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Raising Capital - What to Expect?

Raising capital is the second step, after writing your business plan, for developing/expanding a successful business venture. There are many types of investment capital, and many firms/investors that specialize in investing in new and unproven business concepts. However, there are far more entrepreneurs that are seeking capital then there are investors that want to invest in early stage businesses or startups. This guide will give you some insight as to how raising capital works, alternatives to venture capitalists/angel investors, and the finer points of the capital raising process.

First, of course, the legal disclaimer

Please note that the information in this guide is not to be used as consulting, accounting, or legal advice. The following information is provided with the understanding that this article is not a substitute for professional advice, and is merely for informational purposes. BizPlanDB.com is not responsible for the use of any information contained below or for the factual accuracy of any statements made below.

Now for the Article

At this point, you should have a well developed business plan, and an idea of how much money you need to develop the business. Now it is time to market your business to people that have money. There are many ways to go about this, but there are some things to remember as you begin to send out your business plan to formal investors.

On a side note, this article deals more with people seeking to raise capital from “arms-length investors”, which essentially means people that you have or will have no other relationship beyond the business investment. Many people initially seek to raise capital from friends or family, and this is a perfectly acceptable (and easily accessible) group of people that want to see you succeed. The benefits for raising capital among family and friends are that you can negotiate terms of investment quickly; family and friends are also more likely to give a loan rather than require an equity investment. However, there are many drawbacks to this type of financing as well, especially if 1) the business becomes very successful, and even though you were given a loan, a family member/friend now wants more money, or 2) the business does not work well, and you lose the money of a friend/family member.

Angel investors are typically middle aged males that have a net worth of over $1,000,000. The average angel investor in the United States makes angel investments of $400,000 per investment. Not only are angel investors an important source of capital for your business, but they can provide you with a wealth of information and business insight. Angel investors often seek to take a semi-active role in the day to day operations of the business. Most of these investors like to invest capital in businesses that are located within 200 miles of their primary residence. This makes communication and visits with the investor much easier. Typically, an angel investment is made into a business venture of industry that is familiar to the investor. These people are very smart, experienced, and know what makes a strong small business investment. 99% of the time, these investors will seek a sizable equity stake in the business.

Venture Capitalists are another very popular form of business investment, but these investors are far more selective that their angel investor counterparts. Most venture capitalists demand annual returns in excess of 30% per year, which is an extraordinary feat to accomplish. These investors will also require up to 80% of your business. In theUnited States, the average venture capital investment is $11,000,000. There are approximately 3,000 venture capital firms that operate throughout the country.

The alternative to both of these types of equity financing is to approach a Small Business Investment Company. These firms are licensed by the Small Business Administration to provide equity investments and loans to small businesses like yours. These SBICs are very much like angel investors, but in a group capacity. Most SBICs make investments of $500,000 to $1,000,000, and they make assist a portfolio company with the raising of additional rounds of capital.

Private investment companies, such as venture capital firms and SBICs, invest the money of their limited partners (investors) into profitable projects. In many ways, their operations are similar to that of a bank in that they take the investments of their partners and reinvest in businesses, much in the same way as a bank takes deposits and distributes money as loans to borrowers. However, these firms have stringent investor requirements. Unlike banks, where you can just walk in and make a deposit, these businesses have many restrictions regarding the raising of capital.

Another method of financing your business is to borrow the money. There are a number of programs specifically designed for small business borrowers that have limited collateral or cash flow. There is a popular misconception that the SBA is a direct lender for business loans. However, this is not the case. The SBA acts as a guarantor and provides the bank with the assurance that the event that a loan fails, the federal government will reimburse the bank for the money that was lost. This is why SBA lending programs have a myriad of paper work and forms to fill out because the federal government wants to ensure that it is guaranteeing a relatively safe investment.

Each bank has specific lending protocols developed by the internal management of the bank, so in the event that you are not approved by one bank, you may be able to get approval from another one. There are a number of loan brokers out there that can help you obtain an SBA loan, but you should be very careful when hiring a loan broker. There have been a number of complaints filed against these professionals for their exorbitant upfront and success fees. Loan packagers that ask you for large upfront fees are most likely seeking to scam you. You should always confirm a capital brokers license, state of jurisdiction, and reputation with the Better Business Bureau before you engage any of these agents.

Banks also make traditional bank loans to small businesses that intend to use their funds to purchase tangible assets such as equipment, real estate, or vehicles. Banks like to know that in the event that you cannot pay back the loan that they have a chance to recoup their investment through repossession and sale. Banks do not like to make large working capital loans for businesses that will not have large saleable assets.

In conclusion, there are a number of different methods for you to finance your business, and each one has its different pros and cons. When starting a business and seeking financing, you should consult a certified public accountant to determine which capital structure makes most sense for your business.