Accessing credit and capital is never easy. Banks are typically unwilling to lend to businesses with less than two years of revenues. The drastic reduction in home value has also shrunk the net worth and investable capital base of many investors and entrepreneurs. This has created a very challenging environment for entrepreneurs hoping raise start-up capital.
The Downside of Swimming with Sharks
Shark Tank is a hit ABC television show where entrepreneurs go before a panel of investors and pitch their business ideas. If the sharks believe the idea has legs, they make offers to the entrepreneurs. While it may sound fun and exciting to find a shark of your own, the reality is that investors may not always be needed. The idea of raising start-up capital can tend to take on a bit of a romantic allure. The reality is that once an entrepreneur’s business is successful and generating positive cash flow, he or shewill obviously want to maintain ownership of the maximum possible percentage of the business. This should be carefully considered before bringing outside investors into a business.
As a general rule of thumb, the only companies that absolutely require outside capital are huge, scalable businesses that are aiming for $100 million market caps and higher. Businesses that are aiming to scale up to $3 to $5 million should seriously consider funding options that do not require a dilution of equity.
An outside investor that puts cash on the table during the idea-creationtion phase of a business is most likely going to require around 20% of the company in return. At this juncture, an entrepreneur must determine the minimum amount of cash needed to bring his product or service to market. This is the true amount of financing needed.
If the amount needed to fund the business is in the tens of thousands, which it typically is for small businesses, then other funding options include friends and family money. Now, this is where the decision gets tough. Do you want to borrow money from friends and family? The major risk, of course, is that the business does not take off like you hoped, and friends and family funds are now lost. Now what?
If an entrepreneur believes in his business enough, then he should consider borrowing money from friends and family and discuss with the lenders the exact parameters defining how the money is paid back if the company is successful, and, how the money would be paid back if the company is not successful.
For example, if one borrows $50,000 from friends and family, but the business struggles andultimately folds, then it may take 10 years to pay back the money at $5,000 per year. Having this type of agreement up front will help the entrepreneur take risks with the money, which is absolutely necessary for business success.
Borrowing from friends and family definitely has significant risks—primarily the risk of stressing important personal relationships. However, if it is done correctly, with everyone understanding all of the risks involved, it can be a great way to keep 100% ownership of your company, which will be a hugely rewarding if the business does succeed.
This has been a guest post by Danielle Thomas from processingfinder.com.