Some advice you won't need, and some you will.
Lying on his death bed, Homer Simpson gives Bart his final advice: “Son, these words will get you through anything: 'Cover for me.' 'Oh, great idea, Boss!' and 'It was like that when I got here.'”
If you own a business, you’re an entrepreneur. But you won’t need Homer’s advice because you already do anything and everything. No one will cover for you. You are the Boss. And, you’re always “here”…in your restaurant, at work.
But when your business needs more capital, what are you going to do and where can you find it?
What Do You Do Next?
First, honestly answer a few personal questions:
• Why do I need more capital? How much? At what cost?
• Will investors see me as willing and able to safeguard their money and deliver expected returns?
• Am I ready for partners? Willing to comply with covenants, financial laws, and accounting rules?
Second, inventory and document information about your business that will be the measure by which financial backers will evaluate the opportunity:
• The operating history; past performance and future projections; and its growth potential
• Depth, discipline, agility, and reputation; if and how the Company has transitioned from a personality-driven to a process-driven enterprise;
• Existence and status of intellectual property; condition of the company's books and records;
• Monthly burn rate; and whether the Company can deliver results quickly following new investment and then produce strong, steady growth.
How Are You Going to Find It?
What do investors want, then? Why are they asking these kinds of questions? To varying degrees along a sliding scale, investors want low risk and high returns. Often, confusion lies in matching the right source to a particular deal. You need to know where to look. For example, if you want peaches, try Georgia or Utah. Need coal? West Virginia or Newcastle. Igloos? Alaska.
Keep in mind what motivates the capital source. In virtually every case, capital sources have a problem. They have large amounts of capital available they must put to work, or their organizations won’t be profitable and survive, but it they take too much risk, they won’t be profitable or survive either. It’s walking a fine line. Somewhere in that spectrum can be a source that will see your company as a viable choice for their resources.
Where are you going to find capital? So much depends on the nature of your business, the stage of development you have attained, and your preparation.
In essence, the more sales, profits and assets you have generated or accumulated, the more likely you will be to qualify for one or more capital sources. This doesn’t mean you can’t find capital if you’re not yet profitable, or if you haven’t acquired or created measurable assets or, even, if you have no sales at all. If this were true, how could Silicon Valley be the world tech capital it is?
But not every business is bankable—meaning, commercial banks won’t loan to every business. And not every business can “go public” to sell its shares to the public market for new capital. But, there are many sources of capital and many ways to approach these sources. And sometimes, it just requires you to be creative and come up with new approaches.
Capital Sources and How They Work
Let’s look at leading capital sources:
1. Your personal resources: Use your own capital unless you lack enough for what the business needs, you can’t risk all your capital, your assets aren’t reachable (they’re not liquid), etc. But be creative. Illiquid assets could serve as collateral for a commercial bank loan or a loan from family, friends and fans. For example, A Utah company borrowed land from a third party and used it repeatedly to collateralize loans it needed for growth, paying the loans off each time. The land owner was pleased to put his land to work, be paid a cash fee for doing it, and receive an equity kicker in a growing company.
2. Friends, Family, and Fans: If it weren’t for friends, family, and fans, most entrepreneurs wouldn’t have made it. These are the people who have known you for years. They like and trust you and are most likely to buy in at the start. Remember, unless they’re all active partners in the business, however, the securities laws still apply to the offer and sale of business interests to these friends and family.
3. Partner(s): You have an idea for a new restaurant, and an investor has the capital you need and likes your idea. Form a partnership. It can be a 50/50 partnership where you work and your partner provides the capital or another structure where each of you works in the business. Commonly, the capital partner receives more money back until his investment is returned. Robert Frost wrote: “Good fences make good neighbors.” And in a partnership, a good partnership agreement makes good partners. It’s best to face the issues that may come up at the beginning by putting language in place now on how they will be resolved. If you structure your partnership correctly, you don’t need to worry about the securities laws.
4. Commercial Banks: Commercial banks receive deposits from their customers and lend that money at generally reasonable interest rates. Because their primary purpose is as a regulated depository institution, they have little to no appetite for risk. Even, predictable low-risk returns are what they're after, and small, early growth-stage companies typically don’t fit their mold.
5. Private Placements: Most capital raised in the U.S. is raised through private placements. This consists of the offer and sale of your company’s equity, whether corporation stock, limited liability company member interests, or something else, to investors. Generally, offers and sales of any passive interest in a business opportunity must be registered with the Securities & Exchange Commission (SEC) in what’s called an initial public offering (IPO), unless the company is exempted from that registration requirement, including a “private” placement of securities. If an exemption is available, you don’t need to go to the expense and effort to register the securities with the SEC. Nevertheless, you are required to sell your equity in strict compliance with the rules of that exemption. This can allow you to sell parts of your company to many investors, raising the capital you need.
