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Sources of Funding for Entrepreneurs

 

Introduction

See here for five Stanford STVP videos on Finding the Money

Small businesses use several sources available for start-up capital:

  • Self-financing by the owner through an equity loan on his or her home or other assets.
  • Loans from friends or relatives (aka /Friends, Family, or Fools)
  • Private stock issue
  • Forming partnerships
  • Venture capital, given sufficiently sound business venture plans

Some small businesses are further financed through credit card debt - usually a poor choice, given that the interest rate on credit cards is often several times the rate that would be paid on a line of credit or bank loan. Many owners seek a bank loan in the name of their business,

;however, banks will usually insist on a personal guarantee by the business owner. In the United States, the Small Business Administration (SBA) runs several loan programs that may help a small business secure loans. In these programs, the SBA guarantees a portion of the loan to the issuing bank and thus relieves the bank of some of the risk of extending the loan to a small business.


 



VC money doesn’t make sense in every situation; start-ups are not “one size fits all” and nor should they be funded that way. See the following link for complete story.

Funding

January 26, 2006

The Art of Bootstrapping

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Someone once told me that the probability of an entrepreneur getting venture capital is the same as getting struck by lightning while standing at the bottom of a swimming pool on a sunny day. This may be too optimistic.

Let's say that you can't raise money for whatever reason: You're not a “proven” team with “proven” technology in a “proven” market. Or, your company may simply not be a “VC deal”--that is, something that will go public or be acquired for a zillion dollars. Finally, your organization may be a not-for-product with a cause like the ministry or the environment. Does this mean you should give up? Not at all.

I could build a case that too much money is worse than too little for most organizations—not that I wouldn't like to run a Super Bowl commercial someday. Until that day comes, the key to success is bootstrapping. The term comes from the German legend of Baron Münchhausen pulling himself out of the sea by pulling on his own bootstraps. Here is the art of bootstrapping.

  1. Focus on cash flow, not profitability. The theory is that profits are the key to survival. If you could pay the bills with theories, this would be fine. The reality is that you pay bills with cash, so focus on cash flow. If you know you are going to bootstrap, you should start a business with a small up-front capital requirement, short sales cycles, short payment terms, and recurring revenue. It means passing up the big sale that take twelve months to close, deliver, and collect. Cash is not only king, it's queen and prince too for a bootstrapper.
  2. Forecast from the bottom up. Most entrepreneurs do a top-down forecast: “There are 150 million cars in America. It sure seems reasonable that we can get a mere 1% of car owners to install our satellite radio systems. That's 1.5 million systems in the first year.” The bottom-up forecast goes like this: “We can open up ten installation facilities in the first year. On an average day, they can install ten systems. So our first year sales will be 10 facilities x 10 systems x 240 days = 24,000 satellite radio systems. 24,000 is a long way from the conservative 1.5 million systems in the top-down approach. Guess which number is more likely to happen.
  3. Ship, then test. I can feel the comments coming in already: How can you recommend shipping stuff that isn't perfect? Blah blah blah. ”Perfect“ is the enemy of ”good enough.“ When your product or service is ”good enough,“ get it out because cash flows when you start shipping. Besides perfection doesn't necessarily come with time--more unwanted features do. By shipping, you'll also learn what your customers truly want you to fix. It's definitely a tradeoff: your reputation versus cash flow, so you can't ship pure crap. But you can't wait for perfection either. (Nota bene: life science companies, please ignore this recommendation.)
  4. Forget the ”proven“ team. Proven teams are over-rated--especially when most people define proven teams as people who worked for a billion dollar company for the past ten years. These folks are accustomed to a certain lifestyle, and it's not the bootstrapping lifestyle. Hire young, cheap, and hungry people. People with fast chips, but not necessarily a fully functional instruction set. Once you achieve significant cash flow, you can hire adult supervision. Until then, hire what you can afford and make them into great employees.
  5. Start as a service business. Let's say that you ultimately want to be a software company: people download your software or you send them CDs, and they pay you. That's a nice, clean business with a proven business model. However, until you finish the software, you could provide consulting and services based on your work-in-process software. This has two advantages: immediate revenue and true customer testing of your software. Once the software is field-tested and battle-hardened, flip the switch and become a product company.
  6. Focus on function, not form. Mea culpa: I love good ”form.“ MacBooks. Audis. Graf skates. Bauer sticks. Breitling watches. You name it. But bootstrappers focus on function, not form, when they are buying things. The function is computing, getting from point A to point B, skating, shooting, and knowing the time of day. These functions do not require the more expensive form that I like. All the chair has to do is hold your butt. It doesn't have to look like it belongs in the Museum of Modern Art. Design great stuff, but buy cheap stuff.
  7. Pick your battles. Bootstrappers pick their battles. They don't fight on all fronts because they cannot afford to fight on all fronts. If you were starting a new church, do you really need the $100,000 multimedia audio visual system? Or just a great message from the pulpit? If you're creating a content web site based on the advertising model, do you have to write your own customer ad-serving software? I don't think so.
  8. Understaff. Many entrepreneurs staff up for what could happen, best case. ”Our conservative (albeit top-down) forecast for first year satellite radio sales is 1.5 million units. We'd better create a 24 x 7 customer support center to handle this. Guess what? You sell no where near 1.5 million units, but you do have 200 people hired, trained, and sitting in a 50,000 square foot telemarketing center. Bootstrappers understaff knowing that all hell might break loose. But this would be, as we say in Silicon Valley, a “high quality problem.” Trust me, every venture capitalist fantasizes about an entrepreneur calling up and asking for additional capital because sales are exploding. Also trust me when I tell you that fantasies are fantasies because they seldom happen.
  9. Go direct. The optimal number of mouths (or hands) between a bootstrapper and her customer is zero. Sure, stores provide great customer reach, and wholesalers provide distribution. But God invented ecommerce so that you could sell direct and reap greater margins. And God was doubly smart because She knew that by going direct, you'd also learn more about your customer's needs. Stores and wholesalers fill demand, they don't create it. If you create enough demand, you can always get other organizations to fill it later. If you don't create demand, all the distribution in the world will get you bupkis.
  10. Position against the leader. Don't have the money to explain your story starting from scratch? Then don't try. Instead position against the leader. Toyota introduced Lexus as good as a Mercedes but at half the price--Toyota didn't have to explain what “good as a Mercedes” meant. How much do you think that saved them? “Cheap iPod” and “poor man's Bose noise-cancelling headphones,” would work too.
  11. Take the “red pill.”This refers to the choice that Neo made in The Matrix. The red pill led to learning the whole truth. The blue pill meant waking up wondering if you had a bad dream. Bootstrappers don't have the luxury to take the blue pill. They take the red pill--everyday--to find out how deep the rabbit hole really is. And the deepest rabbit hole for a bootstrapper is a simple calculation: Amount of cash divided by cash burn per month because this will tell you how much longer you can live. And as my friend Craig Johnson likes to say, “The leading cause of failure of startups is death, and death happens when you run out of money.” As long as you have money, you're still in the game.

