Why Won’t People Invest In Your Small Business?

If people won’t lend you money there is a reason.

The most common question I am asked by prospective clients is how they can get some cash to fund the growth of their business. My answer is pretty simple really: get a good business. Whilst that may seem a little glib and chicken-and-egg-ish the simple fact is that there is a lot of cash available to fund good businesses. The problem is that there aren’t that many good businesses to invest in, in spite of what most business owners think. Any sensible investor or lender, banks included, will only normally engage with you if you are a low risk and you have a proven business. The vast majority of people I meet, who decry the dearth of funding for growth companies, seem to think that just because they have a business and a dream someone should fund them, if for no other reason than the better good of the wider economy. Sadly, that just isn’t how it works, nor should it.

There is money of course for the right type of high-risk funding, but it has to have a big upside. The venture capital community are expert portfolio players who make such a good return on 1 or 2 out of every ten investments they make that they can consider the write-offs, or write-downs, of the other 8 as an acceptable cost of sale, but they are normally equity investors and they demand a big return for the big risks they take. All this means that VC’s often have little appetite for the small guys. I have found though that if you have a good story it is possible to find individual investors, or small groups of people who understand the business and believe in the owner, and that you can raise early stage funding this way. I’m not always convinced though that the investors really understand the level of risk they are taking on, without the portfolio protection of serial investments, so this can so easily end in tears. This is particularly so if they aren’t “sophisticated investors” but just family and friends who are just trying to help.

The growth of “crowd funding” has created a mechanism where individual investors can take on far less individual risk by lending small sums to several businesses as long as they have a big enough personal portfolio of such investments. Whilst this does make it a safer game for small private investors, my experience suggests that there are still pretty high hurdles to jump to get access to cash this way; although crowd funders don’t have any cash in the individual investments they have a lucrative and low risk business model that they want to protect. This form of underwriting is a rather egalitarian development in funding that will surely change the role and structure of traditional banks over the next decade.

Of course, many people who are entrepreneurially inclined have no clear idea what business they want to run, but they are aware of just how risky starting something from scratch can be, and so they are attracted to the idea of buying a franchise. They mistakenly think it is less risky when, to my mind, it can be very risky; it’s just a different sort of risk. Franchising is a very powerful way to fund the growth of your business but the “investor” is often not a business or investment expert and so they can be rather naive and take on franchises that are much higher risk than they realised. This is particularly true at the smaller end where franchises are new and not really proven. Franchisees are often buying into a lifestyle dream rather than simply making an investment decision and that rather clouds the issue. In my experience franchising is always a battle between the franchisor and the franchisee, for control of the margin, and it can get rather unpleasant at times. Many franchisees I have met and worked with over the years have not found it a very pleasant experience.

From the above you might conclude that one answer to my question, about how to fund your small business, could be to find naïve investors, but that is not something that I would advocate because it won’t necessarily be in your long term interest to fund a poor business, though you may make some arbitrage gain. No, if you don’t have a credible and proven business model yet, you need to get one. In the absence of family and friends you will need to fund it yourself, at least initially, until you have. You will need a good story and that will need to include proof that your business works. I always suggest you do this at the smallest scale possible so you can both afford it and don’t waste too much time on ideas that just don’t work out. Once you have demonstrated that your idea makes commercial sense, and critically there really is demand, then cash to fund growth really is easier to find. It is, rightly, hard to get cash and it always comes with strings that can be hard to live with no matter where it comes from.

Mark

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