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Business Funding

 Six Choices



Business funding, at the start-up level, allows for only six basic choices - each with its own advantages and disadvantages. These are:

  • Your own money,
  • Family money,
  • Government Grants,
  • Foundation Grants,
  • Loans, and
  • Equity investment.

Let's take a close look at each of these six possibilities.

 Your Own Money

Despite all the hype about the advantages of "leverage", of using other people's money (OPM), the best business funding option in my opinion is to use your own money - if you have it to use. If you don't have enough to start the business you most want, consider starting a lesser business - one that you can afford to fund out of your own pocket.

If you do this successfully, you will not only acquire the capital you need to start your next business, but in addition you will have acquired the credibility needed to attract other people's money, and you are likely to get it on much better terms than you would today. You will also have acquired a variety of useful "connections" and a priceless amount of experience.

If you have the patience and perseverance that this approach to business funding requires, it is always the best business funding choice. It does take time.

When I was in high school I had a classmate who had a clear vision of the financial future that he wanted. He saved up his allowance and bought a second hand bicycle, which he repaired, painted, and sold. With his profits he bought two used bicycles and repeated the process. With the profits from those bicycles he bought a broken down motorbike - a motorized bicycle - which he repaired and sold at a profit. With that money he bought a used motorcycle and repeated the process yet again.

The young man never relented. He graduated from motorcycles to cars, from cars to fixer-upper houses, and from cheap houses to expensive ones. When I lost track of him years later, he was building apartment buildings. I don't know if he is still alive today, but I am sure that he became a very wealthy man. In any case, he exemplified the attitudes and business funding methodology that I am recommending to you.

 Family Money

Family money for business funding comes in several forms: inheritance, gifts, loans, and co-investments. Each of these can be a source of substantial problems, because there are always expectations that follow the money. In the case of inheritance it is the expectations of other family members. When it comes to gifts, loans, and co-investments, it is primarily the expectations of the giver, lender, or co-investor.

These expectations can lead to family quarrels, long-term enmity, and expensive lawsuits, any of which can make your life miserable and sabotage your business and financial future - not to mention your relationships with other members of your family. So before you accept family money in any form, be sure you know exactly what expectations your acceptance of that money entails, and be prepared for all eventualities.

This is easier said than done, so be wary. Tease out all the expectations, spoken and unspoken, and set them down in writing before you cash the proffered check. Make sure all the family members understand your commitment - and then be prepared to over-deliver on that commitment. This caution won't guarantee the absence of future problems, but it will enable you to avoid some of the worst business funding errors that you might otherwise make.

 Government Grants

Government grants are often seen as an attractive business funding option, but they too can lead to disaster for you. Be sure to study all the requirements (expectations) and conditions attached to your acceptance of such a grant. For instance, suppose the grant is for the development of a new product. The grant may require you to give the government free license to use the new product itself, with no further remuneration (no royalties) going to you. The government may then hire a different company than yours to manufacture the product for its own use.

If this happens, you'd better have other customers ready to buy the product from you, because you won't be selling it to the government once they've cut a deal with someone else.

So get a good intellectual property attorney and go over the fine print in the grant acceptance papers most carefully, so you understand all the implications contained therein. Whatever you do with the grant money, you will have the government looking over your shoulder at every step. And complying with the reporting requirements will entail business funding expenses that you wouldn't face if the money came from other sources.

 Foundation Grants

Foundation grants are generally preferable to government grants, but they are often more difficult to acquire. Foundations have very specific requirements for eligibility and for the intended usage of the grant money. These conditions are often arbitrary and even strange-seeming, because they are based on the foundation's particular agenda. If your project happens to fit into the agenda of a foundation, though, this can be a good business funding strategy.

Be aware too that many foundations will only give business funding grants to non-profit organizations, so be careful not to waste your time on these unless you only aspire to own a job, rather than a business.

 Loans

Loans, from any source, are risky propositions unless you have a signed contract in hand that credibly promises to pay off the loan. An instance of this sort might be a case where you have contracted to buy a piece of real estate, subject to financing - AND - a contract to sell the house at a profit. In this case it may pay you to incur the debt required to buy the house. Robert Kiyosaki calls this kind of business funding debt "good debt", because the money you borrow works for you to create a profit. Debts that don't create positive cash-flow in this way he calls "bad debt".

Under these circumstances you might borrow the required funds from a family member, from a "hard money" lender who specializes in short-term loans of this sort, or from an "angel investor", a private individual who routinely makes such loans. In any case, have a reliable real estate attorney go over the contracts with you, so you know what the consequences will be if the deal falls through.

These days the option of borrowing initial business funding money from a bank is not worth considering unless you have substantial assets that you are ready to use as collateral. In this case you will probably be better off if you simply liquidate the assets and then use your own money for your start-up. Typically, in order to borrow from a bank you need to have at least three ways of paying back the money borrowed. These usually include business revenues, collateral, and "other revenues". If you are that well off, you will probably do much better with one of the other sources mentioned above.

