PureVC

Funding Startups Using Loans

Today I received a nice note from a reader about the company, Prosper. I previously posted about this company back in February when it launched. Since inception the company has had a flurry of activity and interest. Individuals in seek of higher interest rates and return on their money have flocked to this site. Individuals have even used it as a way to raise capital for startups or early stage businesses. My reader points out that this is a new and innovative way to raise capital.

While from an entrepreneur's point of view I feel that scrappy startups need to bootstrap their funding needs in creative ways, from the point of view of a lender, I don't agree that raising money in this fashion is the best way:

First of all, financing startups is a risky endeavor that should only be left for those with the financial wherewithall to withstand complete loss of investment. The individuals who use Prosper are largely those that expect a solid return from their investment on a regular basis in the form of a monthly payment. Given the high rate of failure of startups, the default rate would be too unacceptable for the lending base.

From the point of view of someone who cares about the integrity of the capital formation process, I believe that startup or private equity funding should only be provided by those who can afford it. When individuals lose their shirts, they do not play the game anymore. When insitutions and high net worth investors lose their entire investment, they continue to fund companies at different vintages, despite the gyrations of the markets. Thus, what makes the engine of entrepreneurism run is the financial backing of those who will come back time and time again.

If you look at the amount of private equity investment over the last several decades, you will see that the data bear this fact. Angel investing peaks in hot markets and declines in down markets. Institutional venture capital also has its peaks and valleys but not as dramatic.

I also don't believe that debt is the best way to raise capital for a new enterprise because equity should be the greatest motivator for the investor, not debt payments. This is an entire topic on its own that I will save for a later post.

Back to Business Basics - Retail Business

I'm shocked to discover that it's been over a month since my last post. I apologize. It has been a busy month. I've gotten lots of email asking where I have been and why the posts have not been coming. So I promise to return to posting regularly.

Last week I was sent a business plan that was heavy on vision and mission, but light on concrete execution plans and numbers. The topic of business plans can make a whole series of posts unto itself. However, I just want to touch on it briefly here.

Time and time again, particularly in this era of technology and entrepreneurism, I see young individuals who are breaking out to start their own enterprise. Maybe it's the first, second, or third time they are embarking on this endeavor. But if you look closely at what they write and how they talk, it is clear that they are quite ambitious and use a lot of industry buzzwords but actually lack some business basics.

What I usually recommend these types of individuals is to go back to basics. The easiest example to use is that of a retail business, much like the old lemonade stand you run when you are a kid. If you can't describe how a basic retail business operates, what kind of metrics are used, how to research and compare industry standards, then you can't honestly expect to run a grand enterprise. You need to translate those basic business concepts as they apply to your business or trade.

Similarly, you need to know some basic accounting and what general statements you need such as P&L or Assets and Liabilities. If you don't know what "Gross Profit Margin" means or what your industry standard is, then you need to get a clue.

Believe it or not, the SBA actually has a decent guide on how to write a business plan and goes over some accounting and basics. If you don't have at least this level of information mastered, then you should really not embark on raising money.

Having a smart accountant or attorney that charges $400 an hour is great, but it doesn't make you a better entrepreneur. When you approach your funding source you really need to have all of this together and be prepared to show some depth of knowledge much like you would defend a dissertation. Otherwise, the person will not be impressed.

Click here for the SBA guide.