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Exploring Financing Alternatives

Entrepreneurs overlook some very attractive sources of financing because they fail to spend the time and energy to find out what’s available.

Venture capitalists turn down 98 percent or more of the companies that contact them. To get financing from them, you need to know what they seek. Venture capitalists seek to invest in high-growth ventures that provide the expectation of extremely high annual compounded returns to balance the risk that they assume. They seek to invest large amounts usually a minimum of $1 million and up-in enterprises that have experienced management teams.

For smaller amounts, many new ventures go to friends and family, and to professional individual investors called angels. Angels can specialize in high growth ventures in their area or in their industry.

Bankers prefer to lend to firms whose projected cash flow will repay the loan, which has adequate collateral to satisfy the loan if cash flow fails, and whose principles-the entrepreneurs-will commit their personal assets to guarantee the loan.

Development Financing

Development Finance institutions represent one of the prime, sources of business financing. In most areas there are at least 10 sources of local-development sources, 5 types of state development sources, and another 10 types of federal financing sources.

How do you find development finance sources? Call your local Chamber of Commerce, local economic-development organization, state economic-development organization or, the Federal Small Business Administration. 

Raise Financing for Your Business

The various processes for raising money include:

  • Direct private placements of debts with financial institutions, such as banks, commercial-finance companies, leasing companies and venture-capital companies. The procedure is simple: You approach the financial institutions and provide it with the information is asks for, most of which can be found in your business plan, plus details about your history and financial worth.
  • Indirect private placements by institutions, such as insurance companies, through investment bankers. These institutions will only consider financing companies that are recommended to them by the investment bankers and VR intermediaries whose judgment they value.
  • Private placements of equity by individuals. This method of financing normally is done by emerging, high-growth ventures that do not have a long history and are seeking equity.
  • Initial Public Offerings (“IPO”) are probably the toughest form of financing and can cost more than $500,000, so it is usually high-growth companies that attempt them. Investment bankers usually handle these transactions, and they can do so on an “underwritten” basis.
  • Direct Public Offering (“DPO”) has become popular in states that have created so-called Small Corporate Offering Registration programs. Aimed at small companies, a DPO allows the entrepreneurs to sell stock themselves, rather than through an investment banker. But you should definitely consult an experienced attorney.

Appropriate Investment 

Risk can be influenced by the stage of the venture, the competitive advantage and proprietary technology, the expertise and experience of management and many other factors that can determine whether a venture succeeds or fails.

It is possible for a venture to fail and for lenders nevertheless to get their money back. This is the strategy used by asset-based lenders. Banks want businesses to have sufficient cash flow to be able to repay their loan and interest. They also insist on a secondary source of repayment, whether in the form of collateral that they can liquidate or guarantees from sources who could repay the loan.

Asset-based lenders may lend money to a business even when it does not have cash flow. They rely in their security in the form of collateral, and they closely monitor the loan.

Some financial instruments in ascending order of risk include:

  1. Senior loans across all assets: Good for banks because they prefer the least risk.
  2. Senior loans with specific named assets: Good for vendors of equipment or asset-based lenders who have very specific needs.
  3. Subordinated loans across all assets: Advantageous for smaller and community development venture capitalists, who often have lower appetite for risk than the venture capital limited partnerships.
  4. Unsecured loans: For those who trust you. Usually friends and family who are not seeking a high return.
  5. Preferred stock: For sophisticated investors who know that it adds equity to the venture while giving them the control they want.
  6. Common stock: Friends, family and relatively unsophisticated angels who invest small amounts of money in high risk ventures.

Business Stages 

Lenders and investors classify businesses on the basis of where they are on the development cycle.

Some key stages are:

  • The research-and-development stage, when the business does not even have a product or service and has to develop it. Investors expected return: 60%
  • The seed stage, when the business has a product but very little else. It may not have a management team, suppliers, and a place to operate or even a business plan. Investors expected return: 50%
  • The startup stage, in which all the components except financing are in place. Investors expected return: 50%
  • The early-sales stage, when the venture has sales but is still unprofitable. Many of the risks have been eliminated, especially the questions of who will buy and at what price. Investors expected return: 30%
  • The viability stage, when business has passed the break-even point. Investors expected return: 20% to 30%
  • The pre-I.P.O. stage, when the venture has reached profitability and is close to having an initial public offering. Investors expected return: 20%
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