 Equity Investment

Equity investment refers to the circumstance in which you sell a share of your venture to someone who can afford to put up the needed money. This is often a good business funding strategy, but there are a few cautions to be observed.

In this country the selling of "shares" in an enterprise is closely regulated by the Securities Exchange Commission (SEC). If you break their rules you can land in jail, so be very careful how you go about finding your investors, how you present the investment opportunity, and how you execute the transactions involved. Each of these activities is subject to intense scrutiny and regulation and must be undertaken with the utmost caution.

Distributing a letter of inquiry, for instance, may be construed by the SEC as a solicitation of investments, a "no-no" unless you go about it in a particular (and often expensive) way. Selling a piece of your fledgling business may be seen as the unlicensed sale of securities, an act for which there are severe penalties.

 Venture Capital

So-called venture capital companies are sometimes prepared to buy a share of a start-up company, but not always. As hedge funds and insurance companies often provide the capital that venture caps pass on, it becomes ever more difficult for the fledgling business to qualify. When venture caps were a new phenomenon, they were usually vehicles for wealthy individuals to invest in enterprises that involved a certain amount of risk - hence the word "venture".

Today's venture caps are a different breed. Dealing with them can be as unrewarding as dealing with a bank. Because today's venture caps are investing other people's money, they are usually bound by rules that insure the safety of their big investors' interests. As a result, they take very little risk, and are much more apt to fund the expansion of a successful moderate-sized business than they are to put up the money for your start-up enterprise.

If you do find yourself negotiating with a venture capital company, your financial plan must show a realistic and defensible profit potential and your management plan must demonstrate that the company's leadership is experienced and credible. We will examine the requirements of such plans in a separate article, but be aware that lacking such credibility the venture caps will only waste your time.

 Angel Investors

There is one other source of business funding capital that may be helpful, if not essential to your success, and that is the "angel investor". If you must start your business using other people's money, this is probably your best option. Investors in this category are well-to-do individuals who are dissatisfied with the returns they are currently getting on their investments.

Your best shot at finding these folks is to buy a list from a list broker, specifying that you are looking for people with a lot of money in bank CDs (low interest certificates of deposit) and who live in neighborhoods with expensive real estate. A further requirement should be that the addresses at which these folks live are within an hour's drive of your home. Such lists are available, but they aren't cheap.

Next, write a letter introducing yourself to the people on the above list, inviting them to meet you. Give them a compelling reason to accept your invitation, but be sure to have your corporate attorney review the letter to be sure you are not "soliciting investments", lest the SEC takes offense at your letters. This is crucial!

When you meet the above candidates, consider it to be a mutual interview. Put your best foot forward. Make your presentation only if you have excellent rapport with the individual - otherwise withdraw gracefully. You'll only get one shot at each candidate, so do your homework and be prepared to answer all the relevant questions in a straightforward manner. If you don't know the answer to a question, don't try to fake it. Admit you don't know and offer to get back to them with the answer.

 Contract Terms

If you enter into a joint venture with an "angel investor", it is most important that the agreement between you be spelled out in writing. Again, this is a point at which you must consult a reliable corporate attorney to be sure your agreement doesn't violate SEC regulations. At a minimum the agreement should spell out:

  • What each of you puts at risk in undertaking the venture,
  • What each of you will do in the course of the venture
  • What each of you stands to gain via the venture,
  • How each of you can withdraw from the venture,
  • What corporate responsibilities each of you is undertaking on behalf of the venture, and
  • What consequences will ensue if either of you fails to live up to the terms of the agreement.

A more detailed explanation of the structure of a valid contract is contained on in the article, "What Is Law?" If you use it as a guide in drafting your agreement, you will save some money in hiring your corporate attorney, because there will be fewer items for the attorney to correct or add to the agreement.

So what financial terms should you look for in a joint venture with an angel investor? In my experience, if you will be doing all the work and the investor will be putting up all the money, an ethical investor will agree to split the profits with you on a 50-50 basis. Assuming the venture is successful, this will be a "fair deal" for you both.

 A Final Caution

If your joint venture requires the participation of multiple angel investors, you need to be especially careful about how you find your investors, how you contact your investors, how you present the investment opportunity, and how you define the quid pro quo in your final agreement. All of these steps are subject to SEC scrutiny and strict regulations apply. Be sure to study the regulations provided by the SEC before taking any of these steps. While you are at it, I strongly recommend you also check out your state's "blue sky" laws, which similarly govern how you may legally involve others in your business funding efforts.

The Next Step

Once you have digested the material above, you need to turn your attention to writing your business plans: the Action Plan, the Financial Plan, and the Management Plan. This is the next step in developing your offline business funding strategy



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