This article originally appeared in the January 2016 issue of 425 Business.
Traditional bank loans always are an option, but creative financing alternatives also exist for those who need to fund a business
Starting a business is a risky venture. Startups in need of funding can’t necessarily go to their local bank and get a loan, so what is a budding entrepreneur who has exhausted his or her personal and family resources to do? Business owners may be aware of the many different financing options out there but might not understand which ones are best for them. We hope we can shed some light on financing possibilities for those who may be in need of capital to turn their dreams into reality.
Many people assume that bank funding is not available to startups because banks tend to require three years of financial data before they will grant a loan, but some banks do finance startups. If your bank isn’t one of these, perhaps it’s time to switch banks.
The Small Business Administration (SBA) is one possible resource if your local bank says no. In 2015, it launched an online tool called LINC, with which businesses can register and connect with lenders who participate in the SBA’s Microloan, Community Advantage, 504, and 7(a) lending programs. These loans can be used to start a business, to buy equipment, or to provide working capital.
Microloans can range from $500 to $20,000 for startups, or up to $50,000 for established businesses, and can be a good option for those who don’t qualify for traditional funding. Entrepreneurs who come prepared with a strong business plan and background in their field are most likely to get funded.
For businesses that need up to $250,000 in capital, private lenders are “coming in to fill the void left by traditional banking,” said Brent Hall, CEO of Pinnacle Capital Partners. Private lenders may charge higher interest rates than banks, but funding is usually available within 48 hours, which can be critical for businesses that need a short-term loan while waiting for receivables.
Pinnacle’s niche expertise in the beverage industry meshes well with local growth in microbreweries and distilleries, which are often very small businesses that need substantial funds for manufacturing equipment. Despite the availability of various loan programs, some businesses still don’t qualify or need additional funding. There are many alternatives out there, including crowdfunding, angel investing, venture capital, and creative ways to leverage retirement funds.
Crowdfunding seems like an easy answer. Simply set up a campaign with Kickstarter, Indiegogo, or GoFundMe, and the funds will come pouring in, right? Not necessarily.
True, Seattle-based Glowforge recently made crowdfunding history by bringing in nearly $28 million for its 3D laser printer in 30 days, a Kickstarter record. By that standard, it would seem that raising $100,000 should be easy. The truth is that less than half of crowdfunding campaigns reach their goals. On smaller platforms, the statistics are more sobering — about 10 percent of campaigns hit their mark.
“Gone are the days when you can just put up a campaign and say, ‘The crowd will fund me,’” said Domonique Juleon, a business consultant who helps clients find crowdfunding opportunities. “It’s not a magic bullet.” But crowdfunding can allow a business to access capital it might not otherwise be able to get, Juleon said.
The secret sauce behind successful crowdfunding drives is marketing. Glowforge owes its success to a brilliant marketing campaign that capitalized on 3D-printing hype, even though its product, which uses a subtractive laser etching process, technically is not a 3D printer.
Many people assume that crowdfunding is all about the rewards model — individuals put up cash to get the latest technology, often at a hefty discount from the post-campaign retail price. These investors don’t worry about the long-term prospects of the company; they invest just because they like the product and want to be first to own it.
But some crowdfunding platforms are based on equity or debt financing. Seattle-based Community Sourced Capital offers crowdfunded, no-interest loans. So-called “squareholders” buy $50 “squares” that are pooled to create loans up to $50,000. Funded businesses pay a modest startup fee of $250, which pays for marketing, and $50 per month for the duration of the loan. Community Sourced Capital claims that 90 percent of applicants are funded, and 98 percent of recipients pay back their loans in full.
Equity-based crowdfunding became legal in Washington in November 2014, and the Securities and Exchange Commission in October finalized its crowdfunding rules. In reality, though, equity crowdfunding has not caught on, so companies interested in offering equity probably would be better off seeking angel investors.
At a certain stage of development, typically once an entrepreneur has raised on the order of $100,000 to $1 million from friends, family, outside fundraising, it may be time to seek angel investors to provide funding in exchange for equity.
Any individual with $1 million in net worth or $200,000 of annual income qualifies as an accredited investor. The Eastside is home to quite a few of these folks, but finding an angel investor isn’t a matter of knocking on the doors of lakefront properties. While it is possible to find a solo angel who will finance a funding round, a more likely scenario in the Puget Sound is getting help from a group of angels. In these collections, multiple investors chip in designated amounts — usually between $5,000 and $20,000 a piece — and the group decides how to allocate the fund.
Angel groups function similarly to equity crowdfunding, but there is an important distinction. While anyone may contribute to a crowdfunding campaign, most angel groups require members to be accredited investors. Because the group pools money up front, the funds are guaranteed.
Regardless of whether you are approaching one angel or a group, it is important to be prepared. Only 2.5 percent of businesses receive angel investments; simply having a good idea isn’t enough anymore.
“We expect people to have traction in the marketplace before they ask for money,” said John Sechrest, founder of the Seattle Angel Conference, which runs conferences and workshops for entrepreneurs and investors.
Investors are most interested in funding businesses with the resources to act on the founder’s vision and the potential to scale. It is important to prove that the market cares about your product. Many angel groups are geography- or sector-specific, which is something to consider when deciding where to pitch. For example, the Seattle Angel Fund looks for growth-oriented companies in the Pacific Northwest.
Using Your Own Money
Most investors expect a founder already to have used his or her personal finances to fund company operations. An entrepreneur who owns a home will likely need to use it as collateral when applying for a loan.
Retirement accounts are generally off limits as collateral, but there is a way to make use of a 401(k) or an IRA without tax implications. Bellevue-based Guidant Financial helps entrepreneurs secure funds by rolling over existing retirement accounts into a new 401(k), called a Rollover for Business Startups (ROBS), that can invest in shares of their business. This option is open to both independent startups and franchises.
Even though creating a ROBS account is not a taxable event, this strategy is not without risk. If the business fails, those retirement funds are gone.
Around 600,000 startups incorporate in the U.S. each year. Of those, roughly 25 percent get outside funding. It is necessary to have a strong business plan and be able to demonstrate a viable market for your products or services if you wish to receive financing. Once you can do that, investigate funding options, focusing on those that work with businesses like yours, and be open-minded about alternatives.
The money is out there, but it takes work to secure it.