The Cost of Raising Money

The Cost of Raising Money
by William Cate

Only your family, friends, governments and fools ignore basic funding guidelines. These costs have evolved over time because they reflect the cost of helping the foolish find the foolish.

To raise money, you need a short, enticing executive summary and a credible business plan. A professionally written business plan usually costs between US$7,000 and US$15,000. Unless you are a business writer, cutting costs by doing it yourself is usually a mistake. Professionals will do a better job of organizing and present your vision. You should define your target market before you prepare any business plan. Investors, lenders and governments are motivated by different goals and thus your business plan must show them that funding your company will allow them to reach their goal. If you are seeking funding for more than one of these three groups, your business plan should be written differently for each potential funding group.

Lenders expect you to have collateral (assets) that ensures the repayment of the business loan principal and some source of assured income to repay the debt. In theory, if you default on your business loan, the lenders recover their principal by selling the pledged collateral. The lenders' goal is to have little to no downside risk in the loan. If you can't show a credible means of repaying the business loan, you won't get the loan. Lenders don't make money on defaulted loans. At best, they recover their risk capital from the sale of the collateral.

Most governments' mantra is to create local jobs to ensure political stability. While requirements as to terms and industries vary, governments are seeking multinational firms with markets outside the government's borders for goods produced by their local workers. If your business plan reflects this strategy, most governments will offer you half the needed funding in grants or about 75% of the needed funding as low interest loans. Your company can also expect a multi-year tax holiday, etc.

If you are a private U.S. Startup Company, seeking funding from an American Venture Capital Firm, your odds of success are about one-in-ten thousand. You can expect from them up to US$1 million in risk capital. Often, they will increase funding, once they have made their initial investment in your company. Your business plan should show near-term positive cashflow with high profit margins and an experienced and credible management team. The VC Firm will want at least 50% equity in your company. If you are a private non-U.S. Startup Company, seeking funding from an American Venture Capital Firm, your odds of success are about one-in-twenty-five thousand.

Your odds somewhat improve seeking private company funding from American Angel (Accredited) Investors. However, finding them is difficult without using financial brokers. You can easily spend tens of thousands of dollars seeking investors for your private company before you realize that the odds are strongly against your success. For many private startup companies the hunt for money is fruitless. The costs are excessive.

If you decide upon raising money from an American Initial Public Offering (IPO), you will spend $1,500,000 to $2,250,000, perhaps more to do your IPO filing. Add to that 3% of the money to be raised paid up front to an underwriter for "non-accountable" and non-refundable fees. You'll also pay all the costs of doing the "Dog & Pony Shows," which will average about $10,000per presentation. It takes about 18 months. Your odds of success are about50/50. The average amount raised for a startup company is usually less than one million dollars. Your underwriters, assuming they follow NASD (National Association of Securities Dealers) regulations for a "Firm Commitment" underwriting, will take 18% of your money. This is from the capital that they raised for your company. This payment will be at a 10% discount from the IPO share price. You will pay an additional 5% accountable expenses and 3% non-accountable expenses. (The 3% non-accountable expense is paid up front with the signing of the underwriting agreement.) BTW, "Firm Commitment" Agreements are not firm. If you doubt me, have your attorney read the underwriting agreement.

You can go public in the States, without doing an IPO. Doing so may reduce your registration costs, it may reduce the time it takes to trade your shares or it can improve the odds of your becoming a public company. The reason to consider this option is that the odds of raising money as a public company increase to an average of around 1-in-100. The improved odds relate to the facts that (1) you are offering investors liquidity since they can sell their shares to the public and (2) leverage, in that the shares usually command a better price than that reflected by your public company's balance sheet.

Whenever you employ someone to help you, you must pay him or her. Someone raising money for your private company will want to gross between 25% and 30% of the money they raise for you. They will expect their overhead costs paid in advance. While there are tens of thousands of these "Boiler Room" brokers, most of them operate outside of U.S. Law. Their successful funding percentage is usually low.

Most business owners and entrepreneurs think there is a Fairy Godmother who funds businesses, without regard to logic or reality. They spend years searching for this mythical figure. She doesn't exist. So instead, business-funding seekers settle for dealing with fools with money.

In general, businesses start on a shoestring. Successful businesses are oriented to making money from their conception. They grow by re-investment of their profits. If the company's management is wise, the company goes public to use their shares in acquiring cash producing assets. The insiders exit by having their public company acquired by industry giants. The only role of outside investors is to augment acquisitions with cash and company stock.

Seeking risk capital to start a business is an exercise in fools searching for other fools and paying professionals to make the hunt an occasional success. If you are going to take this path, be prepared to pay the toll and accept the risks.

About the Author: William Cate is an Equity Finance Consultant and Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/]. In his Venture Capital Profits, he offers a low cost way to raise money and grow your company into a multinational corporation.