Sources of Investment Capital for Early Stage Software Businesses
My partners and I formed Learned-Mahn in 1973. It was, so far as we know, the first software company in the State of Idaho. Like most entrepreneurial ventures, it evolved from the original concept to the services that were successful over its twenty-year history. We financed the company from savings, sweat equity, family and friends, angels and a local Small Business Investment Corporation. In 1994, we sold the company in 1994 to National Data Corp. This piece and subsequent pieces are derived from my background as an entrepreneur and my work with angel capital.
Sources of Capital. All businesses pass through the “Valley of Death,” the period when the business is spending more cash than is coming in. We call this time the Valley of Death, because if the business doesn’t reach the point where more cash is coming in than is being spent, the business will die.
While in the Valley of Death, the business owners must finance the cash deficit. A common misconception is that banks will loan money to cover the shortfall. However, this is not the role of banks, as they only finance businesses with a history of profitable operations. Early stage businesses must look to other sources, typically equity capital. Equity capital is risk capital, because if the business does not succeed, the capital will likely be lost. If the business does succeed, the capital will earn a share of the profits. Generally speaking, there are four sources of equity capital, listed below by ease of access:
1. Founder’s savings. This is the cheapest capital a business can have. It comes without having to share interest in the business. Frequently, no one else will accept the risk so it may well be the only capital available. Any investor will reasonably expect that the founder has invested his or her savings. If the founder doesn’t have the confidence to commit savings, then why should a non-founder accept this risk?
2. Family and Friends. Family and friends invest because they have confidence in the founder. Often, they are not experienced business people and typically will not do hard economic analysis. Capital from family and friends is a mixed blessing. It may be relatively easy to raise, but there is no pressure like knowing your family or friends will lose money if you aren’t successful.
3. Angels. Angels are high net worth individuals who invest a portion of their own capital into private businesses. They typically invest not only to make money, but also because they like to help entrepreneurs. Unlike family and friends, they will do economic analysis and will negotiate the terms of the investment. While they want to help, they will only invest in opportunities they believe have an excellent chance of success. The Keiretsu Forum and the Boise Angel Fund are angel organizations that accept applications from Idaho companies, although the Boise Angel Fund is nearly fully invested.
4. Professional capital. Often referred to as “venture capital,” this capital is invested by professionals who make their living by investing capital in early stage businesses. Typically, but not always, venture capitalists invest later in the business cycle than the above three types. Highway 12 Ventures is a Boise-based venture capital firm that did accept applications from Idaho companies. Unfortunately, they are also fully invested and are no longer taking applications for new financings., but there are hundreds of other venture capital firms around the country.
Raising equity capital is a tough hurdle for a new business to cross. Successful capital fund raising requires planning and perseverance. The entrepreneur must:
1. Identify a business problem for which there is no optimal solution.
2. Have a product or service that can profitably solve the problem.
3. Have a viable plan to get the product to the market.
4. Convince investors that he or she can execute the plan.
5. Present a deal to the potential investors that will allow them to make a profit in line with the risk they assume.
In future blogs I will expand on all the above. Meanwhile, if you would like to talk your plans over with me, you can make an appointment to visit with me through the below telephone number.
About the Author
Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital, which assists angels in forming angel funds. He can be reached by email to firstname.lastname@example.org. Appointments to see him are taken at 426-3875.