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Funding Sources Explained

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Raising Capital

Capital is typically raised in stages (and over the course of a venture's development), with each "raise" viewed not in isolation but rather as part of a larger overall capitalization process. The chart below shows the typical stages along with the type of funding sources that are most likely to be used during each period.


Debt or Equity

One of the first decisions you should consider is which type of financing is the best choice for your venture. The two general categories of funding include debt or equity:

・ Debt

Debt financing (banks or other commercial lenders) allows the business owner(s) to hold onto the equity (and avoid dilution of ownership). Interest costs are known (or calculable) and are tax deductible, and there is no claim on future earnings. Disadvantages include that the business owes the debt (i.e., it's reflected as a liability on the balance sheet, and you have to pay it back). There can also be dire consequences of a failure of timely repayment (e.g., you can lose the business) and debt payments reduce cash flow and profits.

・ Equity

With equity funding, the company is exchanging a percentage of ownership (equity) for the capital investment. Equity funding does not require repayment or guarantees and these funds may improve the business's creditworthiness. Successfully securing equity funding can also imply an external validation of the company's business by a presumably sophisticated, objective outsider. Equity investors, unlike many banks, don't impose personal liability on the owners (or managers) or take a security interest in the company's assets.


When access to funding is vital to a business's growth and development (as it often is), a careful evaluation of the available options is essential. An emerging business can seek to obtain needed capital in a number of ways. Each avenue has its own requirements, as well as benefits and limitations. A summary of the principal alternatives follows.

Owners, Friends & Family, Others

  • Infusion of additional owner funds (until all accounts, cash and credit lines are utilized to their limit); benefits of speed and maintaining control with no outside ownership (and of delaying dilution until a later, hopefully higher, valuation plateau has been reached); also serves as a tangible demonstration of the founders' commitment to the business (a factor significant to some venture capitalists)
  • Investment (and/or loans) by family members and friends; benefits of speed, favorable valuation/terms and minimal expansion of shareholder ownership to "known and friendly" quantities; downside of possibly creating personal conflict, or "taking advantage" of the lack of sophistication, experience and insight these persons may have in the private equity funding process (e.g., unrealistic expectations of the potential returns, need for/difficulty in raising subsequent rounds, delays and extended time-frames, etc.)

Earnings (Company Generated Funds)

  • Often not considered?internal earnings and cash flow, if sufficient and managed properly and effectively, can be "bootstrapped" to provide capital for limited development and growth.
  • Typically, not sufficient for significant capital investment, development or improvement (or growth through acquisitions or capital-intensive campaigns).
  • In most cases, not a consistent or dependable funding source; inability to take advantage of opportunities as and when they arise.

Commercial & Bank Loans; Government Loans & Aid

  • Banks and other commercial lenders can provide a source of capital to growing businesses (beyond the seed and development stages); satisfying stringent lending criteria?including providing security, an equity cushion and ample cash flow for the timely repayment of principal and interest?is often difficult (or impossible) for most early stage emerging businesses; for the most part, banks look to asset and security-based lending, and not future "cash flow" or prospect-based lending; in the early stages, unless "hard asset" security and/or appropriate personal guarantees are provided, this route is likely a non-starter.
  • The Small Business Administration (SBA) and other government sources of financing may also be available; there have been a variety of recent efforts to increase lending, and the ease of lending (and reduction of complex criteria and paperwork) to small businesses; SBA guaranteed loans can be provided on more favorable terms, with less recourse risk and with longer maturity, than ordinary commercial loans; this option can prove to be extremely worthwhile for the "right" company that can meet the criteria and "survive" the process; this is not a quick source of capital, however?the application and evaluation process can be extensive and time-consuming.

