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The search for startup cash begins
with homework
Dear Small Biz
Adviser:
Can I count on venture capital to start my new business? If not,
other than asking for a loan, what are my options?
Mary
Dear Mary:
Your inquiry is so brief and provides no detail regarding the nature
of the business, the amount of funds needed or the intended use
of those funds. But all of those issues play a significant role
in whether venture capitalists, or any other potential financier,
will even consider your funding request.
The venture capital market in particular has encountered
much upheaval recently. Much of this type of investment went south
with the downfall of many dot-coms. In fact, some VC firms themselves
ended up closing their doors.
Because of this, venture capitalists now require solid
business
plans that contain substantiated market research and that demonstrate
fiscal controls designed to show a return on investment in three
years or less. Some VC operations also are demanding and exerting
more control over losing investments.
In short, this is a time of fluctuation for venture
capital, and there is no universal agreement on where available
funds will move.
Now that you have a little overview of VC, let us
look at your specific situation.
What's VC hot, what's not
The type of business you operate is critical to attracting venture
capital. For example, a dot-com must have a successful track record
before VC firms will even consider investing. Startups, for the
most part, will not be considered.
Traditional ventures, such as retail, services, wholesale
and the like are more likely to be considered by a private investor,
known as an angel, who takes particular interest in the individual
rather than the type of venture.
Biometrics is a hot spot nowadays for many venture
capitalists. It is an industry offering many opportunities; potential
markets are just now being explored so the field is not saturated.
Venture capitalists, with the exception of angels,
are looking at minimal investment sums of at least $500,000 to $1
million if not more. Their deep pockets are equaled only by the
amount of return on investment they expect from the funds. Businesses
looking for smaller amounts generally will not produce the type
of significant returns that venture capitalists seek and will likely
receive little or no attention.
What's the money for?
The use of funds is equally important. VC firms are becoming more
like conventional commercial bankers.
Both financial operations frown on money going mostly
toward compensation and benefits rather than on the marketing and
delivery of product and service. In the banking industry, many lenders
will demand owners defer compensation until cash flow is sufficient
to cover indebtedness and cash on hand is adequate to cover a few
months of operating overhead.
So where does this leave you? Frankly, I don't know
since I don't know what kind of business you have, how much money
you need, the market projections or projected return on investment.
All of these factors are critical, not only to your success in obtaining
financing, but also to the ultimate operational success of your
business.
Mary, you must begin thinking in a focused, concise,
informative manner if you expect to get a positive financing response.
If nothing else, you have learned a little about the VC world and
the levels of expectations. With the tight competition today for
VC financing, you must be prepared to deliver what they expect if
you want any attention.
Alternate financing
This same type of preparation is necessary for any type of financing,
be it a commercial
loan or one guaranteed
by the Small Business Administration.
Another option is taking money out of your personal
residence. Entrepreneurs who own homes sometimes leverage the residences'
home
equity to obtain startup money or cash to keep a business going.
Keep in mind that when you put your home up as collateral, the property
is at risk if the venture fails.
Owners of some smaller operations also sometimes depend
on personal credit cards or signature loans as a source of business
money. Again, these options carry their own risks to your personal
credit history, as well as usually higher interest rates than you
can obtain with a loan.
Mary, I do not mean to discourage you. However, the
reality is that getting financing for a startup is often the hardest
step. I have tried to set the tone for your approach to VC investment,
as well as provide a brief look at other financing options. The
key in all cases is to do your homework and ask the right questions.
I wish you well.
-- Posted: May 9, 2002
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