How to Raise Start-up Capital in 2011
Raising capital for a brand-new business has never been simple, and the continuing recession of 2009 and 2010 made a tough challenge even tougher. Start-up funding may be a little easier to come by in 2011, but securing adequate capital is likely to remain an uphill battle for many aspiring entrepreneurs.
On the down side: Banks are still being much more conservative in their lending than before the recession. Venture capitalists and angel investors are also much less willing to take risks than they used to be.
On the up side: Microlenders can now make loans of up to $50,000, an increase from past limits. There's also a new Internet marketplace of peer-to-peer lending and investing that can provide small amounts of capital.
How can you beat the money crunch? Tilt the odds in your favor by understanding the wide range of capital sources, which ones are appropriate for you, and by making sure you have a solid and well-thought-out business plan.
Raising Start-up Capital in 2011: Go Back to the Bank
One of the main capital sources for small business has traditionally been bank loans backed by guarantees from the U.S. Small Business Association. Of course, that's not so simple these days. Banks sharply tightened their lending criteria in the wake of the mortgage crisis, and the amount of SBA-backed loans dropped from $28.5 billion in 2007 to $17 billion in 2009.
Federal incentives have fostered a small rebound in SBA lending, up to $22 billion in fiscal year 2010. But that's still far lower than pre-recession levels. Regardless of the state of the economy, banks are more likely to lend to established businesses than to a start-up.
"In today's economy, I'd say 75 percent of SBA lenders will simply not do a start-up," says Jerry Chautin, a volunteer SCORE business mentor in Atlanta and Sarasota, Florida. "So the first question you should ask of a potential lender is, 'Will you do a start-up?'"
To maximize your chances of approval for a traditional bank loan:
• Have a well-written business plan, as well as personal experience or very solid mentorship in the industry you're entering.
• Be prepared to put up personal assets (such as home equity) as collateral.
• Provide as much start-up capital yourself as possible. In the recent past, banks looked for a business owner to provide 20 percent of the capital, but now some will want you to kick in 30 percent or more. For restaurants, Chautin says, borrowers may need to provide 40 or 50 percent of the funding.
"The smaller the loan, the easier it is," says Scot Cunningham, a consultant on SBA loans in Moraga, California. "And the more money you have into it, the easier it gets."
Will your business be located in a low-income area? Is one of the owners a veteran? The SBA has special programs to encourage these kinds of businesses.
Dig Deeper: How to Use a Personal Asset Loan for Your Business
Raising Start-up Capital in 2011: Check out Microloan Possibilities
If you can't qualify for a conventional bank loan, consider a smaller loan from a microlender—a nonprofit economic development organization approved by the SBA.
Microlenders provide training and mentoring, along with loans of up to $50,000—a cap that was increased in September from $35,000. They will consider borrowers whose poor credit history or lack of collateral sets them off-limits for regular banks. So they can be an ideal source of funding for a start-up with relatively modest cash needs.
"Because most microlenders are community-based, they have a simplified application and less stringent underwriting criteria," says Mark Allio, regional director of the Massachusetts Small Business Development Center, located at the University of Massachusetts at Boston. "They've historically been focused on neighborhood, Main Street-type businesses or entrepreneurs with credit challenges. They typically, although not always, charge a higher interest rate."
You can find a list of microlenders in your region on the SBA website.
Raising Start-up Capital in 2011: Consider Peer-to-peer Lending
Here's an option for entrepreneurs that didn't exist five years ago—borrowing money directly from other individuals via the Internet.
Peer-to-peer or P2P lending allows people to list and bid on loans using an online auction platform—a kind of eBay for lending. The two biggest peer-to-peer lenders in the U.S. are Lending Club and Prosper, both of which offer unsecured loans of up to $25,000. Most borrowers are seeking funds for personal reasons such as reducing credit card debt or paying tuition, but some are small business owners looking for capital.
"One of my clients with a yoga business couldn't get funding anywhere else because of her credit score," says Gwendolyn Wright, a small business coach with The Wright Consultants and the Renaissance Entrepreneurship Center in San Francisco. "It was a little expensive, but she got a loan of about $20,000 from a peer-to-peer lending site, and she got it within a week."
There are also some even newer "crowdfunding" websites that allow entrepreneurs to raise small amounts of capital such as a few thousand dollars in exchange for a share of revenues. Some examples are ProFounder.com, Peerbackers.com, Kickstarter.com, RocketHub.com and IndieGoGo.com. But there's no guarantee you'll be able to get as much cash as you need: Only ten percent of IndieGoGo borrowers get all the money they're seeking.
Dig Deeper: How to Find Alternatives to Bank Financing
Raising Start-up Capital in 2011: Seek out Venture Capitalists or Angel Investors
Many aspiring entrepreneurs imagine hefty injections of cash from venture capitalists or angel investors, but in fact these groups of investors focus on a very narrow sliver of businesses.
Both VCs and angels (not to mention the new breed of super angels) typically invest in companies that promise a very high rate of return and a clear exit strategy through a public stock offering or acquisition. They focus on industries like tech and biosciences rather than Main Street businesses such as individual restaurants, retail stores, or service firms.
That's in the best of times. And in the past two years of recession, VCs and angels have pulled back even in the technology sectors.
"If you're developing something where they can see a direct, clear path to an acquisition – for instance, something that Facebook or Apple wants—then there will be interest," says Michael Doherty of Doherty & Associates, a business-consulting firm in San Francisco. "But you need to have already demonstrated [buyer] interest or customers. VCs want to provide the bump that finalizes what you're trying to reach."
Dig Deeper: How to Pitch to Angel Investors
Raising Start-up Capital in 2011: Keep it Close to Home
People who know you are the ones most likely to help you, either by lending you money or investing in your business. Approach friends and family like you would a bank, with a clear business plan, terms of the loan or investment, and even a PowerPoint presentation. Put everything in writing.
And keep in mind that being in business together can dramatically change personal relationships—even ruin them, if not managed carefully.
"I went into business with a guy I'd known for 10 years, and in the business he was nothing like what he was in our friendship," says Allio. "But often friends and family are the only source of funding. So I'd recommend it be structured as debt rather than ownership. A loan you can always pay off, but it's not so easy to get out of a business partnership."
Raising Start-up Capital in 2011: Home Equity and Credit-Card Financing
It's not glamorous or sexy, but personal credit cards and home equity lines of credit are the way that many small businesses get going. The strategy here is to rely on your personal finances to get the business up and running. Then, once you've got documented sales and cash flow, you can turn to a bank for expansion capital.
Raising Start-up Capital in 2011: Stretch Your Start-up Dollars With Leasing and Financing
Equipment leasing and vendor financing are two ways to make limited start-up money go further. Equipment leasing allows you to avoid coming up with cash to buy machinery or vehicles, instead paying a monthly fee to the leasing company. Shopping around among competing lessors can get you lower rates.
"Some of the equipment leasing packages are priced surprisingly aggressively," Cunningham says.
Similarly, you may be able to work out an arrangement with vendors where they provide the goods you need but don't require payment for 90 days or more. That can give you time to generate sales and achieve a positive cash flow.