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 potential.

Debt Considerations

• 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?

Equity Considerations

• 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?

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 success.

Angels
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 associations.

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.

Venture Capital
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 you can.

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.

Commercial Paper
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.

Receivable Factoring
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.

Equipment Leasing
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.

Private Placements
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.

Public Offerings
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 forms.

Limited Partnerships
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.

Convertible Debt
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.

State Bonds
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 business.

Workbook Main Menu I return To Chapter 17