I regularly meet people who are in some stage of the start-up phase and looking to raise money to fund their business ventures. Since I seem to have this same conversation over and over, I thought it would be worth the time to provide the general framework of funding sources. The following is organized according to the level of risk lenders/investors are generally willing to assume (from low to high). I have attempted to cover key items such as the level of risk acceptable to each source, typical titles you will encounter, and some general pricing guidelines. Keep in mind there are always exceptions.
To my readers who are professional bankers or investors, I realize this is not new information to you, but perhaps you will find it useful to pass along when asked for funding.
Banks: Typically you’ll be talking with a Vice President or President of Commercial Lending. These are lenders who are making low risk (usually secured) loans to individuals or businesses with a proven ability to repay the amount borrowed. Banks are simply not a source of early stage capital unless guaranteed under a federal lending program (SBA loans for example which have less strict criteria). Because of the low risk tolerance, the cost of money is also generally the lowest. Do not expect to walk into a bank and show them a business plan and walk out with a line of credit unless you have sufficient equity in your home or other assets to fully securitize the loan.
Mezzanine and non-bank lenders: The titles will be similar to either banks or PEGs (see below) but their lending parameters are usually not as strict as at a bank. While you can expect more flexibility than you will get from a traditional bank you can also expect to pay more for that privilege and may be held to tighter success hurdles. Lenders in this area know they are taking on more risk and will mitigate that by taking a more active stance if something does not go as planned. That said, these sources are much more appropriate for operating companies or companies with hard assets than they are for a deal with a venture risk profile.
Private Equity Groups (aka PEGs): Typical titles include, Partner, Managing Director or Principal. These groups come in many styles but typically buy equity in more established operating companies. They may take majority positions (buying more than 50%) or minority positions and usually aim to improve operations and grow the business either organically or through acquisitions. Their long term goals are usually to sell the business at a higher multiple after they have substantially grown earnings although some groups may operate a business for its cash flow. They generally act as partners in building the company, but often seek to exercise control at a high level to protect their investment.
Later Stage Venture Capitalist (VC): Typical titles are similar to private equity groups. They expect a 10x return on their money. Out of every 10 deals they fund, a few will go bust, a handful will be on either side of breakeven, and a few will be home-runs (typically meaning getting acquired or an IPO). They are interested in breakthrough ideas, proven management teams, milestones, and seeing their investment “de-risked” as the firm progresses. They are not lending money; they are injecting equity capital into the business in exchange for an ownership stake. Their stake will depend on the valuation of the business before they invest.
Angels and Seed Stage Investors (aka Early Stage VC’s): These people can sometimes be difficult to find, sometimes intentionally so. They fund very early stage start-ups sometimes as individuals and groups. They are often successful businesspersons or entrepreneurs who have an affinity for the start-up space or perhaps a particular segment. Their due diligence may be less formal than some of the others but that is due to the stage of the business and expectations of what will likely have been accomplished prior to this first round of professional money. While their pricing methodology is the same as later stage VC’s, the capital they provide is often much smaller reflecting diversification desires, high failure rates, and the expectation that more capital will be needed later if certain milestones are successfully obtained.
Friends and Family: Usually, these people have titles like Uncle Fred and Aunt Millie. They love you and hope they will get their money back and even might want to earn a profit but their primary motivation is their belief in you and willingness to help. This is very often the first experience entrepreneurs have with taking in money and is usually not a good guide of what to expect from the professional community as pricing is usually based more on emotion than the market. Later stage investors will look to see how much you have been able to achieve with the dollars invested by this source.
If you are seeking funding, give this list some thought.
If your business could benefit from fractional CFO services, I would welcome the chance to speak with you. Please give me a call at (314) 863-6637 or send an email to [email protected] The archive of these monthly newsletters is posted at the Resources section of homza.com
your cash is flowing. know where.® Ken Homza Copyright @ 2015 Homza Consulting, Inc.