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2013

FamilyFinancers_Body.jpgby Susan Caminiti

 

Chances are they’ve been your biggest cheerleaders as you’ve started and grown your small business. But should family and friends also bankroll your business?

 

Borrowing money from your parents, in-laws, or even your best friend from college may seem like an easy financial solution when capital is not forthcoming in those early days. But small business experts say this option can be more complicated—and emotionally messy—than it seems. “Most small business owners who go to family for money approach it like they’re about to borrow $20,” says Andrew Keyt, executive director of the Family Business Center at Loyola University Chicago. “The process is too informal and that increases the possibility of tension and misunderstandings with family members down the road.”

 

Despite those potential pitfalls, small business owners continue to seek out money from those near and dear. A business financing survey by the Global Entrepreneur Monitor, a research consortium that includes Babson College, showed that small businesses raised $41.6 billion in 2010 in so-called informal funds. According to the respondents, 32 percent said the money came from a friend or neighbor; 26 percent said from a close family member; 11 percent from some other relative; and eight percent from a work colleague.

 

Still, there are ways to borrow seed money from family and friends without making the next holiday gathering stressful and awkward for all involved. Below is some advice from small business experts on how to do it right.

 

Be clear, candid, and professional

If there’s one topic that people are uncomfortable discussing, it’s money. Talking about money to family only notches up the pain. So says Karen Axelton, co-founder of GrowBiz Media, a market research and consulting firm that helps corporations and government agencies connect with small and mid-size businesses. “Glossing over the details of how much you need and why, because it’s awkward to talk about money with your parents or siblings, is never a good idea,” she says.

 

FamilyFinancers_PQ.jpgRather, treat the conversation as if you are having it with a stranger—or better yet—a banker. Arrange a time to speak that’s good for everyone and focus only on the issue at hand. Explain the amount of money you’re looking for, your plans for the funds, and how you intend to pay the money back and over what period of time.

 

It also helps to present potential lenders (yes, even mom and dad) with a detailed business plan. Says Keyt: “Even your closest relatives will want to know if the money is going to some half-baked idea or a business that has a chance to succeed.” Give them time to read it over—preferably without you looking over their shoulder, cautions Axelton. And above all else, Keyt advises, be clear. “Problems arise when both parties have unarticulated expectations. Leave as little as possible open to misunderstanding.”

 

Define the investment

Are you looking for a loan, equity investment, or an outright gift? Each has a different set of issues—and financial responsibilities—so making sure you define the terms is critical, says Axelton.

 

With a loan, you’ll want to determine the interest rate you’ll pay on the money you’re borrowing, the repayment period, and what you’ll use the money for. An accountant can draw up these forms, or you can find them through an organization such as SCORE, she says.

 

Unlike with a bank loan, when the money is coming from mom and dad or the in-laws there’s often wiggle room with the repayment schedule. Pretend there isn’t. Judy Barber, a family business consultant and mediator based in San Francisco, says even if family members don’t need the money repaid on time—or at all—changing the terms of a loan is never a good idea. “It annoys parents because it makes it look like their adult children aren’t taking them or the business seriously,” she says.

 

Money that comes in exchange for an equity investment is a bit more complicated and will require some soul-searching, say the experts. For instance, do you really want your business savvy father-in-law weighing in on expansion plans or questioning your social media strategy? “Those are the kinds of questions that entrepreneurs have to ask themselves if they’re taking money in exchange for a piece of their company,” says Keyt.

 

An equity investment also comes with a fiduciary responsibility to share financial data with investors, and in most cases, make them board members. “If you’re going this route, make it clear what percentage of the company they are getting in exchange for their investment and the liquidity options they have when they want to get their money out,” Keyt explains. Also make clear whether or not you’ll be paying dividends to these shareholders and if so, how often. And get professional guidance. Both Keyt and Axelton recommend using a lawyer to draft an equity investment agreement.

 

As for gifts, well, they too have to be handled with care. To begin with, says Barber, make sure everyone involved understands that the money is just that: a gift, with no expectation that it will be paid back. Further, be sure to stay on top of IRS gifting guidelines. For 2013, the amount of money someone can give as a gift, tax-free, is $14,000, up $1,000 from last year. And of course, the money is not considered taxable income for the recipient.

 

Put it in writing

Just because these are the people who love you most in the world, doesn’t mean you get to take short cuts when it comes to money. Put everything in writing. “Family and friends are naturally excited for you and optimistic about your chances for success,” says Axelton. Bring everyone back down to earth with a written document that makes clear the terms each party has agreed to, she advises. Enlisting the services of a lawyer is advisable, but not always needed when drafting this kind of agreement, but getting any contract or written agreement notarized is recommended.

 

It’s also a good idea to include in this document a list of the risks that the lender is taking on by loaning you the money or making an equity investment in your fledgling company. “Not every business succeeds and it’s up to the small business owner to lay out a worst-case-scenario plan,” she says. “What if the business fails and it takes you double the amount of time to repay a loan? Or you can’t repay it at all? You need to set down expectations in writing so everyone knows what the risks are.”

