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How to Get Outside Capital for Your Business Idea:
A Primer

startup business

When loans from your friends and family will no longer cut it, angel investors can help bridge the gap between starting up and making it big.

The first options are obvious: max out your credit cards, take a second mortgage and cash-in on all those favors you're owed by close friends and family. But these initial contributions will only take you so far. You'll need a bigger investor if your business is going to really thrive. The good news is there's money out there for the taking, and the following sources are an excellent place to look to get the outside capital your business needs to succeed.

Venture Capitalists

Venture capitalists will finance part of your business in exchange for a share of the venture (typically a 2 percent management fee per year and up to 20 percent of any profits their funds make). Generally, they are seeking investments with high growth potential that will give them a high return on their investment (say returns of 40 percent per year, or more). As such, a lot of venture capitalists invest in businesses that deal with cutting-edge technology or biotechnology fields.

Venture-capital firms have money to spend, but unless your business is already fairly established, it may be hard to get it.

"Most venture-capital firms in America will now consider only deals in which they can invest at least $7 million," says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire.

In fact, in the United States, venture-capital funds invest an average of $6 million in each business, according to PricewaterhouseCoopers. Smaller businesses seeking start-up funding are likely better off beginning with angel investors (see below).

Angel Investors

There are an estimated 350,000 angel investors in the United States, according to Sohl. Combined, they invest about $30 billion a year in 50,000 ventures, with an average of $600,000 per enterprise. According to The Economist, a typical angel investor will invest in anywhere from five to 10 new ventures, with anywhere from $25,000 to $250,000 invested in each.

Angel investors can be entrepreneurs themselves or successful professionals, and while they do seek a return on their investment (terms are set on a case-by-case basis), they also like to share their contacts, connections and expertise to further the businesses of people they take a liking to. Because the wealthy are growing increasingly interested in angel investing (for tax breaks, among other reasons), so-called angel networks exist across the United States to help match up potential partners.

bank loans

Standard bank loans can be hard for entrepreneurs to secure, but an SBA microloan may be easier to acquire.

Bank Loans and Microloans

Securing a bank loan off the bat is not always easy for a start-up business, generally because the risk is perceived as too high.

"It's a game of probabilities," says Mike James, executive vice-president of the business-banking group at Wells Fargo. "As a banker you work on very thin margins ... banks can tolerate defaults on up to 5 percent of their loan portfolios. The failure rate of start-ups is much higher than that."

Even having collateral is not usually enough in itself, says James, because "we don't want to be in the liquidation business." However, it's possible to get a bank loan for your business if you:

  • Have good credit ratings (both for your business and personally)

  • Hire a certified public accountant to tell your business story in numbers

  • Conduct presentations at your business site (not at the bank) and involve key employees

  • Offer collateral and cut or eliminate your salary

Small businesses may have an easier time securing a mircroloan under The Microloan Program (which was developed by the Small Business Administration (SBA) in 1992). Entrepreneurs can borrow under $100 to a maximum of $35,000 -- a particularly useful source of start-up funds for businesses that have never borrowed from a bank.

Small Business Administration Loans

Though the SBA does not provide funds directly to entrepreneurs, there are several loans available through a loan officer at your local bank or credit union (such as the Microloan Program mentioned above).

Generally speaking, in order to qualify for an SBA program, your business must have less than $7 million in tangible net worth and less than $2.5 million in net income. Also, most banks require two or three years' worth of financial statements, along with some owner's equity in the business, before they'll lend to your business.

Finally, while securing funding for your new business may seem like the most important task at hand, be sure to carefully analyze the offer, no matter what the source, before accepting.

"Finding out about your investors before you sign them up is critical," says Sohl. "And you have to understand what everybody wants from the business. It's a marriage without the possibility of divorce. If you can't make it work, bankruptcy is the only alternative."

Recommended Reading

Do You Have What it Takes to Start a Successful Home-Based Business?

Delaware Means Business: Ever Wonder Why Most U.S. Businesses are Established in Delaware?

Sources September 14, 2006

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