Financing Strategies for Your Startup

Raising money for a startup has never been easy. But there is some good news: here are the two best bets for finding the money needed to launch a company

Written by Jim McElgunn
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The hard truth about raising money for a startup is that it has never been easy—at least, not since the dot-com bubble popped in 2001. Nor, given that most new businesses fail within a few years, should you expect it to be.

But don’t despair. To be sure, the fundamental reality of startup financing— namely, that you’re probably in for a tough slog—remains unchanged in 2012. Yet, there is some good news: over the past few years, the two best bets for finding the money needed to launch a company have become even better bets.

You can sum up the most encouraging trend in startup financing in two words: angel investors. Actually, make that three words: angel investor groups.

Typical angel investors are 55- to 65-yearold entrepreneurs who have sold their companies, seasoned executives who are retired or semi-retired, or owners of profitable businesses who are looking to invest some of these profits. What all these people have in common is that they’re sophisticated investors who crave the thrill of participating in a new business. They’re not interested in passive investments but in equity stakes in promising business ideas and a chance to mentor smart, younger entrepreneurs.

This country has enough angel investors to populate a small city. The latest estimate, from the National Angel Capital Organization (NACO), is that in 2008, Canada had 16,000 angels. That year, this group invested at least $1.9 billion in total, or about $120,000 for the average deal. And while venture capitalists are rarely seen at or before a firm’s birth, that’s when angels prefer to invest. “Angels are hugely important in Canada for startup financing,” says David Simpson, a financier and serial entrepreneur who lectures on entrepreneurial finance at the Richard Ivey School of Business in London, Ont. “And with the rise of angel investment networks, they’re becoming even more important.”

These networks—regional groups of angels who co-screen potential deals and each ante up for a small piece of the action—aren’t brand new. But several trends have led to their proliferation.

Read: Accelerate Your Success Through a Startup Incubator

One is an increase in the ranks of angel investors. Jason Sparaga, president and CEO of Spara Capital Partners Inc., an Oakville, Ont.-based investment and merchant banking firm, says the brisk growth in the number of Canadians 55 to 65 and of executives taking retirement packages is deepening the pool of people with business savvy and money to invest. And, he says, NACO and other groups have raised the profile of angels and persuaded more people to become one.

Even more important is the upsurge in the number of angel groups. Dozens of these investor networks now operate across Canada, up from just a handful a decade ago. Sean Wise, a professor of entrepreneurship at Ryerson University in Toronto, says the federal government is fuelling this growth by providing funding through regional economic-development agencies that now operate in every part of the country. For instance, FedDev Ontario, the agency for Southern Ontario, has for the past 18 months provided onetime funding of up to $50,000 for angel groups and up to $2 million for angel industry associations.

“We’re also seeing growth in the number of informal angel groups,” says Wise. “These are people who do deals in a given space that they know well or who invest in companies founded by people they know.”

Read: Angel Group Investment Soars

Simpson points to another key development: angel groups now routinely share information with each other. “I was involved in an angels chapter in Southwestern Ontario, and I’d get an alert from, say, an angel group in Toronto that had already vetted a company and said that it looked good,” he says. None of this has made obtaining angel financing a cakewalk. Like other types of investors, angels turn down far more deals than they approve. Your odds are better if your business is of the right ilk. Sparaga says angels tend to be keen on “20- to 25-yearolds who are the best and brightest at their school, have a great business concept and evidence that what they’re doing is an exciting and credible opportunity.”

But, he adds, angels are even keener on people who already have built a successful business. Angels are most likely to consider investing in your startup if it’s in a leading-edge sector, says Sparaga, such as software, the Internet, biotech or clean energy. “But sometimes they’ll invest in someone who’s approaching an old business in an innovative way,” he says.

“In that case, it’s the business model that interests them, not a technology.” Aside from angels, who else is the most likely to help finance your startup? It’s a short list. The Canada Small Business Financing Program (CSBFP) can make it easier to obtain a bank term loan by allowing lenders to share the risk with Ottawa. But the program is designed to finance hard assets such as land and equipment—not inventory, working capital or soft assets such as the skilled talent and intellectual property that are at the heart of most startups today.

The Business Development Bank of Canada provides some seed financing, but it’s geared toward export-oriented technology companies. And outside of the CSBFP, banks are in the business of providing lower-cost money, not high-risk startup capital, unless you offer solid collateral such as a hefty purchase order from a highly creditworthy client or—gulp!—your own home. There is one budding option that could become an important, even transformative, source of startup financing. But not just yet.

“Crowdfunding” allows entrepreneurs to harness the power of social media to gather small sums from each of a large number of people—and without having to file a prospectus with securities regulators. The U.S. House of Representatives has just passed a bill that’s now before the Senate to permit firms to raise up to US$1 million per year by selling equity through crowdfunding sites, or up to US$2 million if they provide audited financial statements.

In Canada, provincial laws permit crowdfunding sites to offer investors “rewards” of products and services, such as copies of artistic works or “fun experiences,” but not to sell equity. “Our legislatures have not yet turned their minds to crowdfunding,” says Wise. However, this past January, the CATAAlliance, an Ottawa-based high-tech industry association, kicked off a campaign urging provincial securities regulators to adopt an approach akin to that in the U.S. legislation.

Fortunately, one financing source that’s as old as capitalism itself—friends and family—has, in the past few years, become a more promising option. Sparaga points out that because Canada hasn’t felt the full effects of the economic upheaval in the U.S., friends and family here still have money to invest.And, says Simpson, ultralow interest rates have made people more receptive to investments with the potential for a decent return.

As well, says Wise, “With the 2008 debt crisis, mutual funds lost so much value that many investors lost faith in them. [People are] more open to a bigger variety of options, including investing in startups.” Another factor that has made it easier to obtain financing from friends and family is the falling cost of launching a business.

The Ewing Marion Kauffman Foundation, a Kansas City, Mo.-based body that promotes entrepreneurship, estimates that, stateside, it costs just US$31,000 to start the average firm. This rises to still fairly modest averages of US$82,000 for construction companies, US$98,000 for retailers and US$175,000 for manufacturers. Wise says even many non-tech firms have become cheaper to launch. Key reasons include access to free or cheap online business tools, endless price-cutting by suppliers facing ever-tougher competition and the economy’s shift away from capital-intensive activities.

The drop in startup costs is most dramatic within the digital realm. Thanks to trends such as the vast economies of scale that the Web has made possible and almost free server time for developers, you can launch, say, a software firm for a small fraction of what it would have cost a decade ago. “It takes only $25,000 to $50,000 to build a proof of concept for software,” says Wise. A sum of that size is far easier to raise from friends and family than $250,000 would be, he says: “Because the amount needed for a startup has shrunk, the number of people who can fulfil that need has become much higher.”

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