Financing the Business

Once the business plan is complete, the next step is to obtain financing to set up your company. The funding required depends on the type of business and the entrepreneur's own investment. Businesses started by lifestyle entrepreneurs require less financing than growth-oriented businesses, and manufacturing and high-tech companies generally require a large initial investment.

Who provides start-up funding for small companies? Like Miho Inagi and her Tokyo bagel shop, 94 percent of business owners raise start-up funds from personal accounts, family, and friends. Personal assets and money from family and friends are important for new firms, whereas funding from financial institutions may become more important as companies grow. Three-quarters of Inc. 500 companies have been funded on $100,000 or less.

The two forms of business financing are debt, borrowed funds that must be repaid with interest over a stated time period, and equity, funds raised through the sale of stock (i.e., ownership) in the business. Those who provide equity funds get a share of the business's profits. Because lenders usually limit debt financing to no more than a quarter to a third of the firm's total needs, equity financing often amounts to about 65 to 75 percent of total start-up financing.

Exhibit 5.5 FUBU started when a young entrepreneur from Hollis, Queens, began making tie-top skullcaps at home with some friends. With funding from a $100,000 mortgage and a later investment from the Samsung Corporation, CEO Daymond John, turned his home into a successful sportswear company. The FUBU brand tops the list for today's fashionistas who don everything from FUBU's classic Fat Albert line to swanky FUBU suits and tuxedos. How do start-ups obtain funding?

One way to finance a start-up company is bootstrapping, which is basically funding the operation with your own resources. If the resources needed are not available to an individual, there are other options. Two sources of equity financing for young companies are angel investors and venture-capital firms. Angel investors are individual investors or groups of experienced investors who provide financing for start-up businesses by investing their own money, often referred to as "seed capital". This gives the investors more flexibility on what they can and will invest in, but because it is their own money, angels are careful. Angel investors often invest early in a company's development, and they want to see an idea they understand and can have confidence in. Table 5.9 offers some guidelines on how to attract angel financing.

Making a Heavenly Deal
You need financing for your start-up business. How do you get angels interested in investing in your business venture?
  • Show them something they understand, ideally a business from an industry they've been associated with.
  • Know your business details: Information important to potential investors includes annual sales, gross profit, profit margin, and expenses.
  • Be able to describe your business - what it does and who it sells to - in less than a minute. Limit PowerPoint presentations to 10 slides.
  • Angels can always leave their money in the bank, so an investment must interest them. It should be something they're passionate about. And timing is important - knowing when to reach out to an angel can make a huge difference.
  • They need to see management they trust, respect, and like. Present a competent management team with a strong, experienced leader who can explain the business and answer questions from potential investors with specifics.
  • Angels prefer something they can bring added value to. Those who invest could be involved with your company for a long time or perhaps take a seat on your board of directors.
  • They are more partial to deals that don't require huge sums of money or additional infusions of angel cash.
  • Emphasize the likely exits for investors and know who the competition is, why your solution is better, and how you are going to gain market share with an infusion of cash.
Table 5.9

Venture capital
 is financing obtained from venture capitalists, investment firms that specialize in financing small, high-growth companies. Venture capitalists receive an ownership interest and a voice in management in return for their money. They typically invest at a later stage than angel investors. We'll discuss venture capital in greater detail when discussing financing the enterprise.