Six Ways to Increase Financing for Start-up Businesses

One of the great challenges of the current economy is getting investors to trade their capital for equity in a small business start up.  Small businesses are high risk, high return investments and when the economy is uncertain, investors tend to shy away from risk.  But if there is to be any hope of getting out of the hole, then small business startup financing needs a jump start.

In their book “Angel Investing: Matching start-up funds with start-up companies,” Mark Van Osnabrugge and Robert J. Robinson discuss six steps to increase investment financing in start up businesses.  They argue that there are billions of dollars in the economy that could be used as start up capital, if only the holders of that capital (investors) and start ups could better identify their mutual opportunity.  Let’s break down each and discuss their feasibility.

1. Awareness

First and foremost, small business owners and private investors need to know that each side presents a golden opportunity to one another.  Many start ups fail to consider angel investors, going straight to the bank for a loan, while many investors fail to consider small businesses as an opportunity to diversify their investment portfolio.

Crude estimates say that probably only 5-10 percent of all business angels use matching services, and a majority of the deals of even those investors may be sourced through other means.  This is partly due to the limited number of ventures these services can offer and their resources limitations.  To correct these problems, government initiatives are needed to support and promote matching services so that these low-profit or nonprofit services can expand in size and number to reach more participants.

2. Education

Unrealistic expectations can break many deals.  It is imparative that investors and startups understand the needs, wants, and position of the other side of the deal.  By walking into a deal education about these points, an investor or business owner is more likely to hold realistic expectations regarding a deal and be comfortable with the end point of the investment negociation.

Business angels and entrepreneurs must receive greater education about the ins and outs of business angel investing…. Exposure to the views of both parties, advice on how to prepare effective business plans and contracts, and a closer look at the characteristics that generally make deals suitable for both parties leave fewer surprises for these practitioners.

3. Inducements

A great deal of potential start up capital sits in the pocketbooks of virgin and latent investors - first time investors and those that have not invested in a considerable amount of time.  To encourage these individuals to invest their private capital into small business start ups, a series of inducements should be promoted.

In particular, making available guidance on conducting deals and better tax incentives may raise their willingness to support entrepreneurial firms.  The existence of co-investment syndicates that they can join may also give them incentive to start investing, but with the added bonus of shared-expertise, guidance and diversification.

4. Role Models

Many young and middle aged entrepreneurs hit it big at the start of this decade during the tech boom.  Now, they’re acting as a new source of start up financing, providing the next generation with the precious financial opportunity they were once handed.

Many of these investors are now supporting the next generation of high-tech products and producing a number of angel success stories.  Hopefully, they will act as role models for others who have struck it rich and are now looking for a fun way to invest their entrepreneurial abilities and funds.

5. Promotion by Other Financiers

It is clear that the health of the business angel market has many beneficial implications for a wide range of other practitioners and intermediaries in the market.  This is why it is crucial that banks and venture capital firms, especially, aid promoting the business angel marketplace, indirectly helping themselves in the long run as those firms that angels supported in their early stages come to them for secured loans or development equity finance.

Banks are tapped into a large, well established financial network and, thus, have the opportunity to promote opportunities for small business customers and potential investors alike.  One interesting idea would be a matching service run by banks, where investor and small business bank clients are introduced through the bank, the investor puts up the capital and the bank receives a fraction of the return.  In addition, the small business administration is already tapped into the growing small business marketing, providing a great oppotunity for startup investment promotion.

6. Business Angel Mutual Funds

A growing trend are business angel-like mutual funds and invest in hundreds of young start up firms.  The goal is to motivate the transfer of large amounts of unallocated high-risk money to start ups, with a solid investment team ensuring that high returns are provided the investors.

In particular, such funds offer many advantages that, we hope, will propel a minority of the ten-to-twenty million virgin angels in the United States (as well as other kinds of investor) to finally invest a small proportion of their portfolio in a diversified fund of unquoted entrepreneurial ventures.

These six steps are designed to encourage deals between small business startup owners and private investors.  With hope, the interaction between these two parties continues to grow over the years as this becomes a more utilized means of start up financing.

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March 24, 2009 | Start Up 

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