Money to start a business comes as either loans and equity investments. In this podcast we explore the sources of money, what makes them different, and some pros and cons of each.
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What are Business Loans
Loans are simple. You get money, and they want it back with interest.
But, there is no such thing as a small business loan. When banks, the Small Business Administration (SBA), or other groups talk about small business loans, they are just using words to market their services. Sounds like they are going to loan money to your small business – right? Wrong. These are personal loans. And they will want their money back even if you decide to fold the business. The only time you can get a true loan to the business is when your business has a track record of earnings and has significant assets. This rarely includes startups.
You should never do a loan to start a business! Never. I know some people have made it work, but for every one that did there are dozens of other broken people, finances, and even families.
The only time I would do a “business loans” is when I already have a business running and I am risking my business assets, not my home and family.
If you think getting a loan is the only way to get started, think again. There is always another way. Always. Just remember, some of the largest businesses in the world today started with nothing.
Investors and How to Get Them
The other form of startup money is investment. An investor is different than a lender, since they will own part of your business. You get money and lose some control. And, in the purest form of investment, if your business goes under, the investors lose their money. You owe them nothing.
Types of business investors
Bootstrapping. While not technically an investor, bootstrapping refers to you just making it happen from the money you have. You may start with nothing, or use tools you already have to start doing business, or perhaps use some money you have in savings. In this case you are 100% owner and the only investor.
Friends and family is money that comes from friendly recourses. Grandma, mom and dad, best friend Bob, (you get the idea) become investors (owners) in your company. These kind of investments can quickly turns friends and family into foes and feuds. Many a family and friendship has been damaged here, so be very careful. Even if the business is a wild success, the original investors often get mad. Most of the reason for fights can be avoided by people being very clear what is going on. Grandma needs to know she is an investor, and not loaning you money. Before I did a deal like this, I would make sure it is in wiring and everyone understands exactly what happens if you win and if you lose.
Angel investors are people with more money than sense. OK, perhaps not always, but often this is way too true. People who make a lot of money often think they are smarter than the average bear and their brilliance in their own industry translates into other industries. So, they want to invest. By doing so, most will violate a basic principle of investing which is never invest in what you do not understand. Some angel investments are structured much more like venture capital (see below) with professionals vetting the deals for the investors.
Investments from a good angel capitalist are a wonderful thing. You get a trusted advisor and their money. They want you to win and will help you win by making introductions to key people and key advice. But, the wise angle also understands that they are not experts in your business.
Bad angel investors become power hungry and take over even if they do not have a clue. They can get in the way of making the deal happen and in some situations can turn a good business bad.
Before doing a angel deal, make sure all parties have a clear understanding of the roles and expectations. Also, make sure you like working together. Any sense of mistrust should be a sign to run. And, for us guys, make sure your wife meets the investor. If she has an uneasy feeling, walk away. I cannot explain this one, I just know over and over I see smart business people using this as a test of sanity. And if you are not married … well that is another post.
Venture capital (VC) investors are professionals whose job it is to find good companies for their fund. The fund gets the money from various sources and the VC does the deal. They become an active owner, usually getting a seat on the board of directors. VCs often have a massive number of resources and relationships they can bring to the table to help your company move forward. They are not without problems, but good VCs can be a true asset.
VCs are normally looking for high growth companies they can generate massive amount of growth in a short time. For instance, a VC would expect a $1 million investment to return $20 million in 3-5 years. While the numbers differ depending on the deal, the key is if you cannot grow fast, you are of not interest to a VC.
There is one more difference between loans and investors. Loans get paid back over a period of time. Investors usually only get their money when the founder (you) makes an exit. You exit the company when you sell it or when you take it public. So if you are looking for a lifestyle business (one that generates a nice income and you can give to your kids), you are not a candidate for most kinds of investment.
How to Attract an Investor?
First note, investors invest in people first. Great ideas are everywhere, but the person who can execute and is determined to make money no matter what, is very attractive.
So my rule of thumb is to act like a bootstrapper, even if you are looking for an investor. Make it happen small and with what you have already. The result is you will get money flowing (revenue) which everyone likes to see. And always have a plan to keep the business growing with your own money just in case you cannot get investment.
I have seen many deals go under because people spend years chasing investment instead of selling products and services. Had they sold something, they might have been able to attract an investor. But, having not sold anything and gathered no investment, they just went under.
Links referred to in the podcast
- Cash Flow Quadrant
- Podcast Answerman
- The Reading List for the Entrepreneur or Tomorrow
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