financing

Q. Have you used crowdfunding sites to raise money for a business project. Asked on LinkedIn by Brandon Schaefer

I see potential problems with doing this. A business project is meant to make a profit, and earn a return for the investors. If the investors are crowdfunders, how do they ever benefit other than feeling good about supporting a business they like?

I see four ways to view such a contribution:

1. It’s a gift. I don’t expect to get it back. I’m giving it to you because I believe in what you’re doing.

2. It’s a loan, with no recourse. If you do well, I’d like my money back, with interest. If you go belly up, so be it.

3. It’s prepayment for services. I’ll put money into your business in the expectation that when you get going, you’ll provide me with product or services of comparable value. Perhaps a plaque with my name on one of your cafe tables.

4. It’s an equity investment. I expect to own a piece of your business, have a share of the profits as dividends, and to benefit on the upside if you sell it later at a premium. I want oversight on how you’re running the business.

If I’m a crowdfunder for you, several things would really irritate me, perhaps to the point of lawsuits:

1. You squander the money, just out of lousy planning and management

2. You divert the money to other uses, such as fancy offices or expensive travel

3. You make a bundle and ignore me. With my $1k investment (among others) you grow your company and Google buys you out, making you rich, then you won’t take my phone calls.

How are these potential situations handled on crowdfunding sites? What are the obligations of the person receiving the funds? What are the rights and recourse of the contributors? This is why we have contracts. The crowdfunding deals I’ve heard of sound kind of loosey goosey.  Fuzzy agreements now = lawsuits later.

If it’s for a good cause–say, you’re raising money to go plant trees to restore the rain forest–then I view my contribution as a gift, and expect nothing back.

But if I’m investing in a business that expects to make a profit, then I want some contractual accountability.

So when you look at Crowdfunding sites, see how they address all these questions and others

 

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From a question on LinkedIn by Arthur Goldhaber

Q: What cost items get left out when store owners are figuring out what size loan they need to open a second location?

A: Here are some expensive items that owners often overlook. I have several small business clients that have recently gone through this—a restaurant, a bakery, and another company that moved to a larger facility. They were good at figuring the new operating costs, lease and facilities cost, and tenant improvements, but there were several ways they underestimated the cost of the expansion:

The cost of expanded inventory. Some owners try to purchase expanded inventory out of current cash flow rather than making that part of the new-facilities investment, and they soon go into cash crunch. Their cash reserves won’t carry them through the time between when they must pay for new inventory and when they get cash from selling it.

Hiring and training a top manager for the second facility. Assume the owner currently runs the first location, and has an assistant manager. If the assistant manager is not skilled or experienced enough to step into being manager of the second location, then a new and more expensive manager will have to be hired and groomed for some period of time. That is strictly an overhead cost.

Help for owner. Since the owner will be totally absorbed in getting the new place going, someone must take over many of his or her regular responsibilities. This may require hiring extra people. (But may be combined with hiring the new manager.)

The cost of getting needed approvals, negotiating a lease, designing the new interior, overseeing the tenant improvements. These things take a lot of the owner’s time, but they also may require hiring expensive professionals: engineer, consulting contractor, lawyer, architect.

Cost of changes in location #1. The original store may need an upgrade to bring it in line with the snazzy new place. May need changes in the back office to accommodate admin for two locations. They discover that their old systems are completely inadequate, and need an upgrade: POS, inventory control, employee time tracking, accounting, plus the computers and networking—all integrating multiple locations.

Hiring and training staff for the new location before it opens, and before it has positive cash flow.

“Stuff happens” funds, to cover delays, glitches, cost overruns. For example, “At the last moment, the city required us to upgrade our handicapped access.”

The cost of capital. They may neglect to factor in the cost of borrowing the capital they need, paying interest on the investment until the new location is profitable.

Get the right kind of loan. Some businesses try to finance expansion with their revolving line of credit, which must be repaid every year. This can actually force you out of business! You must get a term loan for 5 to 7 years, which allows you to repay out of the profits of the expanded operation.

Never finance long-term needs with short-term capital!

Don’t use revolving line of credit, credit cards, or vender credit–except for quick turnover items or as a receivables bridge.

Do use term loans (including a personal loan), equipment leasing, funds from second mortgage or your own savings.

 

The good news is, once a company gets its #2 location up and running successfully, #3 and 4 are a lot easier. And since you’ve proven you can do it, it’s easier to attract capital.

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