Six Biggest Mistakes in Raising Start-Up Capital

Six Biggest Mistakes in Raising Start-Up Capital

By Entrepreneur.com
10/1/2007 10:54 AM EDT

In the movie Little Fish, a video-store manager played by
Cate Blanchett applies for a bank loan to buy the business and expand
into online gaming. When her application is rejected, Blanchett hurls a
framed photo of the loan officer’s child across the room in fury.
Anyone who’s suffered a similar setback knows the feeling.

The business landscape is littered with
would-be entrepreneurs who’ve stumbled in their search for start-up
capital. Many requests are denied. Those who pass the test frequently
have unacceptable strings attached. Some deals that close come back to
bite the business owner in the form of onerous debt, insufficient
revenue share or worse.

Part of the problem lies in the nature of the start-up endeavor.
Freshly minted entrepreneurs are typically major risks for lenders
because they lack business experience, collateral to secure the loan or
both. Neither family, friends, banks, venture capital firms nor angel
investors are interested in losing their investment. You can’t blame
them for not wanting to take a risk on a venture without a reasonable
probability of return.

On the other hand, many financing efforts fail because of avoidable
mistakes that are made in pitching potential lenders, structuring the
agreement or managing the money once the deal is done.

Steering clear of these missteps can increase your chances of
success, both in obtaining start-up funds and keeping the money
flowing. Be sure to avoid these blunders:

1. Half-baked business plans: There’s nothing worse
than going into a money meeting unprepared. If you haven’t put the time
and energy into writing a full-blown business plan complete with
elements such as a cogent business description, financial projections
and a competitive market analysis, the people with the cash won’t put
the time into evaluating your proposal.

The Small Business Administration is a good source for learning how to write a business plan as well as find sample formats.

2. Focusing too much on the idea and too little on the management:
It’s not enough to convince potential backers that you’ve invented the
next must-have gadget or can’t-miss clothing store concept.

You also need a team that can generate the
revenues to repay a bank loan or provide an exit strategy for a VC or
angel investor. Many business novices ignore the second part of the
equation; that can doom their money quest.

The greatest racehorse in the world still needs a great jockey to a
win a race. The same principle applies in business. Showing that you
have recruited a top-notch salesperson, a skilled marketer, an
accountant with start-up experience, other key personnel and even
outside experts like an attorney or business coach who can supply
professional guidance is essential to finding a funding source.

3. Not asking for enough money: In a 2004 U.S. Bank
study of reasons for small business failures, 79% cited "starting out
with too little money" as one of the causes of their collapse. That’s
often because entrepreneurs who are wet behind the ears don’t realize
that they should calculate their borrowing needs based on their
worst-case scenario instead of their best-case forecast.

An old accounting axiom says that everything will take twice as long
and cost twice as much as you expect. While that may be an
exaggeration, new business owners are frequently too optimistic about
how soon they will begin to fill their cash pipeline and how fast the
money will flow. If you’re underfunded, you won’t have a cushion to
tide you over in the event of slow initial sales or unexpected market
conditions.

4. Having too many lenders or investors: One of the
hazards of securing financing from multiple sources is managing too
many relationships and expectations. It takes time away from your core
business. These not-so-silent partners may have conflicting interests
or demands, and the consequences can be devastating.

This is particularly true when you raise money from friends and
family. One hairdresser I know borrowed money from seven or eight
relatives to open her own salon. The business was successful, but there
were perpetual battles over how the profits should be distributed. The
arguments couldn’t be settled to everyone’s satisfaction, so the salon
was forced to close.

5. Failing to get the proper legal agreements:
This is arguably more important than a prenuptial agreement for a
couple with significant individual assets. Every lender or investor
eventually will need his money back, and a legal document covering
everything from the terms to the timing can avoid the kind of acrimony
just described.

6. Poor cash flow management: Too many new business
owners burn through their seed money too quickly and fail to reach cash
flow-positive status in a timely manner. Some causal factors, such as
late product deliveries and economic downturns may be beyond one’s
control, but the executive team is clearly at fault for others, such as
unnecessary spending and overly optimistic expense/income forecasts.

Financial sponsors don’t take kindly to that sort of mismanagement.
And if they turn off the tap, all of your hard work may go down the
drain.

There are other pitfalls to avoid, but the bottom line is this: Play
by the lenders’ rules to get them to open their checkbook, but protect
yourself at the same time. There’s no point in launching a business
that will eventually sink under the weight of your investors’ demands.

If your business plan is good enough and you approach the right people, you should be able to whistle all the way to the bank.

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