How to Raise Money for Your Business in the Great Plains or the Midwest
As the public face of Falls Angel Fund, I receive a lot of inquiries from entrepreneurs and would-be business owners that are looking to raise money to get their businesses off the ground. In the past couple of weeks, I have received inquiries from an entrepreneur running a medical devices startup, an entrepreneur running a mobile app development company, someone that is in the process of opening a local restaurant, someone that has a profitable e-commerce company (I invested in their previous round), and someone that wants to open a kiosk in the mall selling watches.
Each of these entrepreneurs needs money to start or grow their business, but the opportunities that are available to them will vary widely depending on their company’s current traction, the growth potential of their businesses, the entrepreneur’s credit profile, the location of the business and the existing business relationships that the entrepreneur has. For some of these people, a traditional equity angel investment might be appropriate. For others, a bank loan might be a better choice if they can get it.
While communities like San Francisco and New York are awash with angel investors and venture capitalists, they are much harder to come by in the Great Plains and the Midwest. If you’re not in a major start-up hub, you will have to work harder to raise capital for your business and be more creative when it comes to identifying sources of start-up capital. Receiving an equity investment from an angel investor is certainly possible in the Midwest and the Great Plains, but there are many other financing options that may be more easily accessible for your startup.
How much money do you need to start your business?
Before setting down on a path of fundraising, ask yourself how much money you really need to start your business. In many cases, you can start a business with a lot less capital than you might think if you’re willing to get creative. I started MarketBeat, which now generates more than $5 million in revenue each year, with literally no money by using free resources (like Blogger.com) until the company began to generate cash flow to provide for its own expansion needs. Write down your expected start-up costs and how much money you will need to operate the business for the first year and that will give you a good idea of how much money you should try to raise for your business in your initial seed round. If you are having trouble developing a financial model, the Small Business Development Corporation can help.
Be realistic about how much money you are going to be able to raise in your first round. In the Midwest and the Great Plains, a seven-figure seed-stage investment is an anomaly. Most seed-stage companies in this part of the country are looking to raise between $250,000 and $500,000. These dollar amounts are attainable if you can show some traction (revenue) and a decent growth curve. If you try to raise more than that amount at your first round, you may inadvertently push away angel investors because they know that you will have a difficult time raising the full amount you are looking for. If you need more than $500,000 to get your business off the ground, you will probably need to raise money in multiple stages.
Two Types of Financing: Equity and Debt
There are two general categories of financing that small business owners can use to finance the start-up and growth of their business. Debt financing is simply taking out a loan to pay for your business’s start-up costs. You don’t give up any ownership of your company with debt financing, but you will be signing up to make monthly payments with a set interest rate on the money you borrow. Debt financing is usually only available to founders that have cash flow, from their business or from other sources, to make payments on their debt. If you can’t pass a credit check and can’t show how you’re going to pay off a loan, you probably won’t qualify for debt financing.
Equity financing involves an investor taking an ownership position in your company in exchange for a specific amount of money (i.e. how deals are negotiated on Shark Tank). The investor becomes an owner in your business with all the same rights and responsibilities that you have. Investors that make equity investments in companies are often referred to as angel investors and venture capitalists. Equity financing is a more common financing structure for start-up companies, because it doesn’t require a start-up company to generate immediate cashflow to make debt payments and provides angel investors a high-risk, high-reward investment opportunity.
What kind of businesses do angel investors want to invest in?
Angel investors are primarily looking to invest in scalable businesses that have the capacity to grow into earning eight figures of annual revenue. Angel investors recognize that about 7 out of every 10 companies they invest in will fail. This means that the remaining 3 out of 10 companies that survive must make up for all the losses from the seven companies that failed. For the math to work out and for the angel investor to get a healthy return on their investment, the three out of ten companies that survive must be able to offer a substantial return to the angel investor. Angel investors generally cannot invest in restaurants, retail stores and other local-only businesses because they will simply never grow large enough to offer the types of return angel investors need to make up for the companies they invest in that didn’t make it.
At Falls Angel Fund, we have four basic criteria that we look for:
- The company must be a scalable business that has the capacity to grow and offer a substantial return on investment.
- The company must be operated by a high-quality individual that is willing to work extremely hard to make their business succeed. Business models can and do change, which means angel investors are investing in the person running the company as much as the company itself.
- The company must be located in South Dakota, be located in a state next to South Dakota, or be willing to relocate to South Dakota. We avoid investing in deals in other parts of the country primarily because we assume that companies from places like California and Texas have already tried to raise money locally and have failed.
- The company must have some sort of initial traction (revenue) to show that they have actually done something and have a business model that can generate revenue.
Companies that meet these criteria that are looking to raise money are welcome to apply to pitch our fund on Gust at https://gust.com/organizations/falls-angel-fund. Information about other South Dakota angel funds can be found on the Enterprise Institute website.
When should I go to a venture capital firm?
