Startup funds will be harder to come by in 2012, according to hundreds of venture capitalists polled in a recent survey by the National Venture Capital Association.
Sixty-nine percent of the surveyed VCs said they expect venture investments to stay the same or decline next year, compared to just 48 percent who felt that way in last year's survey.
Thankfully, small-business financing options outside the venture capital industry are rapidly proliferating in the digital age.
With just a few clicks, anyone can pitch a business idea to the growing ranks of angel investors. In addition, a number of Web services now provide platforms for entrepreneurs to raise small sums of money from large pools of people -- a process known as crowdfunding.
Even Congress is showing deference toward the Internet's capacity to connect businesses with capital, as lawmakers weigh rule-changes that would allow entrepreneurs to use social networks to sell stakes in their startups. (Under current securities law, entrepreneurs can only solicit donations.)
Still, a large share of startup funds continues to flow from the old-fashioned lender that small-business owners love to hate: banks. And despite reports that small-business lending at banks recently tumbled to a 12-year low, there are still ways for entrepreneurs to improve their chances of being deemed credit-worthy in the eyes of bankers.
So regardless of whether you run a tech startup on the hunt for strategic Silicon Valley investors or you own a local restaurant that's in need of nothing more than a simple bank loan, entrepreneurs must recognize that in the new year, the fund-raising game has changed.
Here are the new ways to raise in 2012:
Janean Chun contributed reporting.
Are there people in your social network who may be willing to help you bankroll your business? Need a way to reach them and a way to handle logistics? Try crowdfunding. Used by both young startups and established small businesses, crowdfunding enables entrepreneurs to raise a pile of cash in small increments from those they already know and from complete strangers. Interested businesses can sign up for one of the many crowdfunding platforms and create a profile that reveals why they're seeking financial support. Once the campaign is designed, crowdfunding services help users promote their campaigns via e-mail and social media. In most cases, crowdfunding services require entrepreneurs to create a goal for contributions (generally less than $50,000), along with a deadline to achieve that goal by. The services typically take a 4 to 6 percent cut of the funding goal if it is reached, and often hold the donations that come in until the goal is met. If the goal is not met by the deadline, some crowdfunding sites will return the funds to the donors, while others will take a cut of the donations that's larger than if the goal had been reached. Click here for a primer on crowdfunding etiquette.
AngelList is a social network that connects startups with investors. An Atlanta-based startup that sells medical iPad apps, for example, can sign up on AngelList to connect with an investor interested in bankrolling a healthcare startup based in the South. How exactly does AngelList work? Startups create a profile and pick which investors can see them. As soon as they share themselves, investors see the startup in their feed. Investors see 10 to 20 new startups in their feeds each day, in addition to the startups AngelList admins send to investors based on the interests they've indicated. As angel investors continue to play a vital role in the financing of young businesses, platforms that connect entrepreneurs to angels have risen in popularity. Even traditional venture capital firms, as they increasingly target early-stage companies, are signing up and find such platforms to be valuable sources of deal flow. Other online services that help startups track down investors -- and vice versa -- are CapLinked and ChubbyBrain. But before you start seeking out angels online, get familiar with the papers you'll need to sign before a deal can close, also known as the the term sheet.
Is there equipment lying around your office that no one seems to be using? Perhaps you're willing to part ways with some jewelry until your company gets up and running? Well, a new crop of Web-based pawn shops has emerged -- and they're drastically under-cutting the fees that typical pawn shops charge, The Wall Street Journal recently reported. Brick-and-mortar pawn shops offer immediate short-term cash loans in exchange for collateral -- but the service fees, which typically range from 10 to 20 percent of the amount borrowed, can make the loans quite costly. New Web-based pawn shops, including Pawntique.com, Pawngo.com and Pawnup.com, now charge service fees that can be as low as 3 percent. How it works: Borrowers complete an online form describing the items they wish to offer as collateral. The online pawn shops decides whether or not to make an offer, and if a loan agreement is reached, the borrower is sent packaging materials to ship the items, typically at no cost. Once the online pawn shop receives a borrower's goods, it will wire funds within 48 hours.
Friends and family are often seen as the first stop on the fund-raising trail. And the advantage of tapping people you already know for startup funds is clear: They're easy to find. But there are three main disadvantages, Paul Graham, a Silicon Valley angel investor, writes: "You mix your business and personal life; they will probably not be as well connected as angel or venture firms; and they may not be accredited investors, which could complicate your life later." (The SEC defines an "accredited investor" as someone with over $1 million in liquid assets or an income of over $200,000 a year.) No matter who your friend or family member is, Fred Wilson, a New York venture capitalist, suggests executing the deal with a convertible note, which is a type of loan that turns into equity in the event of a significant cash infusion. Wilson, in a recent blog post, recommends that entrepreneurs set up the deal so that friends and family get a discount during the next round of financing, and founders give away no more than 10 percent of their companies to friends and family early on.
For entrepreneurs who run profitable businesses, and are looking to raise money without the loss of control that comes with venture-capital investments, or the fixed interest payments attached to a typical bank loan, revenue-based financing may be their best option. Revenue-based loans allow interest payments to fluctuate "when a growing company has inconsistent cash-flows or lumpy or seasonal revenues," writes Andy Sack of Lighter Capital, an investment firm that offers RBF financing. The interest payments generally amount to 2 to 5 percent of a business's monthly revenue, no matter how high or low that month's revenue is. RBF financing is most appropriate, Sack writes, "for companies already generating revenues but without hard assets typically required to get bank loans." Partners in Demand, an online consulting service for entrepreneurs, adds that these types of deals are best suited for startups that are generating $1 million to $10 million in annual revenue, need an extra $100,000 to $3 million in cash, and have at least 50 percent gross margins. Lighter Capital and Next Step Capital Partners are two investment firms that specialize in revenue-based financing for startups.
Contests and Accelerator Programs that target entrepreneurs are all the rage these days. Contest winners receive cash prizes that typically range from $5,000 to $50,000 and rarely dilute stock ownership. Startups also derive exposure from the contests that can lead to crucial connections. At the same time, accelerator programs are popping up everywhere (click here for a map of accelerator programs and here for a list of the top 15 U.S. accelerators). The programs require entrepreneurs to apply and, if they're accepted, move to a set location for around three months, where they get free office-space, mentorship, the opportunity to pitch their businesses to investors on the last day of the program and, sometimes, an automatic equity investment. At Y-Combinator, for instance, the most well known accelerator, each startup gets $150,000 upon being admitted.
Though Bank of America, Chase, Citibank and Wells Fargo say they are increasing their small-business lending in 2012 and recently shared their criteria for small-business loans with HuffPost Small Business, many banking experts believe small businesses may find better luck seeking funds from small banks or community banks, which "aren't as exposed to the European debt crisis as the large banks are," says Bernard Baumohl, chief global economist of The Economic Outlook Group, an economic forecasting firm in Princeton, N.J. Ami Kassar, founder and CEO of Philadelphia-based MultiFunding, points out that small banks, with $500 million or less in domestic deposits, account for 31.5 percent of all small-business loans, even though they account for only 11 percent of deposits. To help you in your search for a bank loan, MultiFunding recently released a tool that grades every FDIC regulated bank in the nation according to its commitment to small-business lending. And if you think banks are only helpful for traditional small businesses, with years of consistent revenue, think again. A growing number of startups are opening up business checking accounts with so-called "venture banks," such as Square 1 Financial and Silicon Valley Bank, which can act as strategic partners in the hunt for cash.