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Business

2006-11-01 08:37:00

Start up your business

Where do 'start-ups' get money?

ANSWER: YouTube, an internet video sharing phenomenon, landed millions in venture capital money in its first year to expand so fast that its founders were able to sell the video-sharing company to Google this month for $1.7 billion. For most entrepreneurs, however, venture capital isn't an option. Venture Capitalists, investing for institutions and rich individuals, likely will invest in fewer than 3,400 of America's more than 20 million small firms this year. Instead, a significant majority of founders reach into their own funds or turn to family members, who provide nearly $60 billion a year in start-up and expansion funding. Most of today's new businesses typically sell a service, like bookkeeping or consulting, so require little more than a moderately expensive computer, a low end fax/scan/print/copy machine, and a home office. Even trendy start-ups, such as the example I sighted earlier, YouTube, get going with a handful of computers lashed together in a garage. A recent survey of small business owners conducted by Wells Fargo Bank indicated start-up costs averaged a mere $10,000 - exactly what Rita Reed needed to found her customer service consulting firm in Chicago. She tapped personal savings to buy a PC, stationery and other supplies to launch Stage Presence a year ago. Many entrepreneurs "bootstrap" their way into business to keep control over ownership and to maximize profit if they sell their firms, says William Payne, an entrepreneur near Las Vegas who now invests in start-ups. "The object of the game is to keep as much of the company as you can," says Payne, who consults for the Ewing Marion Kauffman Foundation, a non-profit advocate in Kansas City for entrepreneurs. Here's a brief look at three of the most common sources of start-up and expansion capital for small businesses: Personal assets, Small Business Administration study published last month says close to 57% of entrepreneurs used personal or family savings to pay for their company's launch. Banks and other investors are more likely to bet on a company's future when founders have risked their own money first, have good-excellent credit rating, and plenty of collateral to secure the debt. Using savings, instead of borrowing, keeps overhead down during the early years when entrepreneurs don't know whether they'll have enough revenue to service debt, is the advice of Rebecca Macieira-Kaufmann, head of the Small-Business Division of Wells Fargo. For example, YouTube's founders relied on their own money to jump-start the company early last year before they attracted $11.5 million from venture-capital firm Sequoia Capital. In 2003 an Atlanta based communications firm, Write2Market, took the "bootstrap" path to launch its efforts. The owner rented out her home, then moved into a brother's basement apartment to minimize living expenses. That move helped generate the $50,000 needed for computers, software and a website. Write2Market now has 10 employees writing brochures and direct-marketing materials for midsize and larger clients, including ADP, the payroll processing giant. Family and friends, the $60 billion a year that family members and friends invest in U.S. start-ups range from loans to gifts, averaging about $23,000 each, concludes an ongoing study of U.S. and foreign entrepreneurship underway at Boston's Babson College, citing figures from 2005 and 2004. Family money is the biggest chunk of the overall $100 billion in annual informal investing in start-ups. In fact, $75 billion in annual start-up money comes from family members and/or, friends, neighbors or business associates. The rest comes from the professional venture-capital industry, now investing around $25 billion each year. Family investments are often very informal. A family member, friend, or neighbor may give you strings-free money to start a business. Although the gift will most likely be repaid at some point in the near term, it's still wise to create some type of document spelling out the details of even the most informal of investments. Finance experts urge entrepreneurs and their family/friend investors to draft documents specifying whether the money is a loan, gift or purchase of company stock. In doing this important step, the entrepreneur protects relatives and friends who might want to write off the investment if the business fails. The document also acts to protect everyone by detailing what share they own if the business succeeds and/or is sold. A loan agreement also lessens the risk of default by setting a fixed repayment schedule. Commercial loans, banks finance start-ups when owners have a solid credit history, related experience and can offer collateral such as a home. About 12% of entrepreneurs relied on a bank loan for start-up money, the SBA study found. Wells Fargo's small-business loans average $30,000 to $35,000 each, says Macieira-Kaufmann. That's often plenty for a typical small business, such as a flower shop, law firm or consultant, she says. More capital-intensive companies, such as manufacturers or a big restaurant, often turn to taxpayer-backed bank loans of up to $2 million through the SBA. The federal agency guaranteed 97,290 loans, averaging $145,000 each, in the fiscal year ended Sept. 30. About one-third were for start-ups according to the SBA's loan programs division. The SBA guarantees repayment only in the event of a default, after the loans are made by approved lenders. As with other lenders, SBA lenders do not approve everyone who applies. Which applicants are SBA's lenders likely to reject? Those without related work and/or business experience, a formal business plan and money of their own to risk in the venture. A good axiom to remember when you're asking lenders and taxpayers to take a risk is, "An entrepreneur must be willing to put their own blood, sweat, tears and money into the venture, too". Finally, getting money to start your business is no easy task. There's no magic wand to wave that will make bags of money appear at your feet. An entrepreneur must diligently search not only their own assets, but those available within their community. The Small Business Solutions Center in Wichita can be a big help, where an enterprising individual can access all the help they may need. Assistance in building business plans to suit target funding resources, legal advice, accountants, strategic planning, business organization, branding/marketing, banks and private capital sources, are but a sampling of the resources available through agencies such as this. It's hard enough to bring a business inspiration from the recesses of your mind to the austere pages of a workable plan. Seeking out an entity to help you achieve your dream makes it much easier and helps you keep your focus on the big picture...the dream. If I have only one thing to advise it would be this...get help. No one makes it through this life, business or otherwise, without help from someone. Aligning with capable people and learning how to get the best from them will accelerate you on your road to success. That advice is also echoed by Bill Gates and Warren Buffet, folks who ought to know.