Why Entrepreneurs Spend So Much Time Raising Money
This is a guest post by Robert Calvin, Adjunct Professor of Entrepreneurship and Marketing at the University of Chicago Booth School of Business, who is teaching the upcoming course Funding Your Venture.
As an entrepreneur, wouldn’t you rather spend your time in sales, marketing, or operations than in raising debt and equity financing for your business?
Most small business people and entrepreneurs do not have a five-year plan for funding their enterprises. They think about funding on an annual basis. Most small business people and entrepreneurs do not understand how to target value-added banks and equity investors which are most appropriate for the seed, early, and growth stages of their business and do not have an understanding of sources of equity funding for the five rounds, which will be necessary.
Sources of debt financing in the seed stage include credit cards, asset-based lenders, and leasing. Then in the early and growth stages, sources shift to banks, government agencies, micro loans, better supplier terms, and possibly customers. For equity financing in the seed stage, rounds one and two, the best sources are friends, family, founders and proper pricing to maximize cash flow. Then in the early stage, rounds 3 and 4, the sources expand to include employees, angels, and crowd funding. In the growth stage, round 5, professional investors such as private equity and venture capitalists become sources along with a possible public offering and overseas investors. If you do the early rounds correctly, the later rounds are easier.
In looking for banks and equity investors, you want to target those who can add value through industry knowledge, contacts, and the ability to participate in future rounds. Entrepreneurs need to think about what percentage of their business they want to own in five years.
To estimate your funding requirements, do a rolling best and a worst-case annual cash flow analysis with assumptions for the next five years. Forecast short term funding needs by analyzing the marginal dollars of working capital (accounts receivables & inventory) needed for each marginal dollar of revenue generated.
Understanding what smart bankers look for will increase your probability of success in raising debt funds. Bankers are interested in the six Cs: Cash Flow, Collateral, Capital, Character and Competence of management, and Conditions within the industry (markets and competition). Once you obtain a bank loan keep in mind that bankers do not like surprises so do not hold back bad news.
Understanding what smart investors look for will also increase your probability of success in raising equity funds. Equity investors are most interested in management’s industry and entrepreneurial experience, management’s ability to execute, market size and growth, scalability, competitive differentiation and pricing power. For investors to be comfortable they need a variety of cash flow projections. Their expected returns will be based on the businesses critical risks and the length of time from investment to exit.
To learn more about how to raise money for your business, consider taking my next course in March, entitled Funding Your Entrepreneurial Venture, where you’ll get more insights and have an opportunity to meet and collaborate with peers. Sign up here, and I’m looking forward to having you in my class.