Bloomberg BusinessWeek: How to Score Funding Without VCs
As your small company progresses through the five stages of growth, your financing options could go from begging to a "reverse merger"
Building a company from scratch is never easy. You have got to create products customers want, a business model that works, and a team that can execute with precision. On top of that, you need lots of luck, good timing, and money in the bank.
Venture capital holds the promise of solving your money problems. But it is very hard to obtain and requires you to give up control of your company to the venture capital firm (see BusinessWeek.com, 7/17/06, "Venture Capital, the Good, Bad, and Ugly"). The best strategy is to constantly review your alternatives and make do with what you have. As your company grows and achieves success, new options will keep opening up. You'll find that financing comes most easily when you don't need it.
Here are some of the alternatives you'll have at the five main stages of your company's growth:
Stage I. When you have nothing but an idea and ambition, you have limited funding options:
1. Personal savings. You may have to crack open the piggy bank, max out your credit cards, and get a second mortgage on your house.
2. Beg and borrow. It's time to call rich friends and relatives and sell them on your vision. Offer them a stake in your startup in return for an investment. Make sure they understand the risks.
3. Loans. Many banks and credit unions provide financing for small businesses. It is always a tough sale and they usually require business and personal assets as collateral. But the terms are always better than what VCs will offer and you'll get a quick response. Just remember that the problem with a loan is that you have to pay it off continuously.
4. Angel investors. Many individuals who have made or inherited their fortunes look for relatively small high-risk/high-return investments. You'll have to search hard but if you can also find experienced business executives who are ready to invest, you may gain more than money (see BusinessWeek.com, 7/24/06, "A Rumor of Money for Entrepreneurs").
5. SBA loans. The Small Business Administration provides guidance on starting a business and information on government-sponsored loan programs. Their Web site sba.gov provides extensive information on what types of loans may be available and eligibility requirements.
Stage II. Once you understand your market and have built a product that customers want, you've got more options:
1. Customer investment/pre-sales. If your potential customers feel they need your product enough, they may fund its completion by investing in your company. This is the most valuable funding you can obtain. It aligns your interests with those of your customers and makes you partners in success. Securing their investment will cause you to focus on meeting customer needs, and will provide the customer with an incentive to be a strong reference.
2. Selling services. You may want to have your team act as paid consultants and provide onsite services for the first few months of product implementation. Customers will get the best possible support, and you'll learn about their hardships and how to improve your product. And you'll be able to pay your bills.
Stage III. By the time you have gone through the trials and tribulations of getting your product to work well, meet most customer needs, and address a sufficiently broad market (see BusinessWeek.com, 5/4/06, "Countdown to Product Launch Part I"), your new options include:
1. Strategic investment. If you have built a great new product, chances are you're stepping on someone else's turf. They will see you as a threat to be eliminated. But others will see you as a potential partner. Your challenge is to understand the competitive landscape and seek partnerships with the right players. You may be able to get significant funding in exchange for some equity.
For the strategic partner you are a gateway into a new market and an acquisition opportunity. At the same time, they can provide you with a new sales channel and act as a big brother and help out in times of need. Be careful that you don't disclose too much information without protective legal agreements and that you don't sign your future away. Hire a good lawyer before you start negotiations.
2. Selling for survival. The single best way of raising capital is by selling your products. You should turn every employee into a "selling machine" and focus on closing deals (see BusinessWeek.com, 7/12/05, "Selling for Survival").
Stage IV. When you've got a great product, a business model that works, and a management team that is itching to take over the world, you will need big money. Michael Guptan, managing director of investment firm Stanford Group, says that this may be the best time to consider being acquired by the right strategic partner or engaging in a "reverse merger." Your options:
1. Acquisition. Building a national or global sales channel and creating the necessary support infrastructure can be very costly. It may make sense to sell your company to a bigger player that already has this system in place. You may be able to negotiate a deal where you and your employees maintain some level of autonomy and incentives for success.
2. Reverse merger. In a reverse merger, you identify a public shell, a publicly listed company with no assets or liabilities, and merge your private company into this shell. After this process, you become a public company and you can attract financing from hedge funds and private equity funds, as well as from retail investors. Guptan says that if you can demonstrate that you have the management team to manage a public company and the vision to scale the business through acquisitions, you will have access to some of the leading funds at attractive rates.
Stage V. When your company has achieved critical mass with steady and predictable sales growth, it is time to consider an initial public offering (IPO). There is a lot of preparation and planning that goes into an IPO. But by this stage, you'll find investment firms tripping over each other to offer you money.
1. Mezzanine financing. This is usually high-interest debt financing to tide the company over until it completes an IPO. The advantage is that doesn't require giving up an interest in the company.
If you have made it this far, your company has graduated from being a small business to a mid-size business. Now it's time to start planning on how you're going to become a big business.