This story ran on on February 16, 2007.

The Six Best Places to Find Funding for Small Businesses

Colleen DeBaise, February 16, 2007

Editor's note: Cash is the lifeblood of any small business. But entrepreneurs frequently cite insufficient funds as their greatest obstacle. In this special report, we've provided the latest tips on where to find capital. We hope the information can help small-business owners clear the money hurdle.

Click on these links to learn more about each type of funding.
Credit Cards5
Angel Investors
Venture Capital
IT'S GETTING EASIER to find cash for your small business.

Entrepreneurs traditionally have tapped into personal savings, maxed out credit cards or turned to family and friends for the money to get a dream off the ground. But now, more opportunities are opening up for the fledgling small business. Banks are approving more seed capital for start-ups, while in the private-equity realm, angels are getting more vocal and venture capitalists are once again searching for interesting ideas.

"It's a good time for entrepreneurs," says Emily Mendell, vice president of strategic affairs at the National Venture Capital Association in Arlington, Va. Money is flowing again into innovative areas, such as technology and life sciences. "The industries are healthy," she says, "as opposed to right after the bubble burst, when everyone went into their shells. It's much better today."

Typically, entrepreneurs use their own money (or contributions from relatives) and combine that with funding from other sources. We've got six places where you should look.

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It's rare, but not impossible, to find a little bit of free money for your business.

Credit Cards28
Angel Investors29
Venture Capital30

On the state and local level, grant programs typically encourage economic development in underserved areas or struggling industries. Designated districts in Miami-Dade County, for instance, dole out grants of up to $5,000 to small-business owners through a Mom & Pop Small Business Grant Program. Last year, Alaska offered grants of up to $25,000 for salmon harvesters to improve their vessels under a revitalization program for the state's fisheries.

Business groups also are a good place to look for grants. In May, the National Association for the Self-Employed launched a new program through which its micro-business owner members (who typically have 10 or fewer employees) can apply for up to $5,000 in grant money to buy equipment, pay for advertising or fund some other specific business need. The group started the program after surveying its 250,000 members and finding that a majority struggled with access to capital.

One of the NASE recipients was Steve Baier, who started a commercial-art company two years ago in Norwalk, Iowa. His options were especially limited. The 28-year-old put himself through college, running up debt in the process. His personal credit suffered and he didn't own a home, something he could offer as collateral. "I don't think I would have been approved for loans, so I didn't try," he says.

Baier received a $2,500 grant, which he's used to upgrade his computer, buy a digital camera and invest in a top-of-the-line airbrush, his principal medium. "It was enough to really get me started in the direction I wanted to go," says Baier, who works from his home, but is now looking at leasing a studio in the spring.

Uncle Sam really has a soft spot for the little guys, thanks to their contributions to the economy. There are about 25.8 million small businesses (typically defined as having 500 or fewer employees) in the U.S., compared with 17,000 large businesses. Small firms employ half of all private-sector employees, and have generated as much as 80% of new jobs annually over the past decade, according to government data.

Credit Cards34
Angel Investors35
Venture Capital36

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SBA Loans 37

That's why the Small Business Administration guarantees loans38 such as the 7a, 504 or SBA Express products for small business. The SBA doesn't actually lend the money, but rather guarantees up to 85% of its value, making it less risky for the real lender (in most cases, a traditional bank) to grant the loan to a small business.

KeyCorp, for instance, does about $200 million in SBA loans a year, according to Maria Coyne, executive vice president and head of SBA lending at the Cleveland-based Key Bank. The government guarantee "allows a bank to extend credit to companies that might not qualify conventionally," she says. "The loans typically have longer terms so you can stretch the payments and make them more affordable."

SBA loans are particularly useful for companies that don't have hard assets to put up as collateral, she says. But there are a lot of misconceptions about SBA loans. "Here's what people think it is: They think it's a grant," Coyne says. "They think they don't have to pay it back. They think it comes directly from the government. They think it's for people with bad credit. They think it's for people who are starting out of the gate, who have never done it before. It's not for the unprepared."

