company’s stock or a partnership interest. If you give stock or a partnership interest, there is another person who now has rights and powers to affect company decisions, even if the person holds only a minority interest (trust me on that one, okay?). Besides, giving Uncle Herman 20% in exchange for $20,000 seems like a steal when your company is worth nothing, but after seven years of your hard work and Uncle Herman’s non-involvement, how are you going to feel when you hand over one-fifth whatever you sell your company for? You will hate it. If you absolutely have to give up stock, try to get some sort of option to buy it back in the future in the Shareholder’s Agreement.
Second, if you do get the money in the form of debt, treat such money like it was from a bank or some other outside lender! This means that you need to thoroughly document the terms of the loan (or stock purchase if it comes in that form) and spell out the rights, duties and powers of the parties involved. Do not attempt to finance your business on a handshake or on the back of a cocktail napkin, every lawyer has at least one horror story to tell about clients who, in the initial stages of their businesses, failed to properly document their relationships.
Moreover, treat the debt as real debt. That means you pay the payments on time or, if you can’t, you agree to new payment terms with the lender.
Other Businesses with a Connection to the start-up
Often, there will be businesses in related industries which are not in competition with your business, but instead dependent on or interested in the area in which the start-up is operating. These businesses could be potential customers or clients for the start-up. Such businesses may be willing to help your start-up get equipment and capital needed to “take flight”. Again, try to avoid giving equity to such angels-of-the-marketplace and thoroughly document the transaction (today’s angel is tomorrow’s slimeball!)
Another source of finding money may be “finders”, who inhabit the twilight realm of law and money where the federal securities laws do not reach and even investment bankers fear to tread. These guys cannot negotiate any part of the financing terms, instead their only job is to introduce you to people with money who are willing to invest it. Naturally, the finders take a large chunk of the money they find for you, and they will probably take a piece of the company as well. The fees can range from 5%-15% of the money they find for you, and this fee might have to be paid up front, regardless of whether they can get you the money. Obviously, most start-ups will not choose finders as their first financing option. When dealing with this type of “professional”, make sure that you have everything in writing before agreeing to anything. A sample finder’s agreement is available.Invention Promotion Firms
If you are an inventor or your small business centers around a new invention, there are businesses out there which are willing to help fund the further development and promotion of invention which have the promise of paying off in the future. These promotion businesses will do it all: from patent filings and prosecutions to raising capital when needed and marketing the product. The downside is that they will take a very good-sized chunk of your business and its profits. If you go this route, you must be prepared to watch while others pretty much run the show. This may appeal to many inventors, and thus they should look into these promotions businesses. Some inventors, however, feel that in this case, the deal is just too tough, and they look elsewhere for the money and expertise they need.
Venture Capital Funds, Buy-out Funds and Mezzanine Funds
If a start-up business is not ready for regular bank or other institutional financing, but the technology or product of the business is marketable and capable of generating profits, venture capital funds will be found nearby, offering the money in exchange for a piece of the company. Some see venture capital funds as heroic rescuers of small businesses which have promise but no access to money–the financial firefighters saving the child-like start-ups from an infernal marketplace. Others see Venture Capital Funds as carrion feeding on distressed entrepreneurs who ran out of money and luck–the narrow-eyed vultures of the financial desert sizing up money-parched start-ups and gauging whether they can begin chewing. (Just for your information, we take neither view. The venture capital funds are just another sources of money, and they are morally no worse and no better than any other, and in fact serve a valuable economic service in many cases.)
There is a much larger section on Venture Capital Funds and what they are looking for in a start-up business. If you have any interest in learning about this possible financial resource, please jump there.
FYI: Venture capital funds usually require a very high rate of return on any investment they make.
Buy out Funds/Mezzanine Funds
This is the what people refer to when they talk about “cashing in.” Buy-out funds purchase existing businesses with a steady, proven history of profits. Often the buy-out funds are purchasing an entreprenuer’s company built over lifetime. Management shake-ups are common when a buy-out fund comes in (but by no means are such changes a certainty). Buy-out funds do not take on the risk of a venture capital fund, so they don’t expect the same sort of return, but they do look for about thirty to thirty-five percent on their money.
Mezzanine funds operate in much the same way as buy-out funds, and often operate right alongside them. The difference is, mezzanine funds do not take equity for their investment, instead they tend to take subordinated debt and preferred stock, which gives some greater measure of certainty.
Direct Public Offering on the Internet
It is difficult for many reasons to find buyers and investors for smaller companies, but you don’t need me to tell you that, right?
Enter the Internet. In 1995 Spring Street Brewing Company, a New York City Microbrewery, raised $1.6 million under regulation A of the United States securities laws. The Securities and Exchange Commission, not surprisingly, responded by issuing new regulations to cover this development.
There are now firms that specialize in Internet Offerings and maintain bulletin boards for direct stock trading. But this doesn’t mean that selling securities and raising money over the internet is going to be easy or the answer to your monetary needs; you will need lawyers and financial advisors to help you just as if you were doing a non-internet offering. But it is something to explore.
We think that this is one of the more exciting applications of the web, and we hope that it continues to grow. We offer more information and links on out Hot Topics page