Opinion: Four questions to ask before capitalizing your startup

If you have started a new business or you’re thinking about it, you’re probably like every other entrepreneur – your mind is focused on funding.

There are as many ways to finance a new business as there are new business ideas. Before you approach any source of capital, an evaluation of your business and its capital needs is critical.  Start the analysis by answering these questions:

• How much money is enough?
• What capital structure – debt vs. equity – do you require?
• Who are your target investors?
• What are your responsibilities to investors?

How much?
While there is no magic formula, you will need to start with a business plan to estimate your company’s cash needs. Without a plan for your business, there’s no need to solicit capital.

One part of the plan often overlooked is your personal financial needs. You will need to eat, pay for housing, etc., while your business gets off the ground. Include this as a central part of your plan.

Your entrepreneurial optimism fuels the passion and tenacity it takes to run your business. Now, pair that optimism with realism. Product development almost always takes longer, sales ramp-up slower and competition can be unexpectedly tough, so, plan for it.

As your plan comes together, build in contingencies. Plan for the worst, and make sure your capital projections account for at least six months of operating costs.

What structure?
Debt is the most common source of capital for many startups and may come from a variety of sources. For example, credit card advances, home equity loans, asset-based bank loans and loans from friends or family. Using debt allows the entrepreneur to maintain 100 percent ownership in the business, which greatly appeals to business owners. As a new business, the owner needs to be prepared to personally guarantee any bank and most third-party loans. Asset-based lending typically will only finance a percentage of the assets’ value and only the business assets, so be sure you have additional funds to finance business operations and the balance of business assets not covered by the loan.

Equity investors become owners of your business. There are several aspects of ownership that can be separated and negotiated as part of the equity investment. Talk this through with your attorney and accountant.

Regardless of the capital structure used to fund your new business, know what you’re willing to pay and what you’re willing to give up before starting any negotiation for investment.

Who will invest?
Family and friends are often key sources of capital, based more on relationships than economics. As the business owner, you will want to treat all investors the same.

You also have probably heard about venture capital, private equity and angel funds. These investment vehicles, if legitimate, have an extensive investment procedure, and frankly are looking for proven opportunities that can improve their value position. These sources – other than possibly the angel fund – are more likely your exit strategy funding, not your startup or operational financing.

If your business is owned, managed and operated by a minority, a woman or veteran, consider grants and other loan programs. Federal and state opportunities exist with the Small Business Administration and should be explored as part of developing your business plan.

Crowdfunding startup financing is governed by the Jump Start Our Business Start-Up Act of 2012, or JOBS, allowing businesses making less than $100,000 annually to raise up to $1 million from individuals by using the Internet. Again, be realistic in your approach. For all the successful Kickstarter campaigns, there are as many unsuccessful ones.

What’s my responsibility?
Unless you’re financing your business through a financial institution – i.e. bank, credit union, leasing company – any investment, debt or equity is considered a security under state and federal law. This key point is often overlooked, but important to understanding your obligations to potential investors.

As a solicitor of securities, you have certain legal requirements to your investors. You must provide truthful information in clear and simple language. The investor needs to understand what they are getting for their investment.

These obligations are governed by federal and state securities laws and regulations. Failure to comply with these rules will expose you to civil and criminal penalties. Look for an attorney who practices in this field to minimize your risk.

These ideas are just the basics to consider when capitalizing your new business. When it comes to funding your business, there’s no one way to succeed.

Michael Cosby is a partner with Husch Blackwell LLP in Springfield advising on all phases of operation, including entity selection and formation. He can be reached at michael.cosby@huschblackwell.com.