My December and January posts explored the differences between small business management and entrepreneurship including the tricky balancing act it takes to do both well within the same company. As I mentioned last month, it’s great when a small business can afford to use only internal funds to develop a new idea, but sometimes additional funding from others is necessary. This is especially apt to occur when a new idea is big enough to offer the prospect of significant growth and return on investment. Here are some thoughts on funding from an entrepreneurial perspective:
• How much money will you need to take the idea from start to cash flow positive? Unlike a startup, an existing business has many advantages when it sets out on an entrepreneurial effort. Relationships are well established, reputation is solid, and systems are in place, so it can be unsettling to consider expanding the budget. Launching a significant new line of business can take a year or more; commitment to eventual success and a long-term, high-level budget that will help keep the project in perspective are both needed. For an initial idea of the funding that will be required, estimate how much cash will be needed before monthly or quarterly sales begin to bring in more than is being used.
• What about borrowing the money from a commercial lending institution? Banks as well as non-traditional lenders may be sources. Assets of the business and/or the owner are typically needed to secure bank loans, and interest payments begin to accrue immediately, which can add to cash flow pressures when the time to market is months to years away. Depending on the specific situation, these terms may or may not make sense. Working with non-traditional lenders sometimes offers opportunities for funding too. Common Capital is an example of this.
• What about equity investors? In general, venture capital or angel investors provide funds in return for an ownership stake in a company. Depending on their backgrounds, venture capitalists and angels can bring a wealth of experience and expertise as well as funding. This can be beneficial but also adds new owners and often requires existing owners to give up some control, which not everyone is willing to do (no matter how big the upside).
What about grants and other sources of ‘free money’? Of course, these can be a big help but rarely supply all the funding that is needed. As you would expect, the competition for such funds is usually intense. Often the team needs to write a proposal and wait. Depending entirely on grants risks delays, disruptions or defeat when/if there is a funding gap or the grant program ends.
The federal Small Business Innovation Research/Small Business Technology Transfer programs and foundations that use grants to further their missions are in this category and may be a good fit, depending on the individual project. Other sources of funding that don’t create a debt obligation or ownership stake are business plan competitions such as the MassChallenge. These aren’t likely to provide everything you need either but can be a good start.
What about family and friends? Family and friends are often willing and able to help in the form of loans, as equity investors or with gifts. In the right circumstances this can be great but it pays to be cautious. Invaluable relationships can be damaged or destroyed if the business doesn’t turn out well or if someone you care about personally risks too much. Here is an example of a very public extreme case.
What other resources are out there? Some states support special programs as part of economic development efforts. In Massachusetts, for example, there are programs that cut across industries such as:
- MassDevelopment’s Emerging Technology Fund
- Massachusetts Growth Capital
- Massachusetts Technology Development Corporation
As well as programs intended to support the growth of a particular sector:
These programs offer a variety of loans, grants and equity funding. Some are competitive and make awards periodically while others consider applications as they arise. It’s important to be familiar with the offerings in your state so you can pursue those that make sense for your project.
• How will this fit into the routine financial management practiced by a prudent small business owner? In the short-term this can be difficult. Entrepreneurial finance often demands that owners combine various sources of funding, as the project ‘burns’ cash. Management by milestones rather than monthly or quarterly goals is essential but can be uncomfortable from the small business financial management perspective. It is essential to keep in mind that the long-term aim is to create a new area of growth that will keep the business healthy as old opportunities fade and, in the best case, increase the value of the business significantly.
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Karen Utgoff, principal of Karen Lauter Utgoff Consulting, is a market-oriented business strategist based in Amherst, MA. Learn more at http://www.utgoff.com.
© Karen Lauter Utgoff Consulting 2012. All rights reserved.
Great overview of options and considerations for businesses looking for capital. Small businesses often struggle with the decision of when and how much to borrow. This post is clear, concise, and extremely practical. Thanks!