There may have been times when as an early stage entrepreneur or someone who wanted to start a business, but hadn’t, you’ve felt the need for some capital to help you get going. It may surprise you to learn this, but you’re in good company. Many people in various stages of their businesses have felt this way.
There are five standard ways in which businesses obtain the funding they need. In the recommended order, they are 1) Family, 2) Friends; 3) Banks; 4) Business Angels; and 5) Venture Capitalists. All of them share certain characteristics to a greater or lesser extent.
First, they’ll want to understand your business plan. That is, they’ll want you to convince them that if they invest with you, their money will be spent carefully and only on necessities; not frivolities such as new equipment or cars that could all be obtained second hand. Some will even object to funding your salary!
Families and friends probably won’t need a plan that’s as detailed as that which a bank or venture capitalist might want.
Second, they’ll want to minimize their risk, sometimes referred to as exposure. Some won’t expect anything from you except your promise that you’ll do everything thing you can to preserve what they’ve given you. Others will expect you to mortgage yourself to the hilt so that you will think twice about pulling out if things don’t work out as you had planned.
Third, they’ll want a return on their investment. The word Invest implies that the amount you’ve been loaned will grow beyond its current size. Friends and family will probably accept less over a longer period of time than the others. Venture capitalists can expect a fifty percent or more return on top of the loan within a few years. That’s one reason why investments by them aren’t made nearly as often as the other four.
Fourth, they’ll want an attractive exit strategy. That means that they’ll want to limit the time during which you will have their money. They’ll want you to pay back the loan with the extra they have earned in a reasonable amount of time. Some will be satisfied with that; others will want a seat on the board or even a share of the business. In that case, they’ll want to receive a percentage of the profits over and above their investment for a certain period after the investment has been made. The length of time they decide to retain their share will vary from investor to investor.