2012: Year of the Financing

-By Stephen Fiedler

You may wonder why experts are so optimistic about 2012 and the economic turnaround when unemployment still rests at 8.6%, Europe is still mired in a debt crisis and Washington is just as deeply divided along partisan lines as it was before the Payroll Tax Cut showdown. While things do appear to be looking up, the US is still vulnerable. So why are we taking on a glass half full outlook? Because unlike the past few years, 2012 is the year of readily available financing. ‘Treps and investors rejoice!

The biggest threat of the ’07-’08 financial collapse was the ensuing credit crunch that nearly dried up all access to loans and lending markets the years following. Bad loans and bad borrowing had forced most banks and lenders to close their doors (if not go bankrupt) making it nearly impossible for startups and small businesses to get seed capital and later stage venture capital. As the numbers reflected during this time in a previous piece, VC State of Mind, venture capital and entrepreneurship in the US took one helluva hit. The recession didn’t just take away jobs, it took away the money that creates NEW jobs.

Rohit Arora, CEO of Biz2Credit, an online credit marketplace in New York that connects small and midsize businesses with lenders echoed these concerns stating that, “The lending market for small business in 2012 is going to be much better — the best year after the recession,” now that credit is more readily available. The chart below confirms this point:

But like everything worth doing, finding funding wont be easy for you young ‘Treps. “It is going to continue to be a fight and a struggle to get small business owners capital at fair prices,” says Ami Kassar, CEO of MultiFunding, a small-business lending consulting firm in Broad Axe, Pa. “It is going to take a long time for us to work our way through this situation.”

So here are some ways to get ahold of financing in 2012. While it may require more creativity on your part, embrace the new age of financing that once again is returning to the US. For more indepth article on specific types of funding, check out Goldilocks and the Three Funders. Otherwise here are the basics for financing in the New Year:

Crowd-sourcing:

More and more business owners and startups are turning to crowdfunding sites, such Kickstarter, IndieGoGo and RocketHub, to raise small amounts of money from large pools of investors–especially if the Securities and Exchange Commission eases rules on such transactions (they are expected to do so to encourage VC in the US). Kickstarter alone has raised than $125 million in pledges since its inception in April 2009. One business raised almost $1 million from more than 13,500 backers in December of 2010, setting a crowd-sourcing record.

Crowd-sourcing isn’t ideal, and can often pull your company and creative ideas in many different directions, but when capital and credit are tight, this is often the only avenue a startup has in the initial stages. It’s a good launching pad, but for those million dollar ideas, they are just one step in a long line of funders, angels and VCs.

Community Bank Loans:

The collective bank loan balances of small businesses have fallen more than 10% over the past four years to $610 billion in June of 2011 from $681 billion in June of 2007, according to FDIC data compiled by Kassar of Multifunding. That’s pretty bad and speaks directly to the startup/small business credit crunch. I know, I know, the same clowns that cause the Financial Crisis, after being bailed out by US tax payers can’t give that same money back to an aspiring entrepreneur with a billion dollar idea? Yeah well that’s the world we live in. Fortunately there’s a workaround.

While large banks sharply cut lending to small businesses, community banks are actually providing more loans. Since 2007, small-business loan volume at small banks grew by $17 billion to $302 billion, as of June 2011. If you want access to good loans and good credit at fair prices (plus the knowledge you aren’t leaving your money with crooks) this is the way to go. It’s the new “micro-loan” and it’s gaining momentum in the US.

Small Business Administration (SBA) loans: 

SBA lending reached the highest level ever in its fiscal year 2011, which ended Sept. 30. The SBA backed 61,689 loans totaling $30.5 billion, a big jump from the 50,830 loans totaling $17.9 billion two years earlier. Risk-averse banks may prefer making SBA loans because the government guarantees as much as 85 percent of the loan in the event of default. It’s a safe bet and the risk-aversion helps your cause in the short term. However, long-term these SBA loans can hinder progress and development. This is your “safest” bet.

Asset-backed lending: 

Asset-backed loans, which are based on the value of collateral, have become increasingly popular among the startup world. Although they are often more expensive than a regular bank loan, businesses often turn to asset-backed lenders when they don’t have the track record to qualify for a traditional line of credit.

In the third quarter of 2011, businesses were making greater use of their asset-backed credit lines, with 40.5 percent in use compared with 37.2 percent a year earlier, according to a survey of members of the industry group Commercial Finance Association. That marked the third consecutive quarter of increased utilization of credit lines. For a piece explaining asset-backed loans, check out When to Issue Equity over Debt.

Hopefully you’ll be able to use these new forms of financing for 2012 and beyond. Go forth and get funding! Here’s to 2012!

Goldilocks and The Three Funders

-By Stephen Fiedler

In this world, there are the thinkers and there are doers. If you just so happen to be an entrepreneur, you are both.

