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Capital
Alternatives
WHAT
TYPE OF CAPITAL DOES YOUR BUSINESS NEED?
What
Does Your Business Need? - Equity, Debt or Alternative
Financing. Too often business owners look for financing
in the wrong place. They think that since they are
a start-up business they need "venture capital" or
a Small Business Administration (SBA) term loan will
help when they face a crunch for working capital.
The following paragraphs will provide some guidance
to helping you identify the type of financing you
need for your business.
EQUITY
When
an individual or an institution "invests" in your
company, they are making a capital contribution to
your business. In return, they own and have control
over some portion of the business and will get repaid
through profit sharing or when the company is sold.
The
business has to have the following characteristics
in order to be attractive to investors:
High
profit margins to provide attractive profit-sharing
income (dividends) to the investors.
Product
or service must have significant market appeal and
show the potential for rapid future expansion.
Potential
for a significant return on investment through an
"exit strategy" such as "going public" or acquisition
by a larger corporation.
Size
of Equity Investment and potential Sources:
Under $500,000: go
to private investors such as Ace-Net.
$500,000 and up: Small
Business Investment Corporations
$1 million and up:
Venture Capital
Funding
Process:
lengthy and expensive
Attracting
Private Investors
Most
equity injections are provided through private investors.
This so-called angel market is estimated to be 5 to
10 times greater than the institutional venture capital
pool. The angel market is most often in search of
investments in the $50,000 - $500,000 range. The difficult
task is finding these investors because this market
is highly fragmented and disorganized and has often
been part of the "old boy's network."
Where
to look for investors?
Start
with business acquaintances that understand and know
your business acumen.
Look
for people in a similar business who could provide
needed expertise and can see the potential of your
business.
Talk
to your banker. (e.g. a recent client wanted to open
a restaurant. When she talked to her local banker
about financing he immediately referred her to several
people in the community who would be interested in
investing in a local restaurant.)
MIT
Forum: started at MIT and the format has now been
take around the world.
What
are private investors looking for?
Better
returns than they could get on a portfolio of blue
chip stocks but less than professional venture capitalists
look for.
In
addition to financial gain, they also look for "psychic
income." Based on their background, many investors
want to contribute their expertise as well.
Investors
are looking for good management and industry potential.
What
deal do I offer them?
When
most people are faced with asking friends and family
and other private investors for capital, they have
very little knowledge on how to approach the deal
to make it favorable for both the entrepreneur and
the investor. With investor financing as opposed to
conventional financing, you can be creative and flexible
for the needs of the business.
For
example: You could structure an agreement that has
both debt and equity elements. Offer to repay the
principal of the investment like a loan over a certain
period of time. Because the investor has offered to
risk his/her capital on your business, it is often
required that you provide a "kicker" as well. This
"kicker" could be a percentage of profits for several
years. In the first year or so there may be no profits
and therefore no "kicker". However in the ensuing
years the investor may reap extra income as your business
becomes profitable. Many people want to structure
an agreement with an investor so that there is a timely
exit for that investor. Many people do not want an
investor involved in their business forever, but want
to ensure they are paid off and out of the business
in a reasonable period of time. Likewise investors
want to know when they can reap their investment.
Be
sure and consult with an attorney and get her to help
you make all the necessary disclosures, etc. -- even
though you are working with a private offering it
requires careful analysis and legal agreements. Here's
some suggestions for communicating with potential
investors:
Have
a carefully designed business plan with a two or three
page investor prospectus.
Investor
prospectus should include:
how
return on investment will be calculated and distributed
guarantees
(if any) to reduce risk
exit
requirements for the investor
length
of time for the terms of the prospectus
DEBT
Debt
financing is when you borrow money from a bank or
alternative financial institution. The lender expects
to get paid back over a specified period. In order
to make sure that the lender will be paid back, the
lender determines if there is enough cash flow to
repay the debt and asks for a lien on additional assets
that can be sold to repay the debt if a borrower defaults.
A business is considered to be attractive to lenders
if it displays the following characteristics:
Borrower
has good personal and business credit history that
indicates good "character".
Business
financial history indicates there is enough cash flow
to repay the loan or,
There
is substantial information provided which shows the
potential for the business to generate enough profit
to repay the loan.
The
business is not carrying significant debt already
(debt/net worth should not be more than 4:1).
The
business and borrower have sufficient collateral to
offer as a second source of repayment.
Types:
Term loans: Usually for start-up, expansion,
purchasing of fixed assets, real estate and other one-time
costs that have to amortized over time. Working capital
can often be included in a term loan.
Line
of Credit: Usually to cover variable/seasonal or
working capital needs of the business. Money is borrowed
for short periods of time, can be repaid, and then is
required again.
Special
Loan Programs: Government (SBA, state, city) and
alternative loan programs (e.g.microloans) offer primarily
term loans and some lines of credit . Most loan programs
are offered in conjunction with a bank. Special loan
programs are used when:
There
is insufficient collateral
There
is insufficient owner equity or downpayment
Loan
is considered "risky" because of the type of industry,
the business is a start-up or emerging business,
or there may be a problem in the ability to repay
the debt through traditional means.
Loan
size is small (under $25,000 are often originated
through microloan programs).
Funding
Process: Once all documentation has been received
and reviewed, many bank loans can be closed within
2-3 weeks. If a special loan program is used the processing
time can increase to 6-8 weeks.
For
more information check out the following:
Loan
Sources - list of some state, federal and small
business loans available.
Loan
Check List - a list of documents you will need
when applying for a loan
Do
you qualify for a loan?
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