 

Maintain communication

No, you don’t have to send out daily emails detailing the new client you just snagged or that you’ve hired your third employee. But when you see or speak with your family investors (and you will) give them a brief, honest assessment of how the business is doing and any highlights, say the experts. And of course, if there are dire problems that could impact your ability to start or continue repaying your loan, alert them to that sooner rather than later, says Barber.

 

In the end, borrowing from family and friends can be tricky, but when done right, it just might give you the money you need to start the next Subway or Walmart. After all, the founders of those companies borrowed money from their families to get their businesses off the ground, and no one could argue those weren’t good bets.

by Karl Stark and Bill Stewart


Don't overcomplicate your pitch to investors. You'll have more success with a business case that can be clearly stated in under a minute.

 

We recently met with a CEO who has built a number of businesses and is currently leading a private equity-backed business in the security space. Within the first minute of our conversation, it became clear why investors were backing him. In this short time span, he clearly defined his marketplace and his company's role in creating value in simple terms.

 

It struck us how obvious this was, but it reminded us of how rarely we see CEOs take this approach. Many entrepreneurs are wired to try to impress others, including potential investors, with the depth of their technical knowledge or complex approach to solving a customer problem. Many of us foolishly believe that, in order to be innovative, a business idea needs to be genius in its complexity.

 

The reality is that investors, like any business decision-makers, are drawn toward simplicity. This means the investment case you propose must be simple in both concept and communication. If you can't communicate a simple investment case, you probably don't have a winning business idea.

 

Try these three steps to build a simple investment case:

 

1. Frame the market and current customer demand.

 

Every investment concept begins with the logic of a customer. Someone has to have a need for your product or service, and the easiest way to prove that is to point to the existing market for that service. Outline the current market size, what customers are currently spending annually on that customer need, and the driver of that customer demand to demonstrate why the demand will continue.

 

2. Describe the segment of the market you're aiming to capture.

 

What customer segment or segments of the market does your product or service appeal to? If you have a product or service that is differentiated from the current offerings, it should appeal to a specific segment more than others. Describe why you are targeting that segment and explain why the segment is profitable and sustainable.

 

3. State your sustainable competitive advantage.

 

What are you bringing to the market that will set you apart and maintain your competitive advantage going forward? If the investor is deploying capital into your business, she will expect a return on investment. The only way to receive a return on investment is to provide proof that you will be able to sustain profitability, even after competitors realize that you are gaining traction and attempt to replicate your solution.

 

The CEO of the security company was able to describe all of this to us in less than a minute. When using this framework on a credible business case, describing your case clearly and logically should be easy. If you have trouble, that's a sign that your business case is not as attractive as you thought.


Article provided by Inc.com. ©Inc.

As new funding options emerge, small business owners have more diverse options for financing growth

 

DIYtoBank_Body.jpg1. Introduction: The Financing Challenge

Economic conditions, legislation, and technology have sparked a sea of change in small business owners’ options for securing funding. Traditional bank lending and venture or angel investment still figure prominently in today’s financing landscape. But today’s alternative sources of funding range from emerging online lenders to crowdfunding and do-it-yourself initiatives.

 

These changes have been developing for years. Bob Seiwert, senior vice president of the American Bankers Association, notes that during the housing boom, some business owners relied heavily on home equity lines of credit and credit cards to fund their businesses. “As values of real estate have dropped, so have those lines of credit,” he says. “There’s no substitute for equity in the business. And banks don’t make equity investments into small businesses. They make loans. We don’t get paid to take equity risks. We get paid to take loan risks.”

 

That also creates a challenge for business owners who saw their equity disappear during an extended period of losses and negative cash flow and who now need permanent working capital. “Bankers are not going to provide 100 percent financing,” says Seiwert. That leaves those business owners in need of funding alternatives, whether that means personal resources, assistance from relatives, or funding from suppliers or major customers “who are willing to make equity investments in the business because they know that business well, have confidence in it, and need that product.”


Image-CTA-v1.gif2. Capital Sources

“We’ve been in a prime-plus world lending to people who really weren’t prime-plus borrowers,” says Charles H. Green, executive director of the Small Business Finance Institute and author of The SBA Loan Book: The Complete Guide to Getting Financial Help Through the Small Business Administration.

 

As bank financing availability tightened for companies facing an equity crunch, new funding options emerged to fill the void. But some are high-interest options that won’t work for every small business owner. “There’s going to be a price adjustment for small business credit,” Green cautions. “These new capital sources online, and there are several of them, are charging from 16-36 percent.” That’s a dizzyingly high rate, but the terms can be viable for a company whose margins are high enough and who need the money fast, he adds. “They need to evaluate what their profitability is, and that will tell them if they can afford it. They need to ask, ‘will this be a net profit to us overall, and will it last?’”

 


Joining the crowd

Crowdfunding— the collective effort of individuals who network and pool their resources, usually via the Internet, to support efforts initiated by other people or organizations—is another emerging alternative for business owners who need to get creative about financing their growth—but here, again, there are caveats. Kickstarter reports that of 32,311 successfully funded projects, 25,695 raised $10,000 or less—and of those, 3,800 raised less than $1,000.

