by Michael Iverson
Once upon a (fairly recent) time, a beverage start-up wanted to introduce a brand new product into a local market. The founders funded the company themselves, with help from friends and family. They developed their proof of concept, the packaging, and ran focus groups. They worked hard.
At the same time, they were showing a well-crafted business plan to potential investors. Eventually aligning themselves with a private equity group with similar companies in their portfolio, they were also able to gain management expertise as well. It was a match made in heaven, and all parties were successful.
“The founders understood the process of securing capital financing,” says Mike Iverson, CPA and principle of Trillium Financial. “They did it by the book, and it worked out for them.”
The path to obtaining capital financing for any start-up, or even an established business, is not always so clear-cut. And it doesn’t help that creditors have tightened their belts in the past few years. But money is out there and it pays to know exactly what type of capital is best suited for your business.
Here are some capital investment options that you may consider for your business:
- Friends and Family – This money is generally in smaller amounts, when a company needs thousands of dollars, but not millions. Terms are favorable because the investors know you and are trying to help. Still, they expect returns slightly north of the stock market.
- Angel Investors – Angels will also invest amounts less than $1 million in very early start-ups, or companies unable to get bank financing. “If a CEO can align themselves with an angel with experience in their industry, he or she can take the company to the next level,” says Iverson. Angels, though, usually want a little more involvement in the business, and it just might be more oversight than an entrepreneur is willing to live with. Also, there could be financing terms that specify that the angel gets control of your company if certain milestones are not met.Angel investors are not as prevalent as they were in past years, but they can still be found. “Ask around in your network, ask your banker, and look on the Internet,” says Iverson. Some sites to get you started include:
http://nationalnetworkofangelinvestors.com
http://www.angelcapitalassociation.org/
http://www.angelcapitaleducation.org - Private Equity Groups – These investors use a combination of debt and equity to help a company grow quickly and offer the founder liquidity or an exit plan, if desired. This option is for companies that need $5-7 million. Some groups offer to finance the debt themselves, at a 9 to 13 percent interest rate; others have a relationship with a bank that will provide the loan. These groups want a 25 to 35 percent return on their investment, so they attach warrants, which allow them to convert the debt to equity at some point. Private equity groups are looking for businesses that have cash flow, some positive earnings and have been around for several years. The fast pace and pressure is not for the faint of heart–investors want their returns quickly.
- Bank Loans – Banks are not in the business of helping companies grow rapidly. However, if you have seasonal issues or specific equipment purchases that you want to make, banks are a very good option, and pretty much the cheapest way to get money. These loans are for viable, established companies with some earnings.
- Small Business Loans – Small Business Investment Companies (SBICs), which are licensed and regulated by the Small Business Administration, are privately owned and managed investment firms that provide venture capital and start-up financing to small businesses, according to the SBA. (www.sba.gov). “SBA loans provide favorable conditions,” says Amy Carson, senior business development manager with UPS Capital Business Credit, “such as longer terms – up to 25 years for real estate – and equity as low as 10 percent.”
- Mezzanine Financing – A combination of debt and equity financing. Basically, investors give money as debt with the option to transfer it to equity in the company if certain milestones aren’t met. One advantage of mezzanine financing is that it’s usually considered equity on the books (rather than debt), so it may be easier for the company to obtain more debt from a bank or other lender.
- Venture Capital – For young companies that need $4-5 million and want to grow rapidly, venture capital is a good choice. VCs usually invest in a proven management team, even if the company itself is less than a year old. VCs want a board seat, they take equity and they will take control of the company if certain milestones aren’t met. In the past, VCs wouldn’t let a founder liquidate any of his money, but in recent years they’ve loosened that rule. These investors are looking for a much bigger return – typically 50-60 percent – because the companies are younger and the risks are higher.
- Factoring – A strict factor will lend money based on the amount of accounts receivable coming in on a monthly basis and can help with cash flow. For example, if you have $100 of receivables, they may advance you $80 of that now. When the customer sends the payment, they keep two percent as a payment and pay you the rest. While this is a simple 24% interest rate and similar to the returns expected by private equity investors, the difference is that you are not giving up any ownership in your business.“Banks like tangible assets. We finance the intangibles, the receivables,” says Steven Gold, president of Allied Financial. “Companies can use the money to make payroll, pay vendors, all in lieu of bringing in equity partners, which is the most expensive money.”
Bottom line: The money is out there – but whether or not you’re successful in securing it for your business depends on the path you follow. Says Iverson, “The way a business is capitalized will ultimately predict how fast it will grow.”