Raising Capital for Small Business

Most entrepreneurs and small business owners have a need at some stage to raise capital in order to realize an idea or expand their current operations. The first port of call is normally the traditional source of finance – the bank.

Despite the promotion activities of most banks, they are usually reluctant to lend to small businesses without the security of property - often the business owner’s home. It is very difficult to get banks to lend on the strength of the business opportunity if it is in its start up or early development phase. This is because financing start ups is basically not what the banks do.

It needs to be recognized that there is a fundamental difference in the business of mainstream banks and venture capitalists. The bank wants to provide loans that are relatively secure, on a long term basis. Business investors and venture capitalists want to put money into something that will provide an above average return and then get out.

There are sources of start-up and venture finance, but it is important for the promoter of a business to understand the differences in the various types. It is also necessary to understand what potential investors are looking for and how to approach them.

How to Get Australian Venture Capital Funding

We often hear it said that the Australian investment market is conservative and will not back the creative and entrepreneurial talent that exists in business. Without wishing to debate that proposition one way or the other, it is fair to say in defence of the investors that they are often presented with propositions that would not inspire anyone to part with their money. Research has shown that only 0.12% of deals that get put in front of venture capitalists actually attract funding. In order to improve the chances of successfully attracting finance, there are a number of things that the promoter should address.

Finding Startup Capital

The first point to consider when looking for finance is the stage of development that the business has reached. It is very difficult to attract other people’s money when it is still just in the idea stage. The most common mistake that business promoters make when they are looking for funds is that they do not look at their proposition from the point of view of the investor. Investors are exactly that – they invest for a return, they are not punters. Nor are they entrepreneurs who want the thrill of developing a good idea. For them, developing the idea is a means to an end of achieving a return on an investment.

So, if there is no cashflow, there is no business and the chances of attracting investment are slim. In these very early stages, the only place that money is likely to come from will be the promoter’s own assets, or family and friends. The other alternative is to look at the various state and federal government grants that are available to assist with the very early stage of development although there are not many of these either.

1. Seed Capital for Small Business

Once the idea starts to turn itself into a revenue generator, it is at the stage that it might be able to attract some seed capital. This would typically be in the range of $100,000 to $300,000 and come from an individual investor or business angel. It is still fairly speculative from the investor’s perspective, but if he can see that the idea has merit and that it has a chance to become a good business, he may put money into it. This form of finance is often by way of a loan rather than equity and will be at an interest rate commensurate with the risk. The investor in this scenario will probably only invest an amount that he is prepared to lose and is not likely to put in anything at all if the promoter does not have money at risk.

2. Venture Capital Funding

The next stage of development for the business is where it has become established and has the potential to expand. At this point, it can start to look for venture capital which will typically be in the range of $2.5 to $5million. The venture capitalist is only interested in investing in a business that will deliver a return. He is not going to back something based only on the potential of an idea. This is a critical point that business owners need to understand. While the entrepreneur is tightly focused on the potential of the technology or product or service, the venture capitalist is really interested in the quality of the business and the management. What he wants to know is, who is going to be responsible for his money and how will they achieve a return for him.

If the business survives these early stages and continues to develop, it will reach a point at which it becomes attractive to the mainstream banking industry for long term debt finance and possibly public listing if it needs to raise further capital.

How to Pitch: a Venture Capital Funding Blueprint

All of this suggests a few things that a business owner who is seeking capital should take into account. The first is to do it in stages. Even if the idea or product has the potential to change the world as we know it (which many entrepreneurs passionately believe their pet project will do), it is better to start by trying to attract a smaller amount to get it off the ground, rather than the amount required to take on the world.

The next thing is that the pitch must be presented from the perspective of the investor. He will want to know how much is needed, what he gets in return, when does he get it and how and when will he exit. (A typical venture capital supplier will normally look to exit the enterprise within 5 to 7 years). Of course he will also need to be convinced that the business has a good chance of succeeding so that it can deliver the promised return. This is going to require a fair amount of homework in order to produce:

• A business plan that shows an effective business and revenue model. It needs to demonstrate a quantifiable need in the market that the business is capable of fulfilling. It should also show how the business compares with competitors on relevant industry indicators and the sensitivity that the projected outcomes have to key assumptions.
• An investment summary and business valuation model together with an exit strategy.
• A strategic marketing plan that demonstrates exactly how the potential will be turned into reality. The plan must address the value proposition of the business and the branding strategy that will deliver above average profits.
• Evidence that there is adequate protection of any intellectual property involved.
• Evidence of a management team with the credentials and credibility to deliver the result.
• A clean ownership structure where the assets of the business are clearly distinguishable from the assets of the owner.

All of the above need to be available in two forms. First is a brief presentation that will capture the attention of the investor and answer his critical questions. The second is a detailed set of documents that will stand up to the scrutiny of the third party that the potential investor will inevitably engage to carry out due diligence on his behalf.

It should be remembered that the investor is highly unlikely to slash his wrists if an investment gets away from him because it was poorly presented. He knows that there is someone else waiting outside the door to pitch the next opportunity.

Small Business Funding Checklist

Here is a checklist of things to consider for small businesses looking for funding.

1. What stage of development is the business at

2. If the business is at stage (iii) or beyond, ensure that the following are in place

• Business plan that details the business model, demonstrates a viable opportunity and contains competitive bench marks
• A strategic marketing plan that demonstrates exactly how the revenue and profitability targets will be achieve.
• Evidence that the intellectual property is adequately protected
• A management team with the know how to deliver the plan
• Evidence that the business owner or promoter has a serious financial interest in the venture
• An investment summary and business valuation model
• A viable exit strategy

Having an awareness of what investors are typically looking for and completing the homework ahead of time will significantly increase the chances of successfully attracting funding.