Strategic Alliances; M&A

  • A "strategic alliance" or partnership with an established operating company interested in some aspect (typically, technology potential) of the emerging business (whether through a joint venture, technology-sharing, licensing, marketing or distribution arrangement or similar agreement) may also serve as a means to raise needed capital (or achieve other corporate goals, including access to new technology, distribution channels, new markets and manufacturing capabilities, reduction of costs and uncertainty, and an enhanced ability to compete).
  • Capital can also be provided through strategic arrangements and relationships with customers, vendors and suppliers, and with others the company does business with (or who are familiar with the company's business, products and services and market); capital-related advantages can also be obtained by acquiring or adding symbiotic or "additive" businesses, services or product lines, or by disposing of (or discontinuing) "drag" businesses, services or product lines.
  • Tread carefully: the strategic partner often has far greater resources than you do (resources that can be used against you if a dispute or conflict arises out of your arrangement or relationship); the investment may not satisfy all the capital requirements necessary for the stage or round in question; the alliance can (and often does) limit the company's flexibility to engage in other alliances, acquisitions and transactions; and the company may find itself controlled, or its future substantially affected or limited, by a much larger company focused on its own agenda and priorities (which may not include the successful development of your company or specific company objectives); protection of confidential and proprietary information (which will need to be shared at some point in the evaluation process) presents complex and thorny issues.
  • If you're doing this (primarily) to raise capital, you probably shouldn't be doing it at all; flexibility (to operate and grow your business, now and in the future), protection/control of your intellectual property (which may be key to your company's upside potential) and freedom to pursue later affiliations, rounds of financing and exit strategies, are important matters to consider, receive advice regarding and structure into any arrangement of this sort; successful alliances are often "bet the business" transactions which require tremendous commitment from management and personnel and the devotion of (often scarce) time, attention and resources; because the topic of strategic alliances could be covered in an entire book unto itself, and is beyond the scope and focus of this primer, limited additional information has been included in this work.

Private Equity (Angel Investors)

Of the two major sources of private equity capital for high-growth business ventures (angel investors and venture capital funds), angel investors represent the oldest, and largest source of seed and equity capital.

  • Angel investors can be seed, development, early or later stage; always involves a illiquid equity investment in (or a calculated "bet" on) a company believed to have superb growth potential; brings capital to the company, typically in the form of convertible preferred equity and perhaps (not significant, subordinated) debt; with the right partner, can bring strategic, market, financial, management, recruiting, "plan execution" and other value-added expertise, resources, contacts and discipline.
  • Unlike venture capital firms, private equity investors are typically private individuals who investing their own money or through a syndication (multiple investors).
  • Among the advantages of private equity investors is that there are a large number and the ideal scenario is to find investors who already know and understand your business.

Venture Capital

Complementary to the angel market is the institutional venture capital market, which invests primarily in the later stage of a firm’s development

  • Venture Capital companies are firms that are typically organized as a professionally managed limited partnership which raises money from large institutional investors, investment companies, investment funds, pension funds and insurance companies. They generally target compound (annual) investment returns in the 35% and greater range (more recently, in the 50% and greater range)
  • Given professional management (and discipline), risk profile and lack of liquidity (or available exit strategy), venture capital sourcing typically involves substantial due diligence, intensive business, strategy and financial planning, and aggressive negotiation of valuation, deal structure and terms.
  • While some firms invest in new and early stage companies, the reality is that VCs are not a viable option for most companies unless they have an established revenue stream, strong growth history and a very visible upside potential.

Private Placements

  • Capital can also be raised through the "private" sale of equity securities to a limited number of (typically unaffiliated, individual) investors, with or without a "placement agent"; depending upon the circumstances, this can be a cost-effective means of raising capital; be wary of the field of available placement agents (some, well qualified; others, attempt to obtain onerous agreements, get significant "up front" fees and lock the company up)
  • Requires preparation, documentation (among other things, preparation of subscription documents and often a detailed private placement memorandum) and a (rather extensive) due diligence, offering and selling effort
  • From a business perspective, private placements have some elements of both venture capital transactions and public offerings: less due diligence/preparation, less expensive, less regulated, less marketing, less documented than public offerings; possibly more expensive (to prepare), but often less negotiated, less due diligence and less documentation, than venture capital transactions (but you'll have to deal with many potential investors, versus a very limited number of sophisticated investors); in many cases, if the offering is not "pre-sold" or conducted by a reputable and experienced placement agent with a solid and relevant track record, the risk of non-consummation (after significant effort and expense) is greater than other alternatives.
  • Private placements must be structured to satisfy available exemptions from the registration requirements of federal and state ("blue sky") securities laws; these laws apply to and strictly regulate the offering process, publicity and communications, disclosure and information requirements and the offer and sale of the securities in question, so experienced counsel will need to be consulted from the earliest stages.

