This article was written for the Small Business Spotlight section of January's Catalogue & e-Business Magazine

Business Angels by Bubbo-Tubbo http://www.flickr.com/photos/bubbo-tubbo/

The theory goes that direct commerce is a cash-generative business. Our customers generally pay up front, and we in turn negotiate credit terms with our suppliers. So why is cash flow and funding so often cited by niche merchants as the factor that most inhibits their growth?

No prizes for providing the answers. Most businesses start life underfunded. Things very often take longer than anticipated. Not everything works to plan (some mistakes being more costly than others). We need more and better people. Ultimately, having tasted some success, we become impatient for growth and need to invest so that the momentum can be maintained.

For these reasons and others, it’s not unusual for direct commerce businesses to need an injection of cash. Take care! Raising finance for your business should not be undertaken lightly. At best, securing funding is a time-consuming diversion from the core business. At worst, it can be a stressful, expensive, and often needless denouement for a promising brand. You could end up diluting your ownership and increasing your personal liability.

If you’re investing in premises or equipment, consider the leasing options. If you’re facing a short-term cash-flow blip, think creatively and work through the usual list of cash-saving and cash-generating measures. If you’re certain an injection of finance is what the business needs, steel yourself for the task ahead, and don’t delay with getting started.

Preparation

The financing paradigm works like this: The more desperate you are to raise cash, the harder it is and the longer it will take. Don’t leave it too late, or you’re at risk of gravely compromising your negotiating position and reducing your options. Figure out your strategy and have a plan in place before you need it. You’ll be grateful later on.

Often businesses struggle to raise funds in times of distress purely because they’re so busy fire-fighting the symptoms of their funding problems that they can’t spare the time to start planning their way out. Never has it been more important to have a firm grip. If you’re on top of your business planning, can point to a recent set of key performance indicators, and are up to date with your financial reporting, you’re more than halfway there.

Develop a good pitch—two sides of A4 or approximately 10 slides. Avoid too much detail, but don’t leave out the key information (how much money you need, why you need it, and what you’ll give in return). Don’t write it as a speech; make it an outline that you can talk around and expand on.

Separately, have ready a good written business plan including your financials. You’ll need a standard nondisclosure agreement if you’re going to be sharing it with someone with whom you don’t already have a confidentiality understanding.
Think of potential investors as customers: They’ll certainly exhibit similar behavioural traits as part of their decision-making, and you need to accommodate them all. In the same way that your prospects make an instant decision on whether to engage further with your brand based on the look and feel of your catalogue or website, potential investors will quickly form an initial decision based on what they think of you as much as your business. You can’t beat having the facts and figures at your fingertips to support any questions you may have to respond to, but at the end of the day, it’s the sizzle that sells the steak in your business. You’ll need to demonstrate passion, belief, and management capabilities as well as a firm grasp of details.

Your options

The amount of funding you’re seeking will, to a certain degree, dictate the most appropriate source. For smaller amounts (perhaps up to £50,000), your bank will probably be your first port of call. An extended overdraft facility secured against the assets of the business is likely to be your best outcome. In today’s climate, however, the bank is likely to take the opportunity to secure any liability with a personal guarantee or a charge over your house—not something to rush in to without proper consideration. Many entrepreneurs are willing to go there, but all breathe a huge sigh of relief when they are finally released from such a guarantee.

The government’s Enterprise Finance Guarantee is designed to encourage banks to provide small and midsize businesses with funding of up to £1 million. The anecdotal evidence is that lenders will still seek personal guarantees (although they are not permitted to take a charge over a principal private residence) and are fairly picky when it comes to businesses with few assets on their balance sheet other than stock. Talk to your bank or consult the Business Link website for a list of participating lenders.

Most venture capital companies are uninterested in making investments of less than £1 million and anyway usually require a level of professional due diligence and legal work that would knock it into touch as an option for most smaller businesses.

Friends and family can fill a gap at the lower end of the spectrum with either a loan or an equity investment. Mixing personal affairs with business can sometimes be difficult, particularly if a dispassionate outlook is required. Each party needs to know what he’s letting himself in for, and some expense on an appropriate agreement is certainly worthwhile.

An angel at the table

Finally, and usually most appealing for small businesses, are independent investors, more commonly known as business angels. Such individuals can make ideal partners. To start, a quick deal is often possible, minimising the disruption to your business. They will usually have solid general business acumen and broad experience, providing you with a useful and interested sounding board. Occasionally, if you’re lucky, they will have direct relevant expertise of your product or your business model and will be enthusiastic about contributing some of their time at a strategic level on a regular basis—something that can be incredibly valuable to your business. As a stakeholder in your business, an angel will be highly motivated to safeguard his investment and deliver a significant return. This can often mean that he will assist you with securing additional funding further down the road.

Wall Street Angel by Bubbo-Tubbo http://www.flickr.com/photos/bubbo-tubbo/

To improve the odds of partnering with the right angel, you need to do some homework. How do you define the ideal investor? Do you want a back-seat investor or an active one? Is his network important to you? Are there particular areas where your angel investor could usefully focus? Are you ready and willing to listen and learn from the investor? When you meet potential angels, take the opportunity to interview them and to make sure they really do understand the dynamics of your business model.

Angel investors do not usually want control of your business, but they’ll expect a significant equity stake, usually between 20 percent and 40 percent, to provide them with the upside they are looking for. They tend to be highly motivated to participate to some degree. They won’t want to run your business (that’s your job), but they will expect certain management controls to be put in place. It’s definitely worth dealing with these principles early on, to avoid surprises or misunderstandings later. Make sure that they are incorporated into your shareholder agreement.

Many entrepreneurs baulk at the prospect of angel financing because of the implications for their own shareholding. If your balance sheet is weak, it can be hard to justify a bullish valuation of your business, even though you believe in its potential. The outcome can be an unpalatable offer in terms of the equity you need to hand over for the investor’s cash. This is a good time to start thinking creatively. Some equity will strengthen your balance sheet, but so long as your investor feels he is being offered enough of an upside, consider a hybrid deal that includes some loan stock. Very often the prospect of extracting a proportion of his investment at an early stage is an attractive way of reducing his risk. It leaves more equity for the business owner, some of which could be offered as options to incentivise key staff.

Raising finance can be a tough exercise, and you’ll need to wear your thick skin. But finding the right sort of partner can be a tremendously revitalising experience for you and your business. Many of the most successful brands in the sector today have been through the process several times. It’s part of running a business, and the ambitious entrepreneur will treat it as an opportunity rather than a chore.

Red flags to an angel investor

Seven signals to avoid when pitching to a potential investor:

The creditor black hole. Don’t imply that you’re raising funds to pay off creditors—focus instead on how the cash will add value or unlock potential.
Silly salaries. Never mind what you think you’re worth; investors want to see you sharing the pain, investing some sweat. None will begrudge you an attractive bonus linked to performance, however.
Wobbly morale. Your team can easily and unwittingly betray any cracks in morale. Work hard to unify your staff  and bolster morale before introducing  an investor.
A flawless business. Your proposition becomes less plausible if it fails to acknowledge any weaknesses. After all, a canny investor will treat them as opportunities.
Unrealistic valuation. Of course you want to hang on to equity, but don’t let that drive an overoptimistic valuation of your (cash-strapped) business.
Risk blindness.Risk-free businesses are fantasies. Make sure you demonstrate awareness of the risks your company faces with some basic sensitivity analysis.
Arrogance.You may think you know everything there is to know about your business, but afford potential investors some credit. There may be plenty you can learn from them, even if you don’t make a deal.