it is with great pleasure that we welcome back our dear friend meg touborg of design investors llc (for her 5th post!) and her colleague amanda allen. meg has already shared her tips for creating a compelling work environment, forming successful biz partnerships, making a strategic biz plan, and successful biz dev, and today she’s is sharing with us some ever-important tips on finding funding for your new business.
CLICK HERE for the full post after the jump!
A few months ago, I wrote about developing a Biz Plan. Today, I would like to help you address what may very likely be a next step after you finalize your initial plan: determining what kind of start-up money, or “venture capital,” the operations of your biz require to accomplish your goals. I asked my colleague, Amanda Allen, Vice President of Design Investors LLC to help me develop a clear orientation to this complex topic. We know that there are many types of capital, and so determining the best fit with the source and conditions of the money is a matter of three overall factors that only you can decide. Do keep in mind that anyone putting any money into your business will do so with some degree of risk, and will therefore expect some degree of your economics, your information and your control. Consider first how you feel about each of these of elements:
- Your Economics
- What do you want as your ownership stake? What share do you intend to keep of future cash flows?
- What priority will you have in the distribution of these flows? What is the timing of these flows (yield, maturity) that you expect?
- Your Information
– What external reporting obligations do you want to have for yourself or your staff?
- How much will you need to prepare and share, both to get the deal done and on a regular basis?
- Your Control
- What level of decision making are you prepared to exchange for the investment dollars?
- Are you willing to concede any of your collateral, budget approvals, termination rights?
- In what ways and how often will your investors be involved in the biz?
In short, if your response to the above topics is that you want to keep all the profits for yourself, account for your goals and results however you please, and not involve anyone else… then “Neither a Borrower nor a Lender Be” and you should fund the biz yourself. This could mean using some or all of your personal savings, pursuing a home equity loan, cashing out your IRA or 401k, and will likely take a good amount of bootstrapping in your personal life. However, if you cannot gather sufficient funds by your own means, or you don’t want to deplete your savings stash, then you will have to give up future cash flows to give outsiders the “incentive” they need to part with their own monies to help you. These alternative arrangements can take the forms known as : Friends and Family, Angels, Small Biz Association Loans, Debt Investments and Equity Investments.
Here is a brief overview of these sources of capital based on OUR experiences. We provide you with a sort of “Zagat” rating system for money-raising, noting the amount of transaction fees (accounting resources for advice and diligence; legal services to review and draft the agreements ) you will have to spend to arrange the actual funding; the likely intensity for Information Requirements and for Investor Controls. Use our notes and our grading system to stimulate your thinking but please consult your lawyer, your accountant and your trusted advisors for advice specific to your biz!
Scour your coffers and couches for whatever you are comfortable putting at risk on your new venture. Critical to your biz success is believing in yourself, but equally critical is good biz sense to plan a cushion to care for yourself and your family should the unimaginable happen, and your business falters or fails. As we said above, this source of capital could come from your available cash, savings and liquidating investments. It also could mean that you take out loans in your personal name (against your 401k, IRA or Home) or personally guaranteeing loans in your company’s name. If you go this route, you will keep all the upside gains, you will not need to share your financial results and you won’t cede control of the operations to anyone else—but you also will not have any protections in the case of downside as all the risk is on your shoulders.
This form of funding will be suitable for whatever your personal circumstances will bear, but is most typical for sums under ~ $500,000.
Professional Transaction Fees: 0-$
Information Requirements 0 /+
Investor controls: 0/+
Friends & Family
This is how the majority of start-ups start out because friends and family are (almost always) supportive of the new biz concept, can vouch for your lifelong work habits and generally do not care about rigorous reporting or accounting practices; because of their long-held trust in you, may not want to be involved in the biz on a regular basis. The transaction is easy to structure and minimal negotiation is required. You will have to share future cash flows with them in the form of interest and principal payments (if you structure as debt) or distributions (if you structure as equity) but they are likely to require a lower return on their investment than actual “outsiders” because their perceived “risk” is lower. In short: this route is the cheapest form of capital.
This form of funding will be suitable for whatever your personal network can offer, but is most typical for sums from $100,000 to ~ $2,000,000.
Professional Transaction Fees $/$$
Information Requirements +
Investor controls +
Angel investors are the next level of formality after Friends and Family. This group tends to be made up of wealthy individuals who enjoy the thrill of the “bet” on you as a Founder and Manager, as much as the actual return on investment they stand to gain. They are usually senior biz people who are accustomed to these ‘angel” arrangements and make a high volume of small investments in early state companies. Because they are outsiders, they will take a bit more information sharing up front and on an ongoing basis. The relationship will require more diligence than Friends and Family but Angels will not expect to have any control nor interest in the day- to- day operations of the biz.
How do you find your Angel? Ask around. Start with your friends and family for referrals to their biz associations and friends. Your peers in banking or the law may have senior people in their firms from whom you can seek advice and connections; your alumni network may have similar recommendations. Before your deal is finalized, you may want to “check out” your Angel with other Founders they have backed, just to make sure that what-you-see-is-what-you-get with the Angel’s support and encouragement to accompany their investment dollars.
This form of funding will be suitable for whatever your personal network can offer.
Professional Transaction Fees $$
Information Requirements +/++
Investor controls +/++
Small Business Administration
The United States Small Business Administration (SBA) supports several programs from which you might benefit. They also provide attractive capital to private equity and venture firms investing in qualifying small businesses through the SBIC program. SBA funding is likely to be increased over the short term to spur job growth since entrepreneurship fuels economic growth – two key objectives of President Obama’s administration over the short term. Because the SBA mitigates part of the risk of investing in a small business, banks and investment firms (you don’t get cash directly from the SBA) who partner with the SBA will offer you better terms than those who do not.