Written at: Atherton, California.



Critical Factors for Obtaining Venture Funding

From: http://www.garage.com/

Sometimes there is nothing more powerful than the passion and vision of an entrepreneur. But sometimes passion and vision are just not enough. It helps to understand the criteria that venture capital firms use to decide which companies to fund.

Some venture capital firms and corporate investors have very narrow criteria—specific technologies at specific stages in specific regions of the country.

Others have broader criteria and invest across many technology sectors and geographic locations. But all investors look for certain critical components in an early-stage company. Below is a brief summary of these critical criteria. If you meet these criteria, you may be able to continue to the next step in the venture financing process. If you don’t, you are likely to receive a polite note passing on your opportunity.

1. Compelling Idea

Every entrepreneur believes his or her idea is compelling. The reality is that very few business plans present ideas that are unique. It is very common for investors to see multiple versions of the same idea over the course of a few months, and then again after a few years. What makes an idea compelling to an investor is that it reflects a deep understanding of a big problem or opportunity, and offers an elegant solution. This is the starting point for getting venture investors interested, but it is not sufficient. The idea alone does not make you fundable. You have to possess the rest of the ingredients below.

2. Team

You may have a great idea, but if you don’t have a strong core team, investors aren’t going to be willing to bet on your company. This doesn’t mean you need to have a complete, world-class, all-gaps-filled team. But the founders have to have the credibility to launch the company and attract the world-class talent that is needed to fill the gaps. The lone entrepreneur, even with all the passion in the world, is never enough. If you haven’t been able to convince at least one other person to drink the Kool Aid, investors certainly won’t.

3. Market Opportunity

If you are focused on a product/market opportunity that is not technology-based, you probably should not be pursuing venture capital—there are different private equity sources for non-technology businesses. Venture capital is focused on businesses that gain a competitive edge and generate rapid growth through technological and other advantages. If you are focused on technology, you should be targeting a sector that is not already crowded, where there is a significant problem that needs to be solved, or an opportunity that has not been exploited, and where your solution will create substantial value. Contrary to popular belief, it’s not about how big the market is; it’s about how much value you can create.

4. Technology

What makes your technology so great? The correct answer is, “There are plenty of customers with plenty of money that want to buy it.” Not, “There are geeks with no money who think it’s cool.” Assuming you have a technology advantage right now, how are you going to sustain that advantage over the next several years? Patents alone won’t do it. You better have the talent or the partners to assure investors that you are going to stay ahead of the curve.

5. Competitive Advantage

Every interesting business has real competition. Competition is not just about direct competitors. It includes alternatives, “good enough” solutions, and the status quo. You need to convince investors that you have advantages that address all these issues, and that you can sustain these advantages over several years. A few years ago entrepreneurs could get away with saying that “competition validates my solution,” but today that’s not good enough.

6. Financial Projections

If the idea of developing credible financial projections makes you wince or wail, you are not an entrepreneur and you shouldn’t ask investors for money. Your projections demonstrate that you understand the economics of your business. They should tell your story in numbers—what drives your growth, what drives your profit, and how your company will evolve over the next several years.

7. Validation

Is there any evidence that your solution will be purchased by your target customers? Do you have an advisory board of credible industry experts? Do you have a co-development partner within the industry? Do you have beta customers to whom investors can speak? Do you already have paying customers? The more credibility and customer traction you have, the more likely investors are going to be interested.

To secure venture funding today, you need a good grade in all seven areas, and an A+ in at least a couple. It’s a tough environment out there, so don’t waste your time with a story that is not compelling and credible.
See here for 2/5/07 Boston Globe article on Bootstrapping:

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