With so many alternative financing options now available, you may assume that raising capital to grow your company isn’t as tough as it was back when traditional banks dominated small-business lending.
However, 43 percent of the respondents to a 2012 National Small Business Association survey [PDF] said that, at some point during the past four years, they needed funds to support their businesses and failed to find any source. No loans. No investors. No credit cards.
Here are some do’s and don’ts for avoiding the common mistakes that many entrepreneurs make when raising capital.
DON’T skip the fundamental planning steps.
While conducting research for the book Heart, Smarts, Guts, and Luck, co-author Anthony Tjan found that up to 70 percent of entrepreneurs he surveyed had exited a business successfully (through an IPO or a sale to another firm), despite the fact that they lacked a business plan when they started the company.
However, if you need to generate capital, a formal business plan is typically required by banks, private lenders, or venture capitalists. Why? Nancy Butler, a certified financial planner and founder of Above All Else, Success in Life and Business, explains that a business plan addresses important financial questions, such as the amount you need to borrow, what you need it for and when, as well as how to manage risk, how much you can afford to lose, and how you’ll repay money you borrow if the company doesn’t succeed.
DO know that personal and business finances intertwine.
You may intend to use your legal business name and EIN for all of your business-related bank accounts, credit cards, and financing. But when your business is less than three years old and/or lacks its own solid credit history, your personal credit often determines your ability to secure business capital.
Preparing your personal credit before applying for business capital can stack the deck in your favor. Check your credit report for free on AnnualCreditReport.com, and take note of the key factors that influence lending risk, including bill payment history and your debt utilization ratio. (Tip: If your debt utilization ratio exceeds 30 percent, pay down personal debts before you apply for business capital to boost your chances of approval.)
DON’T underestimate how much capital you need.
Seeking sufficient capital from just one or two (vs. various) lenders not only ensures that you have the resources you need to fuel growth, but also helps to protect your credit score. That’s because every time you submit a loan application to a lender, you authorize an inquiry onto your credit report. Too many inquiries can hurt your credit — and signal that you’re desperate for cash.
DO objectively determine what the business is worth.
You need to know what your business is worth in order to determine how much you’re able to risk. Naturally, you can turn to a professional valuator. But if your startup is small, you can probably arrive at some rough figures on your own. Start with these questions: How much is the company worth today? How much could it be worth in the future? How long will it take to create the future value? What is the likelihood of achieving success? (CNN Money also offers this convenient calculator.)
Your valuation also plays a role in the type of capital you use. For example, some lenders may require that you act as a personal guarantor to your own business’s financing, using your personal assets (home, car, savings) to back the loan if your company isn’t worth a lot or the business fails.