Instead, a good candidate for an SBA loan is a small business that's been in operation for a few years, with a track record and steady cash flow, she says. And, the business owner should have good credit. In certain rare situations, a start-up can get an SBA loan, but typically only if the business is part of successful franchise or if the owner is an experienced entrepreneur, Coyne says. "I always say to my clients, if I give them money before they're ready, I'm just hastening their failure," she says.

It used to be that entrepreneurs couldn't get early-stage financing from traditional banks. After all, a start-up venture with minimal cash flow isn't the most attractive client to a lender. But that's starting to change.

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Bank of America, for instance, last year launched Business Credit Express, an unsecured line of credit that's granted based on a small-business owner's personal credit score. An entrepreneur in good standing can get access to up to $15,000, starting on day one of the business. Once the venture has been in operation for a year, the bank will provide up to $100,000, based on an assessment of the business. The bank started offering the product after finding that many start-ups were home-based businesses looking for small sums of seed money, says Mario Ruggiero, senior vice president of small business at Bank of America. (While the terms and conditions vary, a number of banks offer business lines of credit, including Wachovia, Capital One and Chase.)

Other banks are displaying their eagerness to work with the small-business community by developing outreach programs for women and minority entrepreneurs, two fast-growing subsets. "As you understand a group better, you are able to do more with them," says Rebecca Macieira-Kaufmann, executive vice president and head of the small-business segments at Wells Fargo. The bank has lent more than $27 billion to women business owners over the past decade and close to $7 billion to Hispanic, African-American and Asian-American entrepreneurs, she says.

Still, to qualify for a significant bank loan (above $100,000), most small businesses need to have been in business for a few years and have to be able to provide financial records. Most lenders look at the "5Cs" — capital, character, capacity, collateral and conditions — before granting loans.

A bank can also help with a home-equity loan, and that's a popular route for small-business owners who don't have any other collateral, says Ruggiero. But, "make sure you have a good plan in place, because you are putting up your home," he says.

Using plastic to fund your start-up is tempting. It's right there in your wallet, it's easy to get cash, and if no one else will give you the money, it might be your only option.

Credit Cards
Credit Cards50
Angel Investors51
Venture Capital52

But tread carefully if you decide to take this route, which many entrepreneurs do. (The most recent research from the Small Business Administration found that the number of small businesses carrying debt increased 25% in 2005 as a result of credit cards.) The trouble, experts say, is that few business owners take the time to read the fine print, so they don't understand the financing terms and fail to guard against rising rates.

And it's easy to get in over your head, especially for first-time entrepreneurs who "haven't had to sit down and develop a business model," says Robert D. Manning, a research professor of finance at Rochester Institute of Technology and author of "Credit Card Nation." While a bank might pepper them with questions before giving them a loan, the credit-card issuer simply supplies the money. "That's why, for so many people who use credit cards to start a business, it becomes a disaster," he says. Most of the time, inexperienced small-business owners will commingle business and personal expenses. When they run into trouble paying the bills, they're forced to declare personal bankruptcy, which can haunt them for years, he says.

The best approach before you charge or withdraw cash is to understand your company's cash flow. Think carefully about whether you can make future payments, Manning advises. "The most important thing is never be late," he says. "Without a doubt, that is going to trigger higher interest rates." Also, consider what you'll do in a worst-case scenario. Think about whether you have an asset that can be liquidated if necessary, he says.

It used to be difficult for small-business owners to qualify for business credit cards. That's changed as issuers — fishing for new business — have started wooing entrepreneurs, sometimes with big rewards and perks. For tips on choosing the right offer, click here53.

And make sure to diversify your lines of credit, Manning advises. Some business owners make the common mistake of relying on just one credit card, and when something unexpected arises, "they're already tapped out," he says. Another option to consider, besides a consumer or business credit card, is vendor financing, where a vendor allows you to borrow money from them in return for you using their products, he says.

