Dr Jeff Cornwall

This
week’s topic for the Forbes America’s Most Promising Companies project is from Brett Nelson, Entrepreneurs Editor at Forbes.com:

At
its core, the America’s Most Promising Companies project is about getting
capital to entrepreneurs who need it. Many go wanting, especially in this
credit-starved economy. With that in mind, how does America‘s financial infrastructure
need to change—if at all—to make sure deserving entrepreneurs have access
to precious funding? For that matter, what are the keys to raising money, in
this or any economic environment?

I find it very worrisome that there is movement toward more government intervention in financial markets that serve entrepreneurs.  Pumping more money into the SBA to prop up businesses that cannot support that debt is bad policy and a bad business decision.  And now we hear that venture capitalists are trying to get their cut of government funding through the bailouts.  Venture capital investment is, by definition, a high risk affair.  If VCs can’t raise money through private offerings it seems to me that there is a good reason — their expected returns have become too risky.  We don’t need to throw tax payers’ hard earned money into poorly performing funds.

Truly deserving ventures can still get funding, although it has gotten a bit more complicated and challenging. 

Equity funding is still flowing.  The amounts are less and the money can be harder to find, but it is still out there.  Entrepreneurs need to be prepared to be able to offer more proof of concept.  The giddy times of dreams and ideas getting money thrown at them are over for now.  Do what it takes to prove you have a viable business — find customers who will buy your products or services.  This will take more self funding for seed money and more bootstrapping to get the business off the ground so you can demonstrate to investors that your business really works.

Debt markets for entrepreneurs are going back to basics.  This is a good thing, I must say.

Traditionally, bankers have operated with a business model that tries to minimize risk.  They are responsible with protecting the deposits held in their banks.  Many banks strayed too far away from this in the recent past, but they are returning to their old ways of doing business.
 
Businesses must be able to qualify for bank credit on their own standing.  This has very little to do with the things that get entrepreneurs excited about their own business, such as opportunity, upside potential, and vision. To a banker, a bankable business is one that will pay back its loans with very little chance of anything going wrong. So rather than getting excited about untapped markets or product innovations, bankers look to three main factors:

Is there adequate cash flow?

Bankers define “adequate cash flow” not as being just enough excess cash each month to cover monthly loan payments, but significantly more than enough excess cash flow.  Also, bankers want see this cash flow already occurring, not projected in the future within a business plan.  That is why bankers are usually not the best source of funding when you first open your business.  Get a track record and some cash flow and you will find that bankers are much more receptive.

Can owners pay back the loan if the business cannot?

Personal guarantees from the entrepreneurs who have the personal net worth to pay off those loans is the second line of defense for banks. 

Is there collateral?

The reality is that banks don’t want to try to collect your accounts receivable, sell your inventory, or liquidate your equipment – and they certainly don’t want to run your business. Don’t assume that such collateral is what banks like to see in a business loan proposal. Collateral is considered the last resort for covering a loan from a banker’s perspective.

The financial markets will improve for entrepreneurs as the financial prospects of their ventures improve.  Private sector efforts to improve the efficiency and effectiveness of financial markets for entrepreneurs, such as angel networks, web resources, and projects like America’s Most Promising Companies can help, but the wounds in this economy will take a long time to heal.