Few startup companies actually launch without the help of outside investors. Which one you choose can also determine what type of entity you form. Here are a few investment guidelines for rising entrepreneurs.
Know Your Budget
Startup costs depend on your particular product or service and how many staff members you’ll need up front. If you plan to sell software, for example, you’ll have to pay developer costs before you actually have a product to market. If you’re opening a retail store, consider how many initial sales you must make before your revenue will start to cover your expenses. The amount you request for funding will largely determine what kind of investors are willing to jump on board.
Know Your Requirements
Hard currency is not the only kind of available capital. Some investors specialize in securities, equity, commodities or real estate. For example, you may have $30,000 in savings to put toward your retail venture. If you have an investor willing to front you a building location, you can direct those personal funds toward inventory or other areas.
Know Your Audience
Most small business owners in need of startup money will look to one or more of the following investors:
- Banks: This is typically the first choice, particularly for small-scale ventures. Plus, the Small Business Association guarantees a number of specialized lender programs, including 7(a), 504 and Microloan. Consider choosing a bank with which you’ve already established a history.
- Venture capitalists: Much of Silicon Valley is funded by venture capital. You will need a high-tech product or a solid business model. These investors are interested in equity and steep returns, so be prepared to give up partial ownership.
- Angel investors: These are wealthy individuals looking for ownership equity, and all candidates will need to establish an online profile. Unlike venture capitalists, angels invest their own funds, and most agreements involve convertible notes.
- Personal investors: This can be a risky move, but many companies begin with funds provided by family or friends. Just be sure your connections are strong, and always sign a promissory note. You may consider finding capital through sites like Lending Club. Think of this as Facebook for financing. Peer-to-peer lending simply connects investors to businesses through the web.
Know Your Commitment
Not all investors work like banks. Moreover, many do in fact want to get rich quickly. Anyone who fronts you money will expect a financial return in the near future, and in many cases, part ownership. For example, as a sole proprietor, you’ll probably have a hard time convincing an investor to fund you without making him or her a partner. If you incorporate, however, the investor has the opportunity to become a primary shareholder. A common dilemma is choosing to incorporate over remaining a member-based LLC. Always consider the exit process, especially if you plan to grow quickly and actually sell. You’ll face double taxation as a corporation during an asset sale, while LLC members only pay personal taxes with pass-through gains. For example, assume you sell your tech company after five years for $50 million. At a 28 percent individual tax rate, LLC owners would walk away with $36 million. A corporation, on the other hand, would need to exit at closer to $100 million for the same after-tax gain. Historically, venture capitalists have favored corporate structures over LLCs because venture funds are tax-exempt. However, fewer startups today are exiting through IPOs. Plus, an investor can easily set up a blocker corporation as a tax shield.
Know Your Pitch
You will likely speak with several dozen potential investors, so be strategic about your focus and approach. These people are hit up all day long, and first impressions are everything. Be prepared with a thorough financial analysis and forecast, and show some concrete figures when discussing potential returns.
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