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
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.
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
Am I willing to pledge company
and personal assets?
What about my personal
Debt lending is more analytical than personal. Are
your ratios right? Do you have the assets? Are you
What type of investors do I
Am I willing to share control
and future profits?
Do I really want investors as
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 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
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.
Our personal favorite. This is where two companies
with parallel interests get together based on their
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
Small Business Administration
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
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
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
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
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 forms.
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
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
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.
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