Seven Biggest Mistakes in Raising Startup Capital
Fri, 11/09/2012 - 4:26pm | by DanielaB
While startup capital can be a tremendous benefit in helping new companies get off the ground and gain a footing in their respective markets, too many small business firms go under because their owners failed to understand how best to “pitch” their business to potential lenders and/or investors. Even for those loan requests that are approved, many come with undesirable strings attached, such as high interest rates, investor input into how the business is operated, or disproportionate revenue sharing. Still other loan arrangements burden new business owners with heavy debt which they are unable to pay back due to insufficient revenue.
It is difficult for new entrepreneurs to obtain startup capital because they represent a risk to lenders and investors due their unproven experience and lack of collateral to secure the loan (e.g. cash on hand, furniture, equipment, etc.). Family and friends can also be uncomfortable lending money to a new business.
Alternatively, many efforts to obtain financing fail due to mistakes by the owner that can be avoided, such as ineffectively pitching the company to potential lenders and investors, failing to structure the loan agreement in the most favorable terms, and/or poor money management once the loan has been approved.
Avoiding these 7 common mistakes can greatly enhance your ability to secure startup funding.
1. Poorly created business plans. A business plan that lacks coherency and fails to adequately explain your business concept, marketing strategy and financial forecasts will result in denial of your loan application. After all, if you could not commit the time to preparing a comprehensive business plan, how serious about your business can you be? Lenders and other funders want to know that they are investing with those who are motivated to succeed.
There are many books available to learn how to create a strong business plan. Another resource is the Small Business Administration (www.sba.gov) which provides step-by-step guides, as well as sample plans.
2. Focusing on the concept rather than the management. While you may have invented the next must-have widget or can’t miss fashion concept, you will also need to show how you plan to generate revenue to repay the loan and generate a health profit. With angel investors or venture capital funding you will also need to present a clearly defined exit strategy to show how these investors may realize a strong return-on-investment (ROI). For example, include in your business plan that you have signed a contract with a highly talented internet marketing firm to develop new clients or hired an accountant with extensive startup experience. Both initiatives show funders that you understand what it takes to establish a thriving business.
3. Not asking for sufficient capital. A study conducted in 2004 by U.S. Bank showed that 79 percent of small business owners claimed that their business failed because they “started with too little money.” This is because many new entrepreneurs base their financial forecasts and borrowing needs on a “best case scenario” rather than worst case. For example, if you believe that the business will bring in $20,000 the first year, base your financial projections on $10,000 - err on the side of conservatism.
There is tried and true saying that everything will take twice as long and cost twice as much as what you originally anticipated. While this may be a bit far-fetched, it is true that many new business owners are too often over-optimistic about how soon they will realize positive cash flow and ask for less money than will be needed. Any business that is underfunded will not have a cushion when the tough times hit due to slowing sales or market downturns.
4. Too many lenders and investors. While this might seem like a nice problem to have, it is also the case that having too many lenders can mean difficulty with managing relationships. This is especially the case with regard to angels and venture capitalists that may have a voice in how you operate the business. Their interests may conflict with yours resulting in less-than desirable repercussions. This can be an especially sensitive situation when the investors are family and friends.
5. Failure to create legal agreements. Drafting a legal agreement which stipulates everything from terms of repayment, repayment schedule, and how much say the investor will have in the operation of the business will help you avoid future conflicts.
6. Poor management of cash flow. Many new business owners spend their startup capital too quickly and, as a result, fail to reach positive cash flow as anticipated. The early days of a business are a time of cash conservation in order for the business to successful weather the inevitable lag in revenue. While some conditions may be beyond an owner’s control, such as depressed economic conditions, other situations may clearly be the owner’s fault such as unnecessary spending or overly optimistic financial projections. Lenders and investors frown on financial mismanagement and may deny further funding unless the situation improves.
7. Choosing the wrong partner. Many new entrepreneurs bring on so-called “experts’ as partners, either legally or by simply delegating responsibility to that person. All too often the company then fails. Just because someone claims to be an expert does not mean they are or that they will be a good fit for your business. Rather than taking on a partner, you can very often obtain the same assistance by outsourcing this work to a third party at much less cost and keep control of day-to-day operations.
Preparation is essential when seeking startup capital. With a comprehensive business plan, full understanding of lender and investor expectations, and knowledge of how to protect your interests, you should be obtain the funding you need and not collapse under the weight of investor demands.