Which is tougher: Getting your child into kindergarten or securing financing for your new business? Both can seem daunting or near impossible. I’ve never met an eight-year-old who is still waiting to get into kindergarten, but I know of many great business ideas that never made it off the ground due to lack of funding. I’ll help demystify the business-financing options that may be keeping your big idea from becoming a reality.
Let’s focus on two of the most common sources of financing: venture capital and small business loans, and look at the ins and outs of each, so you can decide which is right for you.
Venture Capital is a significant investment in exchange for an ownership stake in a company.
If you’ve seen the television series Silicon Valley or the movie, The Social Network, you have a pre-conceived notion of how venture capital is obtained: A group of male engineers—who look to be teenagers—show up in jeans and t-shirts to pitch their idea to older men in khakis, button-down shirts, and logo fleece vests. The investors enthusiastically dole out millions of dollars and the company goes on to be wildly successful.
That scene—an exaggeration, of course—is evolving, and there are now more females on both sides of the table. You’ll find funds that focus on women and minority-led businesses, and seed-stage funds for early-stage ventures.
Who Should Consider Venture Capital?
-Companies that have a large market opportunity and want to grow quickly.
-Businesses with complex product or software development that requires extensive capital or significant time to develop. An example: health-sciences oriented products.
Who May Not Be an Ideal Candidate?
-Small businesses that plan to stay small or those with a limited market opportunity.
-Entrepreneurs who don’t want the pressure of scaling or a board of directors, which typically comes with VC investment.
How Much Money are We Talking?
The average seed-stage investment is $1-2.5 million. Later stage investments average $17.8 million and can reach hundreds of millions of dollars.
What Do I Need to Pitch?
-A compelling, concise presentation that highlights the opportunity, solution, team, progress-to-date, and projections.
-A first meeting with a partner. You will need subsequent meetings and ideally multiple firms, but you have to start somewhere!
-Thick skin! You will likely hear, “No,” many times before you hear “Yes.”
-Securing a meeting. Cold calls and emails rarely work. Try to get an introduction from a mutual contact.
-Getting a term sheet, the written document that contains an offer for investment. You first need to pitch a single investor, then a team of investors, and go through a first phase of due diligence.
Biggest Challenge Once I Have it?
-Sharing ownership and meeting investor expectations.
-Managing a board of directors that likely includes one or more of your investors.
-Spending for growth while making sure you have enough cash to hit key milestones for subsequent funding or to become profitable.
With VC funding you get investors who share your excitement and contribute to the success of your business. They often have extensive experience and can provide mentorship and guidance. On the flip side, along with investment comes pressure to grow. You may not always agree with your investors, which can create a contentious situation until issues are resolved.
Small Business Loans
A small business loan is a loan from a bank that you are required to pay back, with interest, within a certain period of time.
Who Should Consider a Small Business Loan?
-Entrepreneurs who want to retain ownership.
-Businesses with a plan for getting to profitability through steady growth.
-Companies with an attractive market opportunity that, unlike VC-backed opportunities, need not be massive.
Who May Not Be an Ideal Candidate?
Very early stage companies with no means of repaying a loan will have a tough time securing a loan from a bank. In the early stages of development, many entrepreneurs have better luck relying on friends and family for funding.
How much money are we talking about?
The median loan is about $135,000, but it can range from a few thousand to millions of dollars.
What Do I Need to Apply?
-Financial statements (past and present) and projections
-A strong business plan
-Credit and assets. You will likely, but not in all cases, need to prove that the business owners have good credit and assets.
-Finding a bank. Regional or local banks may be more likely partners than national banks, as they are incentivized to work with small businesses. If you are a women or minority-owned business, or located in a rural area, you may qualify for special loan programs.
-Proving the viability of your business idea.
Biggest Challenge Once You Have It:
-Repaying the loan and interest in the specified amount of time.
Small Business Loan Overview:
Financing with a loan allows you to retain full ownership so long as payments are made. However, obtaining a loan can be tough and your interest rates may be high, if you don’t have strong credit. It’s important to note that business owners are usually responsible for the loan, even if the business fails. Talk to your accountant or attorney to ensure you are personally protected, as many people unknowingly personally guarantee business loans.
Don’t let the fear of financing stop you from turning your business idea into a reality. Decide which source is right for you, put together a thorough business plan and a convincing pitch, and go for it.
In my next article, I’ll talk about how to get the word out about your new business through two crucial elements: marketing and public relations.
Lynn Perkins is the CEO and co-founder of UrbanSitter. As a startup veteran, Lynn has more than 15 years of experience building and growing consumer Internet businesses. Prior to founding UrbanSitter, Lynn served as founder and CEO of Xuny.com and VP of Business Development at Bridgepath.com.
Lynn is a graduate of Stanford University. She and her husband enjoy exploring San Francisco with their three adventurous boys.