Angels — typically, wealthy individuals willing to invest in an early-stage company — are the oldest source of start-up capital for entrepreneurs, according to the Center for Venture Research at the University of New Hampshire. In 2005, angels invested $23.1 billion in 49,500 ventures, which comes out to about $470,000 a deal, according to the center's data.

Angel Investors
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Venture Capital59

Angels typically supply a start-up company with enough funds to prepare it for venture capital, which is doled out in larger amounts as the new business gains a track record. While the cash infusions that angels provide are critical to the small-business community, not much is known about who they are or how they operate.

That's starting to change. Two years ago, the Angel Capital Association60 was formed, bringing together 200 angel groups in the U.S. and Canada to share best practices and develop data about the field of angel investing. An affiliate, the Angel Capital Education Foundation61, provides basic information on angel investing to entrepreneurs.

Of course, taking cash from an angel isn't appropriate for all entrepreneurs, says Marianne Hudson, executive director of the ACA. The first thing a small-business owner needs to do is "really think through whether equity capital is right for you and your dream," she says. "Are you comfortable with someone owning a piece of your company? Are you comfortable with someone mentoring and making decisions?"

An angel also needs a return on the investment, which typically comes when the business is sold or goes public, she says. Not all ventures can expect such growth. Start-ups likely to increase in value are in the technology, medical and life-sciences fields, Hudson says.

So how do you find an angel? "The best way to do it is through networking in your community," she says. "Talk to as many entrepreneurs who have gotten angel or venture backing as you can. Talk to attorneys or accountants who deal in the equity-capital world. Talk to business leaders who know everyone. Angels are most likely to invest in an opportunity that's recommended to them."

And stay local. With some exceptions, angels tend to invest close to home. "They not only want to put money in, but they want to coach you and keep track of what you are doing," Hudson says.

The time is once again ripe for money-hungry entrepreneurs.

Venture Capital
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Venture-capital investing hit $25.5 billion in 2006, the highest total in five years, according to the latest MoneyTree Report from PricewaterhouseCoopers. The hot areas continue to be the technology and life-sciences sectors, although VC firms have also begun a foray into the energy sector.

To get venture capital, a company must have a thorough business plan and potential for rapid, high-profit growth. "It is sophisticated money," says Emily Mendell, vice president of strategic affairs at the National Venture Capital Association71. "It's for the entrepreneur who has aggressive aspirations as to where he or she would like to take the company."

A common misconception about venture capitalists is that they're investing their own money, Mendell says. Instead, VCs are typically investing money from institutions, such as big pension funds or college endowments, and, in some cases, money from high-net-worth individuals. "The ultimate goal of a VC when they are working with an entrepreneur is for that company to go public or be acquired by another company," she says.

The University of New Hampshire's Center for Venture Research estimates that VCs invest about $7.4 million per deal. The money is usually doled out in several rounds, over the course of five to 10 years, Mendell says. A VC might invest in all stages of a company's growth: Seed, when a new venture is still an "idea in a garage"; Early, when the venture is just putting a product on the market; Expansion, when the venture's product is trying to capture market share, and Later, when the venture is about to be acquired or go public and needs one last round of cash, according to Mendell.

Entrepreneurs who want venture capital need to have an innovative business model, a strong management team and a strategic plan. What's more, "they'll have to cede some control," she says. "What you're getting when you use a VC is not only the money, but also their expertise." A VC will not only take a seat on the board, but also provide industry advice to steer the company in the most profitable direction.

How do you get your hands on venture capital? Mendell recommends a lot of networking, such as talking to other entrepreneurs who have gotten VC, and doing your homework, such as scanning new business announcements to see who's provided the funding. The NVCA's web site also has industry information, and a "Venture-Backed Company Hall of Fame" to showcase venture capital's role in the entrepreneurial community. (Inductees include FedEx, Genentech and Intel.)

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