For equity financing...
Business Funding Sources Directory
Sources of Capital
While there are many ways to fund the launch and growth of your business, most can be boiled down to three main areas:
- Equity Capital
- Debt Financing
- Other Alternatives
Each financing approach has its own advantages and restrictions, and the type of financing that is best for your business is dependent on a number of factors including your company's business model, financial state, operations, size, stage, industry, geographic reach, and other attributes. Additionally, you should consider your own vision for the company and the management team's sensitivities with regards to ownership, control, and growth.
Essentially, equity capital is money that is invested into a company in exchange for an ownership interest in that company. Traditionally, equity capital—unlike debt—is not intended to be repaid according to a specific schedule and is not secured (or guaranteed) by the company's assets. Instead, an equity investor (i.e., the individual or entity that supplies the company with the money) expects that, within a certain time frame, the ownership percentage she holds will be worth more than the original amount she invested.
You may be more familiar than you think with the concept of equity capital. Millions of people are public equity investors because they own shares in large corporations such as Microsoft and Wal-Mart, companies whose ownership interests are priced and traded publicly. In Equity Capital Market Landscape, however, when we say equity capital, we are referring to private equity capital, which represents money that is invested in private companies, or those that are not listed on the NYSE or NASDAQ exchanges.
How do you know if equity capital is for your company?
Public equity capital is only for large proven companies, often with hundreds of millions of dollars in revenues and profits. The opportunities for companies to secure public equity capital for the first time, or to go public in an IPO, are extremely limited.
Private equity capital, on the other hand, can be appropriate for fast-growing, young companies. Also, please note that for those fast-growing, young companies that have (1) limited capital needs and (2) stable cash flow or a substantial tangible asset base, debt financing may be a better financing alternative.
Why might debt financing be more appropriate?
At first glance, it may seem like equity is a better deal for a company than debt, but private equity investors are no fools. In fact, experienced private equity investors usually make a 25% return on investment (ROI), far more expensive for a company than the typical debt interest rate of less than 15%. Additionally, private equity investors know that an equity investment in a company is a much more risky vehicle for their money than a loan (i.e., debt) to a company. Therefore there are a number of checks and balances inherent in the structuring of a private equity investment and the corresponding ownership interest.
So why does any company seek private equity capital?
Private equity is often the only option for a start-up company with high growth potential. For example, TechForCash, a start-up software company, anticipates product development expenditures of $1 million during the two years of its life. In its third year, fourth, and fifth years, it expects to make $1 million, $2 million, and $4 million, respectively. Despite this remarkable growth potential, TechForCash would probably not be able to get a loan to finance its launch. However, if TechForCash has a strong business plan, an impressive management team, a pilot product, and a couple of clients, a private equity investor may be willing give the company $1 million in development capital, in exchange for, say, 25% ownership in the company.
What are the sources of private equity capital?
There are many types of private equity investors, including angels, venture capital firms, leveraged buyout firms, and large companies, all of which are described below. Most private equity investors, regardless of type, tend to be somewhat specialized based on factors such as investment size, company stage, industry, and region.
In the early days of venture capital investment, in the 1950s and 1960s, individual investors were the archetypal venture investor. While this type of individual investment did not totally disappear, the modern venture firm emerged as the dominant venture investment vehicle. However, in the last few years, individuals have again become a potent and increasingly larger part of the early stage start-up venture life cycle. These "angel investors" will mentor a company and provide needed capital and expertise to help develop companies. Angel investors may either be wealthy people with management expertise or retired business men and women who seek the opportunity for first-hand business development.
Venture Capital Firms
Venture capital firms are pools of capital, typically organized as a limited partnership, that invest in companies that represent the opportunity for a high rate of return within five to seven years. The venture capitalist may look at several hundred investment opportunities before investing in only a few selected companies with favorable financing opportunities. Far from being simply passive financiers, venture capitalists foster growth in companies through their involvement in the management, strategic marketing and planning of their invested companies. They are entrepreneurs first, financiers second.
Leveraged Buyout Firms
Leveraged buyout firms specialize in helping entrepreneurs to finance the purchase of established companies. The approach of such firms is to provide a management team with enough equity to make a small down payment on the purchase of a business, and then to pay the rest of the purchase price with borrowed money. The assets of the company are used as collateral for the loans, and the cash flow of the company is used to pay off the debt. Because the acquired company itself is paying the freight for its own acquisition, these investments were originally known as "boot-strap" deals. Eventually they became known as leveraged buyouts, or management buyouts.
One form of investing that was popular in the 1980s and is again very popular is corporate venturing. This is usually called "direct investing" in portfolio companies by venture capital programs or subsidiaries of non-financial corporations. These investment vehicles seek to find qualified investment opportunities that are congruent with the parent company’s strategic technology or that provide synergy or cost savings.
These corporate venturing programs may be loosely organized programs affiliated with existing business development programs or may be self-contained entities with a strategic charter and mission to make investments congruent with the parent’s strategic mission. There are some venture firms that specialize in advising, consulting and managing a corporation’s venturing program.
The typical distinction between corporate venturing and other types of venture investment vehicles is that corporate venturing is usually performed with corporate strategic objectives in mind, while other venture investment vehicles have investment return or financial objectives as their primary goal. This may be a generalization as corporate venture programs are not immune to financial considerations, but the distinction can be made. The other distinction of corporate venture programs is that they usually invest their parent’s capital while other venture investment vehicles invest outside investors’ capital.
Debt refers to capital that is loaned by a lender to a borrower, who is in turn obligated (1) to repay the original