Plenty of great Internet success stories started in a basement office with a few hundred dollars and a dream. When ambitions run higher, however, a start-up web wholesaler or retailer will need to secure outside funding, and this story looks at some of the ins and outs of what to do when seeking outside financing for a web based venture.
Most small Internet businesses are self-financed, or created with loans or gifts from friends or family members. If an entrepreneur does not have those types of options, they will need outside financing, which, for example, can take the form of loans, partnerships or investments in the business, among others.
Jim Hammersley, director of loan programs for the federal Small Business Association, said the obvious first step is for a company to turn to the bank where they do business, but startups should not be deterred if a bank turns down a request for a loan. Banks turn down loan requests for a myriad of reasons, but two of the more common ones are because the business plan did not go far enough to persuade them, and the company lacked adequate collateral to secure the loan. Hammersley said entrepreneurs will sometimes put up their own home or personal assets as collateral; he neither discourages nor encourages entrepreneurs to use their own home as collateral, but advises them on the inherent risks of such a decision.
With that in mind, a company's next step might be to seek outside financing from an investor or venture capital firm. However, businesses should not make the mistake of thinking that those options are any less stringent than the requirements of a bank. In general, web based businesses often find it more difficult to secure financing, compared to traditional brick and mortar businesses, because of the lack of physical assets.
Get With the Plan
"The key is to have a well thought out business plan," Hammersley said. "It should detail what the product is that a company is selling; who will buy it; why they will buy it; what the pricing structure is; and how will all of that lead to profitability. The plan really has to sell the story of the business, and that the owner is willing to put their heart and soul into the venture."
Tyler Ransburgh, marketing manager for GoBigNetwork.com, agrees. Go Big Network puts businesses and investors together. "No matter which type of financing an Internet business chooses, the company is most likely to find capital if it has a proven business model with existing customers and positive cash flow," Ransburgh said, but he cautioned prospective business owners that a request for financing can take a long time before any money changes hands.
"Raising capital is never an overnight process. Even when you have all the materials ready to confront investors with, it will take months, maybe years, to secure financing through the right investor. If an investor has interest in a business it will take 3-6 months just to research the deal," he said.
Examples of web based wholesalers seeking outside funding are varied. Some strictly want startup money, such as LifeRight.com, which is seeking $10 million for its new multi-channel retail and wholesale outfit that will sell health and wellness products.
In either case, Hammersley said businesses need to show adequate cash flow to cover the loan debt, and he cautioned that projected revenues and cash flow have to be reasonable, even conservative. "Entrepreneurs, by nature, tend to be optimistic when it comes to determining their projections," he said.
Ransburgh said his company works the same way a dating website might work. "We help connect small businesses with investors, but of course, we cannot guarantee a marriage," he said. The company stays in close contact with several investment brokers who often use the site to connect small businesses with their own personal contact list of investors.
Another place to look for funding is through an angel investor. These are individuals or small groups of investors who often use part of their own personal capital to help fund a small business. Though angel investors can take on lots of forms, and are potentially everywhere, they can still be difficult to find. Entrepreneurs can start by networking in their community to look for angel investors. In addition, there are online databases of investors, such as Angel-investor-guide.com.
"Internet based businesses should always enlist support or active interest, if not investors, from other investment sources," Ransburgh said. "The most attractive thing an investor can hear from a business is that so and so venture fund is also very interested as well."
What some investors have begun considering as viable collateral is intellectual property, which according to CFO.com is when, "The borrower pledges its intangible assets, such as patents, trademarks and copyrights,'' as security for the loan. Such collateralization of a non-physical asset is increasingly used for Internet businesses, and again places a lot of emphasis on the business plan.
"Investors tend to view web based businesses differently than traditional brick and mortar outfits because Internet businesses often do not have the assets, such as a building, equipment or inventory, that are commonly used as collateral for financing," Ransburgh said. "This places even more emphasis on a proven business model, management and cash flow."
The success of Web 2.0 social networking sites, such as YouTube, FaceBook and Myspace, may have made investing in web businesses fashionable again, but investors are also looking at extensive past experience in the particular industry in which a company will compete. In addition, one of the concerns with using intellectual property as collateral is the difficulty of determining true value.
"No investment is really a 'safe' bet, but investors can mitigate their risk by sticking with companies that exhibit the strongest business models," Ransburgh said.
"They're looking at web traffic as a source of revenue," said Lu Su, vice president of sales and marketing for online wholesaler, Toy Wonders. "And the truth of the matter is that it can be."
Toy Wonders was entirely privately funded and did not seek outside financing, but Su said that web based wholesalers have to consider aggressive marketing costs when developing their business models. Often, start-ups take too small of a view of what it will cost to properly market the website, almost dooming it from the beginning. "The key is obviously to obtain and then retain customers, but can you turn them into revenue generators, that is the challenge," Su said.
How Much to Seek
Both Ransburgh and Hammersley said there are no rules when it comes to how much an Internet business should seek from investors. However, because prudent investors always want to do everything possible to protect their capital, they will look closely at how much a company asks for and why.
"One of the problems is that entrepreneurs, especially new ones, may try to be conservative, but if they do not ask for enough for working capital, then in effect they will put themselves out of business rather quickly," Hammersley said.
Ransburgh said there are several things to look at when determining how much money a company should seek. "This depends on a lot of factors, including how much the company is worth, if it has raised previous rounds of funding, how much funding it needs to reach the next level, and whether the company can repay the borrowed funds or provide a handsome return to investors within a short period of time," he said. "Remember that it is more than money; the goal should be forming a partnership that builds a highly profitable company, not simply a hard and fast injection of capital."
Things entrepreneurs should do when seeking outside funding:
- Thoroughly research the market, and the venture itself, in order to write a stellar business plan.
- Consider the following when writing the business plan: what is the product that the company is selling; who will buy it; why will they buy it; what is the pricing structure and how will that lead to profitability; does the proposal take into account the working capital it will need to operate; will there be enough of a cash flow?
- Be prepared to wait weeks, months or even years before financing is approved.
- Consider using intellectual property, such as patents, trademarks and copyrights, as collateral.
- Look at angel investors as a possible means to raising funds.
- Consider several factors when determining how much money to request, such as what is the company truly worth; if it has raised previous rounds of funding; how much funding will it need to reach the next level; and can the company repay the loan, or will it be able to provide a handsome return to investors within a short period of time.
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