Life for a go-getting entrepreneur is a dichotomous, focusing on both product development and capital accumulation. Depending upon the stage of your startup/company’s development, there are certain types of funding that green entrepreneurs should turn to in hopes of meeting success in this chaotic and ever-evolving environment. Here are the three main forms of funding for startups and small businesses, including Angels, Angel Funds and Venture Capital. See which one fix you and your company’s needs the most:

Angels:

Angel investments are what most entrepreneurs think of when they first seek outside funding for their business. Angel funding is the smallest form funding and usually comes from  an individual who has significant funds or earning potential (other successful entrepreneurs, doctors, lawyers, etc…) but who is seeking out potential high return investments. Because successful startups produce a much larger return than most stock market ventures, Angels are the risk takers, who either see something as the “next big thing” or want to get on the ground floor of something huge (ideally).

As a result, Angels will often invest between $10,000 to in excess of a $100,000 in a business, often seeking an equity stake in return for their investment. Angels can often be friends, family or close acquaintances that often have more faith in you, the entrepreneur, than the company, because little has been produced yet. They work as catalysts. They get the ball rolling and say to a would be entrepreneur with a great idea: “go for it”.

Angel Funds:

Angel Funds, in contrast to Angles, are a blend between individual angel investors and the more traditional VC investors.  An Angel Fund is usually comprised of a group of individual investors (mostly Angels) who pool their money to make a number of individual investments. Angel funds are an intermediary step towards long-term funding, but they pack a punch if you can get enough investors on board.

An example of a Angel Fund might be 50 individual angels each contributing $100,000 to make an overall fund of $5,000,000.  This overall fund will then make a number of individual investments, allowing the individual angels to diversify their risk.  A typical angel fund will have a submission process, often via the internet, where you can submit your business plan or overview documents.  If selected for the next step, you would present your overall business plan to the members of the fund, where afterwards they will vote to proceed or not.  If the fund has enough votes to proceed, they will often select a small group of members to negotiate the details with the entrepreneur (think board members).

Angel funds will typically invest between $100,000 and $1,000,000 in a company (often in multiple tracks), taking an equity position in the company and will often require board representation. Thus they often typify companies that have demonstrated more than just startup returns–but are actually producing a product that challenges other competitors. That being said, the toughest part for most entrepreneurs when dealing with an angel fund is the group presentation and dealing with competing and contradicting influences from the group of Angels. Angel Funds mean you have got the ball rolling, but your still stuck in startup limbo.

Venture Capital:

This is the big kahuna. While Angels help get you going on your startup, and Angel Funds provide the immense amount of support and capital to get you to a product development and testing, venture capital funding is that final stage of funding that all entrepreneurs dream of. Venture Capital is institutional and comes from professionally managed funds that have $25 million to $1 billion to invest in emerging growth companies. Here it’s not just a bunch of benefactor-like Angels pooling resources together. This is a money management fund with professionals and expertise in knowing where to invest and where the big payouts are coming from. They don’t invest in something unless they expect HUGE dividends.

Venture capital is ideal for high-growth companies that are capable of reaching at least $25 million in sales in five years and is best use from financing product development to expansion of a proven and profitable product or service. The costs and funds are typically expensive and not readily available to most entrepreneurs. This is because institutional venture capitalists demand significant equity from a business. For example, the earlier the investment stage, the more equity is required to convince an institutional venture capitalist to invest. Thus the range of funds typically available is $500,000 to $10 million.

Institutional venture capitalists are choosy and few startups make it to this stage of funding. Compounding the degree of difficulty is the fact that institutional venture capital is an appropriate source of funding for a limited number of companies. Yet once you get Round 1/A the levels of funding and finance begin to skyrocket (see chart above). So if you can make it over the first round of VC funding, and your company is already headed toward the black, venture capital funding is “just right” for you.

The VC State of Mind

-By Stephen Fiedler

On the surface, being a Venture Capitalist seems like a pretty cushy job. You’re at the forefront of innovation. You get to talk to some of the best and brightest minds in the world. You learn about cutting edge technologies and industry secrets. And best yet–you are your own boss. Unlike the entrepreneurs that jump through hoops trying to get a meeting, sit down or even just a 2 minute window to give their pitch, VCs play the patience game, waiting for a million (billion?) dollar idea to come to them. You call the shots…

At least, that how most entrepreneurs perceive the “glamourous” lifestyle and career-path of a venture capitalist. After all, becoming a VC requires little in the way of formal education (15% of entrepreneurs and later VCs have never graduated college) and there is no “VC license” or bar/exam you have to pass. But upon closer examination (and after dealing with and talking to many VCs), the harsh truths of succeeding as a venture capitalist become obvious, especially in this economy.

Don’t believe me? Well just take a look at these figures: According to the National VC Association (NVCA), venture firms shrunk from over 1023 in 2005 to 791 in 2010. Ten years ago, during 1999-2000, venture funds raised $100 billion. Yet in 2010, only 157 venture funds raised $12.3 billion. That’s quite a contraction of capital and venture firms in just a decade!

