CHAPTER 16 - WHAT TYPE OF CAPITAL?
It's easier to find something, when you know what you are
looking for and in what direction it might be.
Debt Versus Equity
Debt funding is normally cheaper and easier to find than equity funding. Debt typically
carries the burden of monthly payments, whether or not you have positive cash flow.
Equity investors expect little or no return in the early
stages, but require much more extensive reporting as to the company's progress. They have
invested on the gamble of very high returns. Therefore, investors anticipate that goals
and milestones will be met.
Debt financing is usually available to all types of
businesses. Equity is generally restricted to businesses with fast and very high growth
- For what type of debt financing can my company qualify?
- How much debt can I afford?
- Can I handle the payments if cash flow is off?
- What happens if interest rates rise?
- Am I willing to pledge company and personal assets?
- What about my personal guarantee?
Debt lending is more analytical than personal. Are your
ratios right? Do you have the assets? Are you credit worthy?
- What type of investors do I target?
- Am I willing to share control and future profits?
- Do I really want investors as partners forever?
- How big of a share am I willing to give up?
- Will I be able to keep up with all the required reports?
- What about disclosing company secrets to potential
Investors will want to take a much larger share of a
start-up venture, than they will of a company with a two or three year track record of
Angels are individual private investors who make up a large portion of
"informal" venture capital. These investors usually keep their money close to
home (50 miles or so). They tend to invest small amounts ($25,000 to $250,000), and they
can be difficult to locate because they usually don't belong to networks or trade
Angels are found among friends, family, customers, third
party professionals, suppliers, brokers and competitors. For the most part, once they
invest in two or three deals they are out of money.
There are a few private investor locating services out
there. Beware of those who charge large ($1,000 or more) advance fees in order to put you
in touch the an investor. Do your homework, check these people out and negotiate a
commission if your request is placed.
Caution: Don't advertise in your local paper for investors until you have
spoken to a securities attorney, or the SEC may give you a call.
Affectionately known as "Vulture Capitalists" in the industry. That may not be
nice, but it's often true. These investors are out looking for huge returns not just good
ones. Venture capital is extremely hard to get and the competition is fearse. These
funding sources get thousands of requests each year and only invest in two or three.
The managers who invest these funds are great at finding
oysters that will produce pearls. They usually are very bright, well educated and
extremely arrogant. Tread lightly here and I highly recommend you go another direction if
Joint Ventures/Strategic Partnerships
Our personal favorite. This is where two companies with parallel interests get together
based on their mutual needs:
- They have the money…you have the plan.
- You have the product…they have the distributors.
Do your homework. Seek out companies with parallel
interests to your own. You have the world's best new phone design and they are AT&T.
This requires much more research than simply asking for a loan. Most of these partners
will settle for 20% to 40% equity in your company. Be careful to protect your ideas by
having any potential partners sign a non-circumvention document.
Small Business Administration (SBA)
A tremendous resource, but the paperwork can be tiring. This is a great place to look. The
SBA has many different programs. Your local bank should have an SBA loan officer who can
explain them to you.
Small Business Investment Corporation (SBIC)
Hi-bred is a close description. These firms leverage their private capital into government
money to form a sort of venture capital fund. Most SBICs are part of commercial banks.
They offer both long term loans and equity participation. They are generally conservative
in the placements, investing only in established companies for management buyouts, funds
to go public, strategic partnerships and bridge financing.
This is a short term debt instrument typically issued from 2 to 270 days. An issue is
normally a promissory note that is unsecured and discounted from its face value. The issue
is usually backed by a letter of credit or some other from of credit guarantee. The
company may pledge assets to obtain a credit guarantee which is then leveraged into an
issue of commercial paper.
Letters of Credit
Issued to your funding source on your behalf, as a guarantee that you will pay. If you
don't pay the issuer does. Your bank might issue the L/C based on your pledge of a
receivable or other hard asset.
An age old method of financing. Funds are advanced against goods sold, accepted and not
yet paid for. Normal advances on accounts receivable are 80% to 90%. The lenders are
looking for ninety (90) days or less to be paid. Funding is available for older accounts
receivable, but the rates take a dramatic turn upwards.
Purchase Order Advances
Leveraging your future. If you have purchase orders with your customer base, you may be
able to get advances towards their completion. The typical advance is less than 50%, and
the rates are very high. Don't choose this one unless there's no other way.
You can think of this as renting assets. You gain the capital equipment you need and agree
to pay rent for a specific period of time. There is no interest rate here, but the rates
tend to be higher than commercial loans. Some of that is offset by being able to expense
100% the payments (pretax). Check with your tax accountant to be sure.
Asset Sale Lease-Backs
If you are cash poor and asset heavy, this may work for you. Here you are selling your
asset for cash to a funding source who leases it back to you (typically with a lease end
purchase option). The downside of this approach may be capital gains or sales tax.
A do it yourself stock offering. A great way to raise small amounts of capital ($500,000
or less) with a few investors (typically less than 35). These are now available in a
boiler plate format in most states. Contact your state's Department of Corporations for
information on what is required to stay out of trouble.
504, 505 & 506 Offerings.
Forms of stock offerings that let you raise more money and
have more investors than private placements. These are great vehicles if you take the time
to figure them out. Contact the SEC, they will be happy to send you the rules and the
You can look for one or form your own. Limited partnerships usually exist for the purpose
of investing. The general partner has all the exposure and management duties, while the
limited partners have put up all the money. There are numerous Limited Partnerships out
there that have been formed to invest in businesses. You can search them out or inquire
with your State as to the requirements for forming your own.
This is normally a loan than can be converted (at the lender's option) into an ownership
position in the company. These are most common with seed or start-up funding where the
lender would like a piece of the rock in the event you become a tremendous success.
Most states have revenue bonds. These bonds are usually designed as debt instruments,
where the company issues the bond and the state agency underwrites it. These bonds are
generally issued to promote manufacturing facilities that will create jobs.
Lines of Credit
A revolving account that is continuous in its nature. The funds are available as draw
downs against the total line. These types of accounts are most commonly secured with
accounts receivable and inventory as collateral.
This covers the major types of business financing. There
are numerous creative ways to finance your business. If one of those comes your way take a
moment to investigate it. You can never know too much about how to capitalize your
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