Four sources of investment capital for early-stage businesses

By Kevin Learned - Special to the Idaho Statesman
Published: 04/06/11

All businesses pass through a period when the business is spending more cash than is coming in. We call this time the Valley of Death, because if the business doesn’t reach a point where more cash is coming in than is being spent, it will die.

A common misconception is that banks will lend money to cover the shortfall. This is not the role of banks. They finance only businesses with a history of profitable operations. Early-stage businesses must look to other sources, typically equity capital.

Equity capital is risk capital. If the business does not succeed, the capital will likely be lost. If the business succeeds, the capital will earn a share of the profits.

Generally, there are four sources of equity capital, listed here by ease of access:

1. FOUNDER’S SAVINGS. This is the cheapest capital a business can have. It comes without having to share interest in the business. Frequently, no one else will accept the risk, so it may be the only capital available. And any other investor will reasonably expect that the founder has invested his or her savings. If the founder doesn’t have the confidence to commit savings, then why should a nonfounder accept this risk?

2. FAMILY AND FRIENDS. Family and friends invest because they have confidence in the founder. Often they are not experienced business people, and typically they will not do hard economic analyses. Family-and-friends capital is a mixed blessing. It may be relatively easy to raise, but in my experience, there is no pressure like that of knowing your family or friends will lose their money if you don’t succeed.

3. ANGELS. Angels are high-net-worth individuals who invest a portion of their own capital into businesses. They typically invest not just to make money, but because they like to help entrepreneurs. They will do economic analyses and will negotiate terms of their investments. They will invest only in opportunities they believe have an excellent chance of success. The Keiretsu Forum and the Boise Angel Fund are angel groups that accept applications from Idaho companies.

4. PROFESSIONAL CAPITAL. Often referred to as “venture capital,” this money is invested by professionals who make their living by investing in early-stage businesses. Typically, but not always, venture capitalists invest later in the business cycle than the above three types do. Highway 12 Ventures is a Boise venture-capital firm that accepts applications from Idaho businesses.

Raising equity capital is tough for a new business. Successful fundraising requires planning and perseverance. The entrepreneur must have identified a business problem for which there is no optimal solution, must have a product or service that can profitably solve the problem, must have a viable plan to get the product to the market, must persuade investors that he or she can execute the plan, and must present a deal to the potential investors that will allow them to make a profit in line with the risk they assume.

Kevin Learned is a counselor at the Idaho Small Business Development Center, a member of the Boise Angel Fund and a member of the Finance Committee of the Idaho Technology Council.

kevinlearned@boisestate.edu


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