Feature Story

 

Funding Options for Startups

 

By Colin Kelly Jr.

 

Think your highly disruptive business plan for that Everything On a Stick fast-food franchise idea will start a VC bidding war? Think again. No matter how convenient and tasty your bleu-cheese-filet-mignon corndog prototype is, odds are you won't be getting a $2 million Series A round from a venture capitalist anytime soon.

In fact, fewer than 1 percent of companies in the United States ever see VC money. Why? The short answer is because VCs have very tight and defined criteria for investment. They look only for high-growth deals with the potential of returning 10 times an initial investment within five to seven years.

Back in the real word, the rest of us a have a wide range of other options. Many options involve debt financing — some type of loan requiring eventual repayment. Other options involve equity financing in which you give up a percentage of ownership. Some options may involve a combination of both debt and equity funding.

One word of warning: Anytime you accept some type of equity funding, pay special attention to the effect of share disbursements on your company's capitalization table (often called a cap table). Consult a business and finance attorney or get advice from a seasoned entrepreneur. This is especially true if you ever plan to seek VC money at a future date, as a messy cap table will often sour any potential VC interest. There may be a better way to structure the deal saving you headache down the road.

 

In no particular order, here are some of the more popular means of funding a startup:

 

Friends and Family 

Typically a debt and/or equity arrangement, friends and family money is a broad term describing funding you get from anyone you know. Typically this person likes you and believes in your idea. Remember, this is also a person you still may have to hang out with on a regular basis even after your company tanks and you lose his or her money, so be careful. Even if the money is a gift, get a business and finance attorney to help structure the deal. Getting everything on paper now helps avoid lawsuits, cap table issues and blood feuds later.

 

Angel Investors

While money from friend and family technically can be considered angel money, a typical angel deal involves someone a bit more sophisticated at investing than your uncle. Angels invest their own money and often work together in groups. Deals can involve debt, equity or a combination of both. Angels don't have the same requirements as VCs and are much more flexible in the types of terms they can offer. See growutahventures.com for a list of Utah angel groups.

 

Self Funding

One of the best ways to start a business is from your savings account. If you've just some made money by selling a previous business and live in Utah, you can avoid some capital gains taxes by rolling the money into a new business.

 

Bootstrapping

The classical definition of bootstrapping involves starting a company with very little up-front capital then ratcheting the company up step-by-step based on incremental revenue growth. Bootstrappers justify every penny spent and keep budgets lean. Profits earned during the early years typically are invested directly back into the company to spur growth. Bootstrapping often means slow growth, but also reduced risk.

 

Seed Fund Incubators

Pioneered by Y Combinator and new to the scene, seed fund incubators offer an intensive multi-week entrepreneurial mentoring course and $5,000 to $30,000 in funding in exchange for 2 percent to 10 percent of the equity in your company. Seed fund incubators generally look for promising software or Internet startups with one or two founder/employees. Other U.S. seed fund incubators include TechStars, LaunchBox and Summer@Highland.

 

Bank Loans

Signature loans and bank lines of credit are good ways to get quick cash, but they are hard to qualify for if you don't have collateral or haven't been in business for at least two years.

 

Venture Debt

There are different flavors of venture debt out there, but at its core, venture debt is a loan for young companies that can't qualify for a bank line of credit. In addition to repaying the loan with interest, you may need to give up a small part of your company's equity but it's generally less than 5 percent. You may also have to sign a personal guarantee on the loan. For many growing companies, it's cheap money since there's not much equity given away. Silicon Valley Bank (SVB) first launched the idea. Comerica and SVB are two active classic venture debt lenders that will fund Utah companies. Locally, Zions Bank recently began doing some venture debt funding and InnoVentures (formerly UTFC) has been funding startups using its own version of venture debt for years.

 

SBA Loans

Small Business Administration loans are great, but often to qualify you need to be in business for two years and/or come up with collateral. For many, that means putting their house on the line.

 

Leasing/Financing

If your startup requires a substantial amount of equipment, you may be able to lease or finance the gear instead of purchasing it, thus freeing up money garnered from other funding sources for various other uses.

 

Credit Cards

Many a business has been started on $50,000 in credit card debt spread out over 10 different cards. Make sure to constantly monitor interest rates and make payments on time or you can quickly get in trouble.

 

Home Equity Loan

Although it can put your house at risk, home equity loans are one of the most popular methods of financing a startup.

 

Sweat Equity

Every entrepreneur puts in a lot of hours, but can you and a few key employees afford to go the first 12 or 18 months without a regular paycheck? If you can, you'll greatly increase the chance of surviving the first few years. Making payroll every two weeks is a cash-flow killer.

 

Seller Financing

If you're buying an existing business, you may be able to get the seller to finance part of the purchase price over time structuring the deal like a bank loan.

 

Grants

If you spend enough time looking, odds are you will be able to find a local or federal grant related to your industry. The hardest part of getting a grant is often figuring out where to start since finding the right grant is truly the proverbial needle in a haystack. Be cautious of companies who offer grant-finding services. Some are legitimate, but many are scams.

 

Factoring

Factoring is the process of selling part of your account receivables at a discount to a third party (called the factor). The factor buys a percentage of your unpaid invoices then collects money directly from your customers. Factoring isn't a loan, it's the outright selling of assets so your credit score isn't an issue. Factoring is a quick way to raise money if you can't get some kind of a loan. You take a pretty big hit on the discount given to the factor but at least you don't have to wait 30, 60 or 90 days to collect on your invoices. Of course, you need to actually have a business up and running with real account receivables before you can take advantage of factoring.

 

Micro Loans

A local nonprofit organization, the Utah Microenterprise Loan Fund (UMLF) has helped hundreds of Utah startups with loans ranging from $1,000 to $25,000. UMLF is more flexible than the SBA or a bank when considering credit score and collateral. Visit umlf.com for information.

 

Launch - Summer 2008

 

 

For the full "digital magazine" version of Spring 2008, visit: www.nxtbook.com/nxtbooks/growutah/launch_2008summer/