You don’t have to search very far to find entrepreneurs who have had a tough time raising outside capital to grow their business. More than two-thirds of more than 1,000 entrepreneurs polled in a survey recently released by Ernst & Young found it difficult to gain access to the capital they needed to grow.
Why? I have spent the last 22 years working closely with entrepreneurs and the last 12 years working specifically with high-tech entrepreneurs and have seen many common mistakes. The good news is that they are fixable, especially in this age of unparalleled access to information, networks and capital.
At the most basic level, there are two sources of funding for a growing business: lenders who loan you money for a period of time and look to get repaid with a return, and investors looking to buy a piece of your company in return for long-term capital gains when the price of your stock increases.
Many entrepreneurs go wrong in their fundraising strategies by failing to understand the differing needs of lenders and investors.
Lenders, as a rule, are not interested in your vision for a great business. They are solely interested in risk management and the capacity of your business to repay the credit that they advance to you.
It can be extremely difficult to get credit as a small business. The fact is, most small businesses fail. Lenders know this. To successfully raise debt financing for your business, you need to first have a financial plan that will allow for debt repayment. For this reason, debt is not usually the first outside capital to go into a business.
In addition, you must have assets that the lenders can take as security in the event that you fail to make scheduled repayments. The most common assets are receivables that are less than 90 days old and inventory. When you are starting out you may also have to give personal guarantees.
Many of the entrepreneurs we back are frustrated to find that, even to get a $10,000 company credit card, they need to give a $10,000 deposit. Even though this may not make financial sense, it is important to establish your credit history, so go ahead and get that credit card.
The equity investor side is even tougher to navigate. Investors come in all shapes and sizes and have differing objectives. The challenges entrepreneurs face in raising equity boil down to the same root cause as debt – failing to understand the needs of investors.
Angel investors as an example are looking for businesses that can quickly get to cash flow positive. Venture capital investors like me, however ,are looking for businesses that can go grow very quickly and become very large and valuable. We are not concerned with cash flow or profits.
And, of course, all equity investors are looking for an exit strategy. We buy shares at one price in the hopes of selling them for a much higher price in the future.
This is another source of friction with entrepreneurs. If you are planning to run your business for the rest of your life, don’t try to raise outside capital. After all, you are not looking to sell your business.
The solution for raising debt or equity for your business begins with having great mentors or advisors in your corner. This is particularly true if you want to raise equity. You need to surround yourself with people who have done this before and can help you navigate the process. This will help you find investors whose objectives align with yours.
Finally, it helps to get creative with financing options. The best source of financing is your customers. If your business can’t afford to extend traditional credit terms, then don’t do it. Try asking customers for more money up front or giving discounts for early payment. Don’t buy expensive equipment; lease it instead. Use outsourced services rather than incur fixed costs.
There are so many creative ways to stretch the finances of your business.
Special to The Globe and Mail
Mark MacLeod is a partner at Real Ventures, one of Canada’s largest and most active seed-stage venture capital funds, and a leading startup finance expert. He is a frequent speaker and blogger on funding, growing and exiting high-tech businesses and can be found atwww.startupcfo.ca.