Contrary to popular belief, business plans do not generate business financing. It’s true that there are many types of financing options that require a business plan, but no one invests in a business plan.
Investors need a business plan as a document that communicates ideas and information, but they invest in a company, a product, and people.
Myths About Small Business Financing:
Venture capital is a growing opportunity to finance companies. In reality, venture capital funding is very rare. I’ll explain later, but let’s assume only a few high-growth plans with high-powered management teams are risk opportunities.
Bank loans are the most likely option to finance a new business. In reality, banks do not finance the creation of companies. I’ll have more on that later, too. Banks are not supposed to invest depositors’ money in new businesses.
Business plans sell investors. You don’t really have a well-written, compelling business plan (and pitch) that can’t convince investors of your business idea, but you’ll also have to convince those investors that you’re worth investing in. When it comes to investment, it is as much about whether you are the right person to run your business as it is about the viability of your business idea.
I’m not saying you shouldn’t have a business plan. Should. Your business plan is an essential piece of the financing puzzle, as it explains exactly how much money you need, where it will go, and how long it will take to earn it back. Everyone you talk to will expect to see your business plan.
But depending on what type of business you have and what your market opportunities are, you need to tailor your funding search and approach. Don’t waste your time looking for the wrong type of financing.
where to look for money
The money search process must match the needs of the company. Where you look for money and how you look for money depends on your business and the type of money you need. There’s a huge difference, for example, between a high-growth Internet-related company seeking second-round venture financing and a local retailer looking to finance a second location.
In the following sections of this article, I’ll talk more specifically about the different types of investments and loans available to help you finance your business.
1. Venture capital
The venture capital business is often misunderstood. Many start-ups resent venture capital firms for not investing in risky startups or ventures. People talk about venture capitalists like sharks, because of their supposedly predatory business practices, or sheep, because they supposedly think like a herd, all wanting the same kind of deals.
This is not the case. The venture capital business is just that, a business. The people we call venture capitalists are business people tasked with investing other people’s money. They have a professional responsibility to reduce risk as much as possible. They should take no more risk than is absolutely necessary to produce the risk/return ratios required of them by the sources of their capital.
Venture capital should not be considered a source of funding for any but a few exceptional start-ups. Venture capital cannot afford to invest in startups unless there is a rare combination of product opportunity, market opportunity, and proven management. A venture capital investment must have a reasonable chance of producing a tenfold increase in market value within three years. You need to focus on newer products and markets that can reasonably project sales to increase by huge multiples in a short period of time. You need to work with proven managers who have dealt with successful start-ups in the past.
If you’re a potential venture capital investment, you probably already know this. You have members of the management team who have already been through it. You can convince yourself and a roomful of smart people that your company can grow tenfold in three years.
If you have to wonder if your new company is a potential venture capital opportunity, it probably isn’t. People in new growth industries—multimedia communications, biotechnology, or the far reaches of high-tech products—are generally aware of venture capital and venture capital opportunities.
If you’re looking for names and addresses of venture capitalists, start with the Internet.
The names and addresses of venture capitalists are also available in a couple of annual directories:
The Western Association of Venture Capitalists publishes an annual directory. This organization includes the majority of California venture capitalists based in Menlo Park, CA, which is home to a staggering percentage of the country’s venture capital firms.
Pratt’s Guide to Venture Capital Sources is an annual directory available online or in print.
2. Type of venture capital: Angels and others
Venture capital is not the only source of investment for new or small companies. Many companies are financed by small investors in what is called a “private placement.” For example, in some areas there are groups of potential investors who meet occasionally to listen to proposals. There are also wealthy people who occasionally invest in startups. In start-up lore, groups of investors are often referred to as “doctors and dentists,” and individual investors are often referred to as “angels.” Many entrepreneurs turn to friends and family for investment.