6. Crowd Funding: There are two types of crowd funding. In donative crowd funding, such as Kickstarter or IndieGoGo, a financial backer receives a token for donating money to the cause, a t-shirt, or preferential pricing. Equity crowd funding, on the other hand, enables individual investors to get in on the upside action. However, in the limited but growing number of states in the U.S. where equity crowd funding is legal, it is subject to regulatory “I”-dotting and “T”-crossing.
7. Venture Capital: The venture capital industry raises pools of investment capital from institutional sources such as pension funds, insurance companies, and successful enterprises to invest in early stage companies. They plan to receive a substantial return on their investment (ROI) and distribute their profits to their investors and themselves. They offer connections to management talent, additional capital pools, and the possibility of an acquisition at a much higher valuation or an initial public offering through which they and other investors can exit their investments.
8. Investment Banks: Investment banks do not take deposits and are not commercial banks. They serve as intermediaries, often called underwriters in public financings. They connect a promising equity or debt opportunity to institutional or private investors. For this, they receive a fee of a percentage of the funds they raise for the issuer. They are gatekeepers, and as such take great care in evaluating the substance behind each opportunity in what is known as “due diligence”. They largely determine what capital is available—if any—and at what price. Their motivation is having a successful closing, maintaining good relationships with their capital sources, and an opportunity to run your next, bigger, round.
9. Merchant Bankers: Merchant bankers are investment bankers that invest their own capital alongside the capital they raise from institutions and other investors to invest in opportunities. They earn fees for the placement of the capital they and their investors invest and participate in the upside and downside potential of their investments.
10. Private Equity: Private equity generally consists of a large pool of capital assembled from institutional and private wealth for the purpose of funding the acquisition of large companies either directly or through management buyouts. They also supply mezzanine or interim unsecured loans with equity kickers to operating companies to bridge those companies to their next financing round. Private equity funds are organized with different investment appetites. For example, some invest in minority interests in well-run companies as a step towards the eventual acquisition of the remainder of the company when the owners enter retirement and want an exit. Most focus on acquiring operating businesses and enhancing them for intended resale at a higher valuation.
11. Distributorships/Licensing/Franchising: Some companies have products that are recognized as winners. Rather than sell their equity (at all times, only 100 percent of a company’s equity is available), one local company preserved its equity by selling product distributorships to parties around the world. The distributorship fees in this case, amounted to over $150 million for the company. Another local company sold the rights to distribute its product in Canada for $1 million and in Europe for $2 million. It was this financing that funded product development for both Companies.
12. Government Programs: The Department of Defense (DOD) and other agencies of the federal government are required to include small businesses in their procurement programs. This can mean purchase orders for your company. Such purchase orders can, in some cases, provide the commercial confidence necessary to arrange loan facilities for your business. In addition, there are federal and state funds available for development of new technology. The Small Business Innovation Research (SBIR) grant program is one of those sponsored by the DOD. The Department of Energy regularly publishes requests for proposals (RFPs) to develop new technologies for which they will provide funding grants and it even encourages unsolicited proposals for grant funds to develop new ideas.
13. Acquisition: If you’ve developed an operating company that’s attractive to private equity, investment bankers, merchant bankers, or similar sources, you may find the additional capital you need from any of them that invest in your industry. But don’t waste your time if a source has targeted the funds it raised for a different industry. Management of such a fund has a fiduciary duty to invest the funds they are given substantially in the way on which they had sold their investors.
14. IPO: If you qualify, a public offering of capital—when all is said and done—typically provides the least expensive capital available. To offer your equity to the public market in the U.S. requires filing a full disclosure registration statement with the SEC, which includes your company’s audited financial statements, and then awaiting comments from the staff of the SEC. You will also need to find an investment banking firm that is interested in your company who will locate investors for your equity once the SEC declares your registration statement effective and sales of your securities can begin. This process typically requires three to six months to complete, depending on the complexity of the offering and the condition of the market for your equity. Increasingly, the capital markets in Canada, the U.K., and elsewhere have become go-to sources for growing U.S. Companies.
There are other sources of investment capital available beyond those mentioned in this article. What those are greatly depends on the nature and maturity of your enterprise and your preparation. Consult an experienced securities attorney or financial accountant to assist you in finding what may be successful for your business.
The opinions of contributors are their own. Publication of their writing does not imply endorsement by FSR magazine or Journalistic Inc.