Venture capital firms are the big brother of angel funds. They typically invest in more established companies (higher revenue) that have larger capital funds. In the Midwest and the Great Plains, you may be able to raise up to about $1 million from angel investors (assuming you have a solid and investable company). Companies that need to raise more than $1 million will need to work with a venture capital firm that has access to greater amounts of capital than angel funds or individual angel investors would have available. The venture capital firms in Sioux Falls, South Dakota include Bird Dog Equity Partners, Bluestem Capital, McGowan Capital Group, Prairie Gold Ventures and South Dakota Equity Partners. There may be other firms I am unaware of.
What kind of companies will a bank give a loan to?
Banks generally do not offer loans to upstart businesses because it is impossible for them to quantify the risk they are taking. Banks may, however, offer you a loan based on your personal creditworthiness and your personal income. If you have decent credit and a source of income other than your new business, you may try to get a personal line of credit from a bank. In effect, they would be giving you an unsecured personal loan that you just happen to be using for your business. For business loans and business lines of credit, banks are generally seeking companies that are more established and have the cashflow to make payments on their debt.
If you have a troubled credit report, you will have a very difficult time getting anyone to invest in your business or loan you money. If you have no credit score because you have never borrowed money, that may not be as much of an issue. If you have a bad credit score because you have missed payments on debt that you owe, you probably won’t qualify for any kind of debt financing. This makes sense, since banks and finance companies only want to loan money to people that are likely to pay them back. If you are in this situation, your only two choices are to either clean up your credit or find a wealthy individual to offer you a loan that believes in you and is willing to loan you the money or invest in your business.
Where else can I get money?
If a professional angel investor or a bank loan isn’t an option for you, there are several alternatives that you may consider:
- SBA Loan – The Small Business Administration offers several loan programs where they will guarantee a bank loan to a small business. There are specific guidelines that entrepreneurs must meet to qualify for an SBA loan. More information about SBA Loan programs can be found here.
- SBA 504 Program – The SBA 504 loan program offers subordinated, fixed rate financing to healthy and expanding small businesses. Long-term, fixed rate financing (10-20 years) and reasonable rates (near long-term U.S. Treasury bond rates), make the SBA 504 an attractive and effective economic development financing tool. One entity that facilitates SBA 504 loans is the South Dakota Development Corporation.
- Proof of Concept Funding – In South Dakota, The Proof of Concept Fund is a loan program that will provide up to $25,000 investments for eligible applicants to conduct research demonstrating the technical and economic feasibility of an innovation significantly enhancing the likelihood of commercialization of the innovation.
- Revolving Economic Development & Initiative (REDI) Funds – In South Dakota, REDI funds provide a loan for up to 45% of a project’s cost to start-up firms or firms looking to relocate to South Dakota. These loans have a 2% fixed interest rate and are amortized up to 20 years on building projects and 10 years on equipment.
- Revolving Loan Funds – In South Dakota, organizations such as the University of Sioux Falls, South Eastern Development Foundation and SD Grow offer revolving loans to growing small businesses. These organizations often target a specific geographical area.
- Peer-to-peer lenders – Companies like Lending Club (www.lendingclub.com) and Prosper (www.prosper.com) offer unsecured personal loans (that can be used for your business) for 12 month, 36 month and 60 month terms. The interest rate you pay will be almost entirely based on your credit score.
- Crowdfunding – If you have a wide social network, you may try to create a crowdfunding campaign for your business on KickStarter or IndieGoGo. For this strategy to work, you really have to have a compelling story that is presented well and an existing audience of people that you can promote your campaign to. The entire message of your campaign has to be about the people participating in the campaign, because no one will want to make a donation just so that your for-profit business can get off the ground.
- A Part-Time Job – If you need a relatively small amount of capital to get your business off the ground (less than $25,000), can’t or don’t want to get a loan, can’t or don’t want to receive an equity investment, you may just need to get a job and save up some money to launch your business.
- “Friends, Family and Fools” – Try to convince someone that you have an existing personal relationship with to loan you the money that you need to start your business. When you can’t get a loan or get an equity investment from an angel investor, finding one person that can loan you money to start your business may be the best option.
- Grants – If your business is focused on science and research, you may be able to receive grants from the federal government. The Small Business Administration offers grants through the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. Grant recipients are required to meet federal research-and-development goals, and have the potential for commercialization.
- Personal Savings and Assets – You may consider using any savings that you might have to get your business off the ground. I generally avoid recommending taking money out of a retirement account to invest in a business, but some entrepreneurs will do that. You can also consider selling anything valuable that you might own that you don’t absolutely need, like an extra vehicle or a collection of old coins.
- Personal Credit – It’s a very risky proposition, but some entrepreneurs have been known to finance their initial business operations using their personal credit cards.
Not sure where to go?
If you’re not sure what financing option is right for you, there are several non-profit resources that are available to help you navigate the fundraising process and identify which fundraising method is right for you. SCORE (formerly known as the Service Corps of Retired Executives) is a great resource that can connect you with an experienced mentor (at no cost) that can help you determine which capital sources you should pursue. In South Dakota, the Small Business Development Center also offers free consulting to small business owners and the Enterprise Institute offers fee-for-service coaching for companies seeking an equity investment.
(Initially Published: 11/22/2016, Last Updated 11/25/2018)