 

That’s not to say that crowdfunding is off-limits to companies with higher funding aspirations: the total includes 326 projects that gained $100,000-999,999 in financing, and 15 projects have raised more than $1 million. DIYtoBank_PQ.jpg

 

But the odds are daunting. Those 32,311 funded projects represent just 43.8 percent of 77,072 projects that were launched on Kickstarter. The remainder failed to gain full financing—12 percent received no financing at all—and projects that fall short of full financing get no financing, in keeping with the company’s all-or-nothing policy.

 

Moreover, the site reports that crowdfunding works best for companies that have already established a following among likely supporters. “In most cases, the majority of funding initially comes from the fans and friends of each project,” Kickstarter reports in its FAQ. It adds that social media and press are “big sources of traffic and pledges”—which means this approach to financing is best suited to companies that already have a strong social media platform.

 

The angel alternative

Angel, or venture investors aren’t likely to come from your circle of friends, but those that agree to invest in your company will expect to join your circle of advisors. That distinguishes them from the business banker who issues a loan and simply wants it repaid.

 

A venture investor is essentially taking a stake in the company. Susan Preston, general partner at CalCEF Clean Energy Angel Fund, notes the attributes she seeks in a business that’s seeking funding: “Having validation in the market that there are customers who are willing to pay for the product is certainly an excellent attribute, and it is a plus for the company. But for me it is more about: Who are the customers? What is the market potential? Can the company scale? And can it give me a return that is high margin for the money I would be putting in?”

 

That doesn’t mean, however, that you have to accept loss of authority and venture capital as a package deal when working with angel investors. “With some exceptions, investors don’t come in and try to run the daily show. They’re there to help the entrepreneur grow,” Preston says. “I always advise entrepreneurs that you need three things from your investors. The third most important is the money. The first is their sage advice, because 90 percent of the time, angel investors and venture investors are prior successful entrepreneurs themselves.” Their experience leads to the number two item on the list: their connections. “They know people. They know prospective customers, experts in the field, and can bring those in to the company’s advantage.”

 

With that in mind, business owners should consider prospective angel investors’ personalities and professional fit, not just their ability to provide funding. Good entrepreneurs understand their limitations and recognize the value of advisors who can provide greater strength in those areas, Preston says. “It really is a lot of honesty with yourself: where do I need help, and where can I most benefit from support from my investors and advisors?”

 

Taking it to the bank

While angel investors and bankers differ in what they expect of business owners who seek funding, they share one critical trait. Success in either type of financing depends in part on personal relationships. That element is often lost on a new generation of small business entrepreneurs who are accustomed to conducting business, and particularly financial transactions, electronically and virtually.

 

“But there is one thing that you can’t do online, and that’s build a relationship with a banker,” says the ABA’s Seiwert. “At the end of the day, the credit decision that a banker makes is based on their knowledge of your business; it’s based on a degree of trust that that banker has built up over time with you. And that trust can only start via a personal relationship. The people who get the money or who have the best chance of getting money in an economic downturn, when times are tough, are those who have relationships with bankers.”

 

Relationships help business owners to understand what bankers need to make a favorable credit decision. Of even greater value, he says, is the opportunity for business owners to get feedback on how bankers view their companies. “Bankers have the benefit of seeing lots of business owners, and they have a feel for what works, what doesn’t work, what are best practices, and what are not best practices.”

 

Interaction with business bankers also keeps the company’s track record on their radar. “By building a relationship, you have the loan officers watching what you do,” says Mitchell Petersen, professor of finance and director of the Heizer Center for Private Equity & Venture Capital at Northwestern University’s Kellogg School of Management. “They see this track record of when you’ve taken out, borrowed from suppliers, and repaid, or when you’ve borrowed a small amount from me, you’ve repaid. So there’s a paper trail that shows you are able to take out credit and repay it.”

 

3. Enlisting Bankers as Advocates

Beyond that trail of hard data are softer indicators of the company’s merits as a borrower, he adds. “If you’re a loan officer, and you saw a firm operate very well under very unfavorable conditions the last three years, you’re much more comfortable with that person. That loan officer can go up to the credit committee and say, ‘I’ve seen what happens when they’ve lost a major customer, and here’s how he responded. I’ve seen when he took money out and there was opportunity not to repay it, and here’s how he responded.’ He’s essentially vouching for you, and they’re more likely to do that if they know you well.”

 

“Behind every credit decision is a character assessment. If you don’t have a personal relationship, then the only thing the banker has to go on is your credit score as a gauge for how you’ve performed in the past,” Seiwert says. “The question a banker has to answer is, if you get in trouble, will you work with me to ensure that the loan is repaid as agreed, or as soon as possible as agreed? That communication, that whole trust-building, over time builds up the banker’s confidence in you, so when times are tough and you apply for credit, that banker can be your banker within the organization. Maybe you’re right on the borderline of a yes or a no. That kind of relationship can push you over into positive territory.”

 

How do small business owners position themselves to get their credit requests approved? Seiwert advises them to approach their bankers now—before they need a loan—and ask whether credit would be available to them today and what the loan terms would be. “That’s going to get that dialog going,” he says. “It’s better for you to find out now rather than later.”


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