Q: Whether a small business loan, venture capital or an investor, what should I be aware of when seeking outside financing for my business?
Richard Lowe, owner
The Writing King
A: These are very different sources of financing, which have different terms and expectations. Whatever source you use, you are giving up control and giving them a voice in your business. Are you ready for that?
Venture capitalists (VCs) make equity investments in a very select group of very high potential businesses. They expect to exit in three to five years for 10 times their investment. Taking VC money means you are building your company to sell. The terms of these deals are complex, so obtain good legal counsel.
Banks issue loans with terms and covenants. Terms specify interest rates, length of the loan, collateral, personal guarantees, etc. Covenants stipulate liquidity ratios, debt ratios, cash balances, etc. Failure to meet these terms will allow the bank to call the loan. Most small business loans require a personal guarantee, which puts your wealth and home at stake.
The term “investor” covers a broad spectrum, but we will break them into two categories — friends and family and business angels.
Friends and family are the most common investors. Terms vary widely. For family and friends, the real considerations are fairness, their risk tolerance and the risk to your personal relationships. Friends and family frequently invest at the worst times — early stages or during crisis — and under poor terms, so you need to think carefully about who you take money from.
Ask yourself a few questions: Can they afford to lose what they are offering? Can they tolerate the risk? How and when will you repay them? Can they wait long enough? Can you stand them having a say in your business? If you lose the money, how much damage will be done?
Angel investors are high-wealth individuals. Terms vary from convertible debt to various types of equities. They are generally long-term investors (three to five years), but they are looking for substantial return. Again, get legal advice. You want more than just money from an angel. Will he or she make your business better?
David Deeds is a professor of entrepreneurship at the University of St. Thomas Opus College of Business.