Going Public

  • Typically, the initial underwritten offer and sale by a company of its common shares to a large number of "public" investors; effected through the means of a Prospectus (included in a Registration Statement) filed with, reviewed and declared effective by, the Securities and Exchange Commission ("SEC"), a marketing program (the "road show", orchestrated by the managing underwriter(s), following the printing and distribution of a "red herring" preliminary prospectus) and, ultimately, "pricing" and closing, with the sale and public trading of registered stock, and with the net proceeds going to the company
  • Given the substantial burden, expense and risks, and the extensive preparations and disclosures, involved, this route is clearly not for every company, management team or entrepreneur; if you choose to "go this route", advance planning and preparation (as early as possible) can avoid unnecessary delays, mitigate the demands on management time and reduce the ultimate cost of the IPO process
  • When appropriate and successful, an IPO can be an efficient and effective means of raising substantial capital (now and in the future), providing liquidity, increased net worth, employee compensation currency, name recognition and other advantages (but risks and disadvantages must be considered as well); the market's receptiveness to IPOs (in general or in your industry), which has recently shown weakness, can change quickly and dramatically, so "timing is everything."

These ten tips can help in the search for angel investors:

1. Know who you're looking for.

The average angel investor is male, 49 years old, has a college graduate degree, at least five years of investing experience in private companies.

2. Look in your own backyard.

Most of the investments made by angels are close to where they live. Networking is one of the most neglected and most effective ways of finding angel investors. Join your chamber of commerce,
industry groups, software associations and other business groups and then attend their meetings. Many areas have angel networks, find out what's available in your area.

4. Polish your business plan.

You only get one shot, make sure your presentation, both your pitch and your business plan, is the best it can be. Your plan is the first - and very often the only “first impression” you get to make. Have it reviewed critiqued by someone you can trust to be brutally honest ? and not a close friend or family member. Practice, practice, practice.

5. Be realistic.

Being unrealistic is the most critical mistake entrepreneurs make in their business plan according to angel investors. Back up your assumptions and projections with research. Take a hard look at whether you can really achieve the objectives set by your business model. Be flexible in negotiations and valuation.

6. Be patient.

It takes time to obtain financing. The average time it takes an angel to close a deal, from receiving the business plan to writing the check is 67 days.

7. Angel investors give to charity but invest in businesses.

Angel money is not free money, it is not a grant, and it is not an entitlement. Angels invest for a number of reasons, and one of those reasons is to generate a handsome return on their money, the average expectation is a 24% annual return.

8. Get the best management team.

The most critical factor in an angel investor's decision to invest is the quality of the management team. Make sure your team is the best you can put together. If you don't have CEO experience, find
someone to join your team who does.

9. Be passionate

If you can't convey enthusiasm and passion for your company who can?

10. Persevere

Rely on more than one way of finding investors, use your contacts, your network, your attorney and accountant. Don't give up. Don't take rejection personally.


I know that investors are much more selective now than they were a year ago. What has changed in their evaluation process?


In a word - profits.

Inherent in every business plan is the struggle to achieve a balance between spending and profitability. On one side of the scale is the need to have sufficient funding that will allow the business to generate strong and sustainable revenue growth. On the other side of the scale is the need to reach a positive cash flow (profits) in a reasonable period of time.

The trend in recent years among private equity investors has been to allow the burn rate or negative cash flow period to extend beyond what had been the traditional thinking. The argument underlying the Internet business model, for example, was that profits would eventually develop but only after the business was able to achieve a certain critical mass. The only way to achieve this critical mass was to increase and frontload spending with the primary focus being on brand identity, market exposure and fulfillment capabilities. The result was unprecedented spending on print media, prime time television and even Super Bowl ads.

The carnage of the past year has driven investors to adapt a much more critical analysis of expenses and the use of cash. What this means for the entrepreneur is that the supporting documentation, backup material, justification and rationale for use of cash has to be very clear and supportable. If your plan allocates $100,000 for marketing expenses, the investor will want to know where, how and when these funds are being used along with your expectations of the results.


Is there a recommended approach for developing a forecast and financial projections?


The method that you use to develop your financial projections is very important. As a general rule, forecasts developed using a "top-down" approach are widely discouraged. As the name implies, this type of forecast starts with a total market size number and revenue or unit projections are simply based on a certain percentage of that number. While this method is relatively painless, it invariably lacks and the substance and credibility that your need to convince an investor that your forecast is accurate and reasonable.

The preferred method and one that most Investors demand is a bottom-up forecast where you are able to identify who your customers are or will be, where they're located, how large they are, who the decision maker is and so on. From an investor's perspective, you can never know too much about your customer base.

