A look at key sources of capital for startups

December 13, 2011

For an entrepreneur, the need to raise startup or growth capital is often one of the largest barriers to success. As someone who has been down the road many times, I am here to say that funding is out there, but you have to know where to look, what and who to ask.

In my experience, sources for capital can be loosely broken down into four categories: traditional, angel, venture, and emerging. Each category carries with it advantages and disadvantages depending on the size of your business, your tolerance for involving others in your day-to-day decisions and the accessibility of the source.

Traditional

Traditional lending sources include friends and family and banks. Friends and family are often the best place to start, because you’ll often benefit from friendly terms and the least amount of administrative requirements. However, be wary of jeopardizing personal relationships. My best guidance is to be completely open and transparent with friends and family about the business risk before they hand over a check, communicate regularly with updates and never hide from bad news.

Banks have long been a staple of small business lending. If you decide to go this route, prepare an airtight business plan and always have a back up funding source in mind. According to FDIC data, small business loans have declined 39 percent since 2007.

Angel and venture

Angel investors are a great source of capital, if you can find them. These angels are often wealthy individuals or small groups in search of ways to grow their personal assets. While not without strings, angels tend to make less formalized investment deals. This appeals to business owners wary of outsiders micromanaging day-to-day operations.

More formalized in structure and investment strategy than angels, venture capital firms will have specific and targeted investment goals. Do your research before approaching any of them to understand their investment strategy and market focus. Then once you find a potential match, you’ll need to spend some time showcasing how your business matches their philosophy.

Don’t waste your time pursuing VCs that don’t seek investments in your specific market area or will ask for more control than you are willing to allow. When working with VCs, be prepared for a hands-on addition to your board and a potentially significant dilution of equity. That said, the best VCs bring tremendous value based on their experiences with other startups and can make all the difference in the world. In other words, it’s a heck of a lot better to own a smaller percent of a growing business than 100 percent of a business that’s going nowhere fast.

Emerging/alternative

A fourth category of investment comes in the form of alternative sources, pending congressional approval. The first, known colloquially as “crowdfunding,” would allow small businesses for the first time to solicit funds over the Internet from individual investors.

This seems like a great idea in terms of its ease (raise money with nothing more than a tweet!). However, the more investors you have, the more you may have to “herd cats” to get any decision approved. While they may be harder to find initially, it is always easier to deal with a few sophisticated investors who will add value rather than a multitude of voices each with their own self-interest.

Also emerging is the possibility for small businesses to use advertisements to attract wealthy investors. The problem with this approach is the inherent passivity of advertising. You don’t know who, if anyone, is going to answer that ad.

My advice would be to dedicate the time and money you would have spent on advertising to researching a specific angel or VC who shares your business philosophy. Tailoring a pitch to one or two groups is more productive than placing an advertisement and hoping someone responds.

From whatever source you choose to solicit funds, researching, networking and product are always key. Without the former you don’t know whom to approach. Without the latter, no one will be inclined to go into business with you.

Properly combined, a well-run small business with a sound plan stands a good chance of securing funding even is this turbulent economy.

Gregg Smith is chief executive of KoolSpan, a Bethesda-based provider of security solutions to the mobile device market. KoolSpan’s TrustChip secures mobile devices from hackers and has been implemented by companies and government organizations in 18 countries around the world.

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