Below I outline a few of the myths and point out the realities:
Myth 1: You need a lot of capital to start a new business — Not true. The typical start-up only requires about $25,000 to get going. Many entrepreneurs keep the cost of financing a new business down by designing their businesses to work with little cash. They borrow instead of paying for things. They rent instead of buy. And they turn fixed costs into variable costs by, say, paying people commissions instead of salaries.
Myth 2: You are likely to raise money from someone else — Maybe. But if you do, you are in the minority. Even in studies of businesses as much as eight years old, the majority of businesses received no money from anyone other than the founders. And for brand new businesses, a relatively small percentage are able to get money from venture capitalists, business angels, banks, trade creditors, friends and family combined.
Myth 3: Your personal credit doesn’t matter; it’s the business borrowing the money — Not true. Very few entrepreneurs can obtain capital on the basis of their business ideas alone. Almost two-thirds of founders use personal debt to finance their businesses. And about half of the founders of sole proprietorships less than five years old personally guarantee the debts of their businesses.
Myth 4: Venture capitalists are a good place to go for start-up money – Not unless you start a computer or biotech company. Computer hardware and software, semiconductors, communication, and biotechnology account for 81 percent of all venture capital dollars, and 72 percent of the companies that got VC money over the past 15 or so years. VCs only fund about 3,000 companies per year and only about one quarter of those companies are in the seed or start-up stage. In fact, the odds that a start-up company will get VC money are about 1 in 4,000. That’s worse than the odds that you will die from a fall in the shower.
Myth 5: If you want angel money, you need to find rich investors — If rich means being an accredited investor — a person with a net worth of more than $1 million or an annual income of $200,000 per year if single and $300,000 if married — then the answer is “no.” Almost three quarters of the people who provide capital to fund the start-ups of other people who are not friends, neighbors, co-workers, or family don’t meet SEC accreditation requirements. In fact, 32 percent have a household income of $40,000 per year or less, and 17 percent have a negative net worth.
Myth 6: You need to look for equity when you seek external financing – Actually, you’re more likely to borrow money from someone else than you are to get an equity investment from them. According to the Federal Reserve’s Survey of Small Business Finances, 53 percent of the financing of companies that are two years old or younger comes from debt and only 47 percent comes from equity. But most of the external financing that companies get is debt and most of the equity comes from founders. So you are actually five times more likely to get a loan from an outside source than you are to get an equity investment.
Myth 7: Banks don’t lend money to start-ups — This is another myth. Again, the Federal Reserve data shows that banks account for 16 percent of all the financing provided to companies that are two years old or younger. While 16 percent might not seem that high, it is 3 percent higher than the amount of money provided by the next highest source – trade creditors – and is higher than a bunch of other sources that everyone talks about going to: friends and family, business angels, venture capitalists, strategic investors, and government agencies.
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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.
Scott is a member of the Small Business Trends Expert Network.