The bottom line is preparation. Your ability to support and defend the information in the business plan is just as important as the plan itself.


I know that investors place a great deal of importance on the management team. How should I address this issue in my business plan if I don’t have a management team?


Most investors consider a company's management team to be one of the best predictors of future success. But if you don't yet have a management team in place, there are several steps that you can take to address this issue.

A good place to start is to develop a relationship with a local management recruiter. A good recruiter will be more than willing to help you in anticipation of future commissions and they can provide valuable information such as salary levels for budgeting purposes. More importantly, they can put you in contact with individuals who might be interested in joining your company.

Since most startups don't have income or funds for salaries, you'll want to look for individuals who will join your management team in exchange for equity or future performance bonuses. These may be individuals who have retired early, sold a business or perhaps they're between jobs. Ideally, they'll bring valuable and relevant experience to your team and can help you avoid typical startup problems.

A second option is to seek key personnel who would be willing to join your company once you have funding. These may be individuals who are currently employed but see the opportunity of getting in on the ground floor of a promising new company. Your accountant, for example, might welcome the opportunity to come on board as a comptroller or CFO once you have secured funding. You would list them in the business plan as an "Acting Comptroller" or Acting CFO" and their biography would mention their current position and employment status.

Another recommendation is to assemble a solid board of directors or advisors. While not officially members of your management team, your board can add a great deal of credibility while providing expert counsel and direction.

One of the primary objectives of your business plan is to minimize perceived risk and a good management team is an essential ingredient.


How much money do I need to start my business?


One of the challenges that many business plan writers face is determining the amount of funding they need to start their business. This is not a step that should be taken lightly and you certainly don’t want to pull a number out of the air. So, how do the experts do it?

As a start, it is always a good idea to know in advance what type of investor you want to attract. Ideally, you should look to a funding source that already knows your business, has some understanding of the market and is in a position to appreciate what you bring to the table. The amount of funding you need will very often dictate the type of source. In the rarified air of venture capital, it is unusual to see funding deals of less than several million dollars. Below that number, private or angle investors are a more likely source.

Another consideration is the length of time it will take to get your business to a positive cash flow position. If this time period goes beyond twelve months as is often the case, the likelihood is that you'll need second stage funding. Investors rarely invest beyond a year to minimize their exposure and they'll want to look at your first year performance before committing to a second stage.

Funding requirements are generally summarized in a "use of proceeds" table that will include categories such as salaries, marketing expenses, development cost, operations, etc. An investor will want to know how these numbers were developed, and if your plan was written properly, you should be able to extract this information with relative ease. Under the management portion of your plan, you should have a manpower table that summaries current and future employees, timing and salaries. The marketing section should have a summary of your planned marketing expenses and so on. An investor’s main concern is that you have properly anticipated all of your costs and that you have them covered.

Your plan should help you prepare for meetings with investors and how you intend to use their money is a fertile area for tough questions.


What information should be included in the Executive Summary?


Ask any five business planning professionals what topics should be covered in an executive summary, and you'll get five very different answers.

Part of the problem, I believe, lies in the terminology itself. An "executive summary" would seem to imply that the first few pages of your business plan should include a complete recap of the entire plan. This seems simple enough. Just copy and paste a few key paragraphs from each section of the plan and there you have it - nine pages with 76 paragraphs that have absolutely no flow, no continuity and no emphasis on what is or isn’t important to the reader. Reading a dictionary is more invigorating.

Not surprisingly, one of the most common criticisms of executive summaries is that they invariably include too much information. There may be a few nuggets in there somewhere, but finding them buried as they are is a real challenge and one that very few investors are willing to undertake. Simplicity is the key.

An executive summary should strive to accomplish one key objective - sell. Not inform. Not educate. Sell. Not only is the summary your best chance to plant a hook, it is in most cases your only chance. Conceptually, the summary should be more along the lines of the proverbial elevator speech rather than a Cliff Notes version of Homer's Iliad. It is the three to five pages that grips the reader and compels them to move forward with the rest of your plan.

The executive summary should include a very brief description of your business, your market and your positioning in the market, your business model and your management team. Many plan writers also include use of proceeds and a summary of the income statement. But most importantly, you want to focus on what your company brings to the table. What is your unique selling proposition? What will separate you from the rest of the pack?

Good words or phases to use in this section - unique, proprietary, patents, first mover, partnership with Microsoft…

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