Banks aren’t the only way small businesses can get a loan or raise capital. Venture capitalists, angel investors and peer-to-peer lending networks have the money and the willingness to invest. Which road a small business should go down to get funding depends on the type of business and its growth prospects.
Venture capital firms are investment companies that invest in start-up firms. VCs are usually focused on specific industries whether its technology, biotechnology or consumer facing companies. While there’s some VC firms that will invest in the very small, many are looking to invest more than a million dollars. “If someone’s looking to raise $100,000, $500,000 or $1,000,000, it’s not likely to come from a VC,” says Paul Morin, founder of blog www.companyfounder.com.
Raising money from a venture capitalist means the small business will have to be willing to give up some control and be open to the company being sold, potentially in a short time frame. VCs are looking to get a quick return on their investment and exit the business either through a sale or initial public offering.
“Venture capital is appropriate for companies that have experienced management teams, well packaged business plans and fast growth potential,” says Rich Sloan, co-founder of StartUpNation. If your small business fits the bill, the next step is to get in front of a VC, which can be challenging. VC firms are bombarded with start-up plans each and every day, so getting their attention can be tough.
According to Sloan getting a referral is much more effective than trying to cold call a VC firm. Small business owners can also look to local universities for referrals since many schools have close relationships with local venture capitalists. “Each venture capital company has a formal, generic, arms length process for submission of business plans,” says Sloan. “If you go through the standard process you are not going to get their attention.”
Bottom Line: VC funding is only good for small businesses that have a strong management team and are operating in a hyper growth market that’s seeing a lot of interest. “Venture capital is appropriate for only a fraction of companies to raise capital,” says Sloan.
Often high net worth individuals, angel investors are people that have cash to invest and are looking to put their money to work. They can be career angel investors or people that retired and are investing as a hobby. Unlike VCs, angel investors typically aren’t looking to cash out quickly and often times have much more patience than a venture capitalist will.
Angel investors also have different criteria for their investments. According to Sloan of StartUpNation angel investors are looking for compelling businesses that are exciting to them. “They are looking for the cocktail party conversation pieces,” says Sloan. “Generally speaking angel investors are both helpful and patient so angel investors typically don’t have rigid criteria like venture capitalists.” It’s a fallacy to think the angel investor would treat a $15 million investment better than he or she would treat a $100,000 investment, he says.
When it comes to finding an angel investor, the most effective way is through networking, whether it’s through the local Chamber of Commerce, at a cocktail party or making direct calls to investors in your town or community. Small business development centers, which are government funded and available throughout the country, may also have links to private investor groups.
Another surefire way to access an angel investor is through their attorney or accountant. “If you want to be the next hot tech company then hook up with the hot tech attorney in your city or town and become a client,” says Morin. “It’s the best way to get to know you and be willing to make a referral.” Same goes with an accountant. “These investors have to have these professionals to run their funds and lives and they tend to be great referrals.”
Bottom Line: Angel investors are more accessible, more patient and more willing to make small investments as long as the company speaks to them. “It’s the most viable (source of funding) for small businesses looking for their first funding,” says StartUpNation’s Sloan.
Peer-to-peer lending or microloans is another way a small business can raise money. Websites like Prosper.com and Lending Club serve as conduits for small businesses and lenders to meet and make arrangement for these small loans.
With peer-to-peer loans it’s not a guarantee that you will get the loan. Lenders, which are lending small increments of money, have to like you and your business first. “Different Websites do it different,” says Sloan of StartUpNation. “Some do debt financing, some sites do equity stakes and some sites are value equivalent, which means people might be able to gain the value of your product,” he says.
Finding a peer-to-peer network to apply for a loan is as simples as doing a quick Google search. At prosper.com, for example, borrowers choose the amount they need to borrow and post a loan listing that includes why they need the money. Investors then review the loan listing and invest in the listings that meet their needs. Once the process is completed the borrowers make fixed monthly payments.
Bottom Line: Applying for a peer-to-peer loan is easy to do, although you aren’t guaranteed you will raise the money going this route. What’s more you aren’t going to be able to raise millions of dollars with a peer-to-peer lender. “Peer to peer lending makes sense if you are looking for small amounts of money,” says Sloan.
Donna Fuscaldo is a freelance journalist covering personal finance, technology and the small business market. She’s written for Dow Jones, Wall Street Journal, AARP, HouseLogic and Bankrate.com. She currently has a weekly column on foxbusiness.com covering small business and technology. She resides in New York with her husband and daughter.