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Entrepreneur's Toolkit: Step 2 - Raising Capital

Monday, July 07, 2008

From loans to angel investors, finding money for your business can be an uphill battle, but one you can conquer with the right approach.

Provided by Inside Business Magazine
Written by Peter Strozniak

As a serial entrepreneur, Dan Quiqq has raised about $6 million for the four businesses he has started. He has since sold three of his companies and is now CEO of Verishot of Solon, which markets a hole-in-one video-monitoring system for golf courses.

But Quiqq admits that no matter how many times you’ve raised money, it never gets easier — especially in Northeast Ohio, which is not always a hotbed for large investors. Last year, Verishot secured $200,000 from the North Coast Angel Fund LLC, and Quiqq is gearing up to raise more funds to support its national growth goals.

“The thing about raising capital,” Quiqq advises, “is that you’re never done raising capital.”

With a business plan already in place (see Step 1), you have already won half the funding battle. A well thought-out plan will not only clearly define your business and its mission, but also help determine how much capital you will need to succeed. What’s more, a business plan isrequired if you want to borrow funds from the bank, angel investors and others you plan to approach.

You have your plan. You know your goals. Now, where to start:

Savings, equity, 401(k)

If you have savings and investments, look to use those resources first to limit your debt load. But instead of selling your assets, Gabe Adler, a certified public accountant for Beachwood-based Zinner & Co., advises entrepreneurs take out a loan against an asset to avoid paying taxes. What percentage of those assets you should use to start a business depends on the value of your assets and how much you’re willing to risk, Adler continues. Generally, bankers and investors require entrepreneurs to invest 15 percent to 25 percent of their personal equity in a loan deal. The more personal assets you are willing to wager, the lower the interest in most cases.

But think twice before you sell other assets such as rental property, because you’ll be required to pay an appreciation tax, leaving you with less cash, Adler says. You can avoid the tax liability by taking an equity line of credit against the rental property. Another option is to get a home equity loan because the interest rates are lower, repayment terms are generally flexible and there’s a tax benefit.

Some entrepreneurs use their 401(k) retirement accounts even though many experts don’t recommend it. One of Adler’s clients recently rolled his 401(k) in his new company and used the funds to buy stock in his company. While Adler doesn’t comment on whether this is the best option, he says using your 401(k) could be an alternative if you’re running out of funding sources. But he cautions that you risk losing your retirement fund if your business fails.

Friends and Family

Most experts and entrepreneurs recommend borrowing from family and friends. To prevent uncomfortable misunderstandings and conflicts, draw up a written agreement outlining the risks, especially the risk of losing their money.

Every detail should be addressed in the promissory note, including a repayment schedule, what happens if the business is sold and how lenders will be informed of the company’s milestones such as its profits and losses. Free templates at noto.com can give you ideas about how to develop your agreement.

“Getting a good lawyer is a wise investment, because we see so many companies that mess themselves up with very casual agreements that end up biting them later,” says Becca Braun, COO of JumpStart Inc., a Cleveland-based entrepreneurial organization that supports and funds early-growth companies.

Banks, SBA and DPOs

Many Northeast Ohio banks offer loans for startups and early-growth companies through federal, guaranteed low-interest loan programs offered by the U.S. Small Business Administration. The SBA guarantees a 50 to 85 percent repayment on defaulted business loans.

“Depending on the type of business, you need to put in 20 percent to 40 percent of your own money,” says Gil Goldberg, director of Cleveland’s SBA District. If you have more skin in the game, the banks figure you’re more committed to making the business work, he adds.

Before applying for a loan, clean up any inaccuracies on your credit report. Make sure you ask for a loan amount you truly need, Goldberg advises. The first three years will be tough, and unexpected expenses always occur.

A financing option for small firms with moderate overhead expenses is the microloan program offered by SBA’s Small Business Development Centers. At the Lake County SBDC, for example, microloans can range from $1,000 to $20,000. Lake County also offers a speedy capital loan program for companies looking for $1,000 to $5,000.

For early-growth companies that need funds to buy or lease equipment, machinery or other hard assets, a direct public offering may be another option worth exploring, Adler says. DPOs are far less expensive than initial public offerings and are not as heavily regulated. DPOs enable small companies to sell preferred stocks of up to $1 million.

Angel Investors and Groups

Angel investors or angel funds provide money to early-stage companies. Over the last few years, angel groups such as the North Coast Angel Fund, Akron ARCHAngels and JumpStart Inc. have been channeling millions of dollars to small businesses.

What’s more, JumpStart launched Ideacrossing.org, which matches entrepreneurs with angel investors throughout the country. Another group, Ohio Venture Association of Cleveland allows entrepreneurs to make a five-minute presentation at its monthly meeting to attract capital.

Venture capital firms are another option, but only a few pump money into startups and early-growth companies, Braun says. Most VC firms invest in companies that have a proven product or service that is expected to perform and produce strong returns.
Be sure to target venture capital firms that have a history of investing in startups and early-growth companies, Braun advises, otherwise you’ll be spinning your wheels.

Since 1988, Quigg estimates he has raised about $6 million in capital from individual angel investors, angel investor funds, friends and family. It’s better to get your business up and running in the best possible shape with the capital you have , he adds, no matter how meager it may be. “If you build good business, you will attract investors and they will understand why you need the capital to expand,” he says.


Free Money
Federal, state and local institutions offer grants for small businesses.

• Local organizations: Ohio’s Third Frontier program funnels grants to early-growth businesses developing high-tech products such as fuel cells, software, medical devices, biomedical products, advanced materials, instrument controls and electronics. Over the last two years, the Innovation Fund of the Lorain County College Community Foundation channeled $550,000 in grants to early-growth technology companies throughout Northeast Ohio. On the federal level, the U.S. Small Business Association’s Office of Technology manages two programs providing $2 billion in grants annually to high-tech small companies.

“Clearly, the grant money is out there,” says Marsha Powers, president and CEO of Cleveland-based Powers Financial Group. “Competing for a grant is not rocket science, but you have to devote time to understand the grant system and the grant process.”

• Search the Web: Start your grant search at grant.com and gov.com. At gov.com, go to the search field and type in “grants.” Search results will list grants available at each federal agency. Another federal grant resource is sba.gov.

• Be a competitor: Competing for grants is a long-term financing strategy, particularly for companies developing new technologies for commercial applications, says Warren Goldenberg, CEO of CardioInsight, a firm developing a high-tech medical device that promises to create a noninvasive procedure to treat cardiac arrhythmias and other heart problems. Target government grants directly related to your product or service, Powers advises. Allow about six months to a year to learn about the grant process and system, which can also help you determine what grants to apply for. If you can’t invest the time, consider outsourcing the responsibility to a business consultant who can help you compete for the grants.