The truth of the matter is being a VC is no easy task, even when the economy is booming. We live in a fickle world where trends, consumer tastes and technologies change more often than Lady Gaga’s wardrobe. Further, the expectation of a VC is to find the “next homerun” constantly weighs upon them, forcing them to be over-diligent, constantly networking and reaching out, just in case that next-big-thing comes their way. Over-preparation is under-appreciated, but not in the VC world. Just look at Mr. Warren Buffett. He reads up on EVERYTHING, even if it’s out of his industry’s reach. That’s because you never know how markets will evolve and how industries will converge. Know your landscape.

As a VC, sleep is a luxury, and multitasking borders on the insane. Deciding when to push on or when to cut your loses can be the difference between long-term success and immediate failure, but there are no rules set in stone in when or where to do so. It’s really a work in progress. Plus, as a VC your main responsibility is to the funds’ limited partners, meaning you must bend to their whims at times.

Sounds stressful? Well it is. Here are three of the most important skills you’ll need as a successful venture capitalist. See if you’ve got what it takes:

1) Raising Initial Round of Capital: As mentioned above, the VC market has contracted substantially over the past decade as both innovation and investment have stagnated in the US. Yet despite this apparent slowdown, for best-in-class VCs, raising money is a quick, in-and-out 90 day process. This means a true VC needs to move fast, act with certainty and avoid indecision and distractions. Patience here is not the standard. Go forth and get capital!

2) Finding the Next Mark Zuckerberg: When you boil it down, venture capitalists are about finding PEOPLE first and foremost. After all, thats how you get these new and brilliant ideas. In a previous post I wrote about Impediments to Growth: The Personnel Premium (click for link) and how valuable finding the right people to employ at your startup is for long-term success. Well it’s the same for VCs. Their livelihood is dependent upon their ability to judge those around them. One wrench in the gears and the startup’s gone under.

Thus, a true VC meets every potential entrepreneur with a level of skepticism and a wary eye. You must ask yourself if the entrepreneur is capable of turning an idea into a product or if they suffer from the abstract. Here you look for both creativity and ingenuity along with tenacity and ambition. A good poker face helps, but there’s no substitute for good instincts.

3) Generating Returns: This is often the most neglected component of being a VC. Everyone seems to focus on the startup and initial stage of development, but lets face it, getting your money back (and multiplying the returns) is what being a VC is all about. Creating something is all fine and dandy, but it’s not gonna pay the bills unless you can generate returns from your startup. Diagnosing the long-term returns of your company over 5 and 10 year time periods thus becomes a must. Myopia will do you no favors in a constantly changing business environment.

A good metric of long-term success in the VC game, known as the Internal Rate of Return (IRR) will show you where you stack up. According to Thomson Reuters, the median return for a VC over a 20 year period ending Septemeber, 2010 was 12.1 percent. That obviously includes the dips of the early 2000s but also includes the dot.com boom in the 90s. Sounds like a decent return, right? But if you want that homerun shot, expect more in the 15-20% area. While those are big gains, they are to be expected from a successful VC. Thus, the pressure to produce large returns just comes with the territory.

Still think you’ve got that VC state of mind?

Advice from “The Pitch Coach”

The following is TedTalk presented by entrepreneur and startup guru, David S. Rose on how to pitch to VCs and investors. His advice will help you tease out the main talking points for your company/startup to better assist in funding and finding financial backing.

If you are thinking startup, then Rose’s rapid-fire TED U talk on pitching to a venture capitalist will show you the 10 things you need to know about yourself — and prove to a VC — before you fire up your slideshow.

As Rose will discuss, the most important part of pitching to VCs is demonstrating –and sharing–your vision, so that investors and VCs see your passion and integrity before they partner up:

Known as “the Pitch Coach,” Rose is an expert on the business pitch. As an entrepreneur, he has raised millions for his own companies. As an investor, he has funded millions more. Full bio and more links

When to Issue Equity Over Debt

In my posting How to Structure a Seed Financing in Today’s Market, I recommend that founders push to structure their initial funding as debt as opposed to equity.

Typically, venture capitalists that engage in seed financing and provide debt, do not want to be heavily involved in the business.  For a venture firm, a $100,000 -$250,000 seed investment is small and they most likely are doing many such financings.  It would be overly burdensome to take a hands-on role with all of their seed companies.  If you want more more in-depth help, such as a bringing on one or two sophisticated board members, you might seek to partner with some angel investors who will view the smaller investment as a more substantial investment and therefore be more committed to the operations of the business.

Occasionally, however, founders might prefer to issue equity.  If you are new to operating a business and want more hands on help from your funders, equity could be the better approach, especially if cash flow issues are a concern. Ideally, experts suggest that businesses use both debt and equity financing in a commercially acceptable ratio.

This ratio, known as the debt-to-equity ratio, is a key factor analysts use to determine whether managers are running a business in a sensible manner. Although debt-to-equity ratios vary greatly by industry and company, a general rule of thumb holds that a reasonable ratio should fall between 1:1 and 1:2.

So the level of your sophistication in running a business, your network and the level of support you want from your investors, will help you determine the right funding structure for you and your new company.