ANGELS AND VENTURE CAPITALISTS



SMALL BUSINESS FINANCE

The United States Small Business Administration (SBA) estimates that, as of 2003, there were approximately 23.7 million small businesses in the United States. The SBA defines a small business as "an independent business having fewer than 500 employees." Small businesses represent over 99 percent of all employers, and they employ more than half of all private sector employees. Moreover, small businesses employ about 40 percent of all high-tech personnel such as scientists, computer workers and engineers. These firms create anywhere from 60 percent to 80 percent of net new jobs each year, and they represent 97 percent of all exporters of goods. Small business create more than 50 percent of the private gross domestic product, and they pay about 45 percent of the total United States private payroll.

Clearly, small businesses play an important role in our business economy. It is important to note, however, that two-thirds of new small businesses survive at least two years, and about half survive at least four years. Owners of about one-third of the firms that closed said that their firm was successful at closure. Major factors contributing to a firm's success include an ample supply of capital, the fact that a firm is large enough to have employees, the owner's higher level of education, and the owner's reason for starting the firm in the first place, such as freedom for family life or wanting to be one's own boss.

As noted above, a firm's supply of capital is often a major factor in the firm's ability to survive. Consequently, business owners place a substantial emphasis on finding sources of funding for their business. Capital is typically defined as any asset that can be used to generate resources for the business. Capital for most businesses is generally comprised of some combination of cash, inventory and fixed assets.

PLANNING FOR A FIRM'S CAPITAL NEEDS

When starting a business, business owners typically need three types of capital—working capital, fixed capital and expansion capital. Working capital supports a business' short-term operations, and it represents a business' short-term source of funds. It may be used to purchase inventory, pay bills, or take care of other unexpected emergencies. Fixed capital represents those funds that a business needs to purchase land, buildings, equipment, machinery, furniture or other fixed assets that will be used in the business. While working capital supports the business' short-term needs, fixed capital supports the business' more permanent needs. Businesses need expansion capital when they seek to finance growth, expansion, or other long-term initiatives.

SOURCES OF CAPITAL

As business owners assess their needs for all types of capital, they must also assess what sources of capital are available to them. Conventional wisdom has often noted that many start-up businesses tend to secure their capital from the four F's: founders, families, friends and fools. This humorous observation, while bearing a nugget of truth, merely scratches the surface when looking at all of the sources of financing available to businesses in need of capital.

Some businesses owners choose to finance their businesses with debt. Debt financing is capital that a business owner has borrowed and must repay with interest. Debt financing may include traditional bank loans, credit card debt, lines of credit, unsecured loans, financing from commercial finance companies, insurance policy loans, securing trade credit and Small Business Administration Loans.

Many business owners, however, are uncomfortable with debt, and they choose to pursue sources of equity financing. With equity financing, the people or entities who contribute capital to a business do so in exchange for a share of ownership in the business. The business owner gives the equity investor a share of ownership in the business since the equity investor is assuming the primary risk of losing his or her funds in the business. If the business fails, all of the equity investors lose their investments. If the business succeeds, the founders and equity investors share in the benefits.

The types of equity investors that business owners typically pursue include themselves (via their personal savings), family members and friends, partners, share-holders, angels and venture capital investors.

ANGELS

Angels tend to be wealthy individuals, many times themselves entrepreneurs, who invest in new businesses in return for equity ownership interests in these new businesses. It is important to note, however, that angels do not make these investments out of the kindness of their hearts. Angels tend to be extremely savvy business men and women who seek to take calculated risks with business ventures that might enable them to generate tremendous gains when the businesses in which they invest "take off." Angels represent an outstanding source of financing for businesses that have grown too large to be financed by family and friends, but are still too small to attract the attention of venture capitalists.

Angels fill a substantial need in the capital market for young businesses. Typically, angels will finance new businesses with capital needs in the range $10,000 to $2 million.

ANGEL-HUNTING TIPS

  1. Business angels are looking for investments capable of achieving a return of 20 percent or more, so make sure you can achieve this before you waste time chasing investors.
  2. Angels tend to invest locally, so start your search within a 50-mile radius of your business premises.
  3. Concentrate on successful individuals within your industry since angels prefer to look for investments in industries they know something about.
  4. Use any contacts and networks you may have.
  5. It may take six months to a year to find the right investor and another three to six months to negotiate the deal. Don't pressure investors—they may walk away.
  6. The first meeting is the most important because business angels tend to place emphasis on the entrepreneur and management team and how well they will be able to work with them.

Joanie Sompayrac

FURTHER READING:

Karlsgaard. "Dollars from Heaven: A Choir of Angels Bedevils the VCs." Forbes, 1 June 1998, 23.



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