Inside Small Business | Small Business & Home Business Marketing
What I Learned on the Inside (part 1)
BY JEFF KEARL
Editor’s Note: The most difficult hurdle for most new businesses to overcome is financing: you have the idea, but how do you get it off the ground? Should you borrow from friends and family, seek private angel investors, try to attract a professional venture capital investor, or eschew outside investment completely and pursue a slower, self-funded strategy? Jeff Kearl, head of sales and marketing here at LogoWorks, came to work with us from the heart of the dark and mysterious world of start-up financing, the venture capital firm. Since his intimate knowledge of this important subject is regularly sought, we have asked him share some of his insights with you in a series of articles. The first installment in this issue is “Sources of Capital”. Next month, Jeff tackles the issue of valuation in “How Much Do I Give Up.” Finally, he asks the question “To Raise, or not to Raise.” We wish you success in growing your business.
About three and half years ago I joined vSpring Capital, a leading early-stage venture capital firm based in Salt Lake City. I correctly assumed it would be an unparalleled opportunity to learn how to be a better entrepreneur. Not only was I exposed to the inner workings of hundreds of small businesses seeking financing through the investment evaluation process, but I was also able to observe the unique qualities of the different entrepreneurs running each of the 26 portfolio companies where we had equity investments. I remain grateful for the rich experience I had at vSpring.
Since joining LogoWorks, many of our customers who are running small businesses have asked me for advice on raising capital. The questions are generally about sources for capital, valuation, and whether or not I think they should try to raise venture capital. I thought this newsletter would be a good place to provide some general answers.
Sources of Capital
First and foremost, the best source of capital for financing a business is revenue from your customers. Many entrepreneurs would come into our office seeking an investment and say, “If I just had the money, I would be successful.” By contrast, a small number of entrepreneurs would say, “I’m going to be successful whether you decide to invest or not. You can sit there and watch or start helping me.” Almost as a rule, we never invested in the dependent entrepreneurs. Dependency is just not a trait of successful entrepreneurs. So, don’t make your business dependent on outside capital.
That said, most businesses require some amount of capital to get started. I recommend using your own money even if it requires some cash advancing from your personal credit cards. In addition, American Express has a several great credit cards for small businesses. This will force most entrepreneurs to watch every penny and help develop a company culture of frugality from the very beginning. When you do approach investors, they will appreciate that you have “skin in the game”. Having limited financial resources will also force a focus on sales and every entrepreneur should spend some time talking with and selling customers. Only by selling can you learn how to fine tune your offering.
On to the subject of borrowing from friends or family” while I am aware of some terrific success stories, I recommend not borrowing any money from friends or family. While they may be the only people who believe in your ability to succeed, a failure, which you may not be able to control, may forever alter that perception.
At this point, your credit cards are maxed out and you’ve made the wise decision to refrain from borrowing money from your friends or family. You’ve done the hard work required to sell some early customers and figure out the repeatable formula for adding new customers. Your customers love you. Now you’re ready for an angel investor. Angel investors are high net worth individuals who have generally been successful in business and are considered “qualified investors” by the SEC. Most large cities have networks of angels (see www.bandofangels.com, www.techcoastangels.com or www.utahangels.org). These networks generally meet regularly to review business plans and hear presentations from entrepreneurs. The right angel investor can be easier to work with than a professional investor and you may get more favorable investment terms. If you can’t find an angel network near you, then try to identify other companies in your industry that have been successful. The entrepreneurs who founded those companies might make great angels. Moreover, seek investors who are sophisticated, well networked, and experienced.
While some venture capital firms will invest in an entrepreneur with nothing but an idea, the odds of that happening are similar to winning SuperLotto. Most venture investors are looking for a fairly complete management team, products that address large emerging markets, and novel business models or intellectual property. We’ll discuss those qualifications in more depth later. Also, after the dotcom implosion in 2000, VCs began to focus less on teambuilding and competitive risks. There were plenty of talented people looking for work and far fewer companies in each category getting financing. This gave investors more time to do due diligence and focus on business fundamentals, specifically customer demand. They called customers to understand why they were buying and how satisfied they were. In the depressed corporate spending environment that followed the dotcom crash and the 9/11 tragedies, companies that had happy customers who were still buying stood out from the crowd and became many of the best investment prospects. Therefore, like I said in the beginning of the article, the best source of financing is revenue. Also, spend real time diagnosing your customer’s needs and your value proposition, invest in expansion only after you’ve grown (Sam Walton style), and use frugality as a competitive advantage. Ironically, once you do those things, you’ll have your choice of venture capital investors.
Posted on Friday, July 16th, 2004 at 1:55 pm and is filed under Money/Finance, Small Business. You can follow any responses to this entry through the RSS 2.0 feed.