Professional Transaction fees $$$
Information Requirements ++
Investor Controls ++
The main benefits of Debt include maintaining operating control and future upside profits as well as tax write offs for interest paid (assuming you have positive Taxable Income). These attractions sound very appealing, but Lenders do require you to be in compliance with your credit agreement terms, any “covenants,” and specific biz targets that you determine up front. Whereas in an equity arrangement, you get the capital and don’t owe it “back” in any specific time frame or amount, with Debt you start paying interest and premium IMMEDIATELY and on a set schedule. So, given that you have to start re-paying the amount you just borrowed right away, Debt works best if you have stable consistent cash flows that will comfortably allow you to make regular payments.
Unless your loan is held by an individual who knows you well, you will have to provide significant information about your biz recent performance (typically, the past 3 years), a strict biz plan (including projections for next 3 years), your company’s assets (such as the value of your inventory details with aging) your company’s liabilities, your personal background, etc. to obtain the loan. Going forward you will then need to provide a more limited set of this information on a regular basis so the lender can keep active tabs on your biz.
If something were to go awry while a portion of the loan was still due, the debt holder always comes first in a payout of whatever was available, and so would get paid back before any equity holders in a bankruptcy proceeding. But, assuming a successful outcome when the loan is repaid, you own and control the company just as you did before you took the loan out and all profits are yours to keep.
This structure is can be used in transactions of any size.
Professional Transaction fees $$$$
Information Requirements $$$$
Investor Controls $-$$$$$
Equity is a much more flexible device than debt – you pay back what you can, when you can, in the form of dividends – but in exchange, you permanently give up a slice of your upside by offering the investor a piece of your biz. In addition, you cannot write off dividends on your taxes, so this option does not shelter any income. Equity holders may also require you to give them significant control (e.g., as extreme as the right to be able to fire you) and will play a more active role in the business (likely requiring regular reporting, Board of Directors meetings, informal discussions and Q&A, etc) These involvements can be either good (they have valuable experience, complimentary skills or customer connections to offer and are genuinely supportive of your biz ) or bad (they distract you, and consume staff time in preparations).
Equity works best if you are in an early growth phase and do not have significant positive income or steady cash flows and if you can find a partner who can add value to your business with more than just a check. Investment agreements can take as much or more information sharing as debt to obtain the equity and will require consistent reporting and information sharing down the road as well. When it comes time to distribute excess cash or proceeds from the sale of the company, remember that you will have to share these dollars with your other equity holders in the proportion you originally agree. If you give up more than 50% of your company, and thus become a “minority owner” you might not even get to have the final say when the company is sold.
This structure can be used for transactions of any size.
Professional Transaction fees $$$$
Information Requirements $$$$
Investor Controls $-$$$$$
Do not forget that your trade partners (e.g., vendors, landlords) can also act as sources of funding. Given the state of the real estate market, landlords may offer several months of free rent and often even capital subsidies to set up your office space. In addition, to win new business, vendors may be willing to extend you payment terms to help you get the biz going. You can also use “bartering” in creative ways to lower initial cash outlays. If you are a graphic designer, pair yourself up with a supplier to your company who needs a new web site design and “exchange” your skills for what you need from them—no cash outlay. Or, reward another supplier with product or office design services if that is your trade.
Professional Transaction fees 0
Information Requirements 0
Investor Controls 0
Other sources of capital include mezzanine, private placements of equity and debt and public offerings of equity and debt but very rarely will these forms be available early on, as they require a track record of performance and assets. The majority of firms and available money in this space focuses on mid- to large-cap companies (>$100M). There are boutique private equity firms and investment banks that specialize in specific industries and smaller deal sizes.
Whatever source of funding you seek, please consider that “there’s no free lunch” in bizness (well, unless you barter your design services with a caterer) so therefore be thoughtful in your motivations and considerations for raising money. Asking another person, or company, to share in the risk of your enterprise does entitle them to varying degrees of involvement—from profit sharing (the upside) to information flow, even to exertion of controls as to how the day-to-day biz is run. Balance is critical between the amount of money you seek and the amount of the other elements you may have to give up to get it. You need to agree long-term financial and strategic support from whomever lends you money, in what ever structural form, and to do so in a ways that leaves you feeling motivated and sufficiently independent, in addition to being just well-capitalized. Successful transactions result from balancing these perspectives and you will want to seek advice from other small biz owners (even in non-creative fields) as to how they fared with these different forms of capital sources in their own entrepreneurial experiences.
ABOUT MEG TOUBORG
Meg combines her love of design, fashion and culture into her career as “the business side of creative people and entrepreneurs.” Her past roles have spanned from product development, to sales, to operations and marketing and licensing for premium brands such as Saks Fifth Avenue, Coach, Kate spade and Waterworks. She has three children and enjoys involvement in the public schools. In 2007, Meg became an entrepreneur herself and with her business partner, founded Design Investors LLC in Westport, CT.
ABOUT AMANDA ALLEN
Amanda brings the rigorous discipline of a prior career in investment banking for consumer goods companies to Design Investors, where as Vice President of the firm she assists companies in their financial and operational needs, and researches opportunities in the design marketplace. She and her husband live in Connecticut where she enjoys hands-on decorating and renovation projects, encouraged by their two dogs Stella and Brutus.
ABOUT DESIGN INVESTORS LLC
Design Investors LLC was established with a singular objective: to support the growth and profitability of the design industry’s most promising products, business services, and media companies. The firm partners with founders and management teams of portfolio companies to infuse creativity with capital, and reinforce business plans with an extensive resource network and many years of relevant management experience. Appreciating the unique vision and opportunities available to each investment, Design Investors works side-by-side with companies to maximize value through building market leadership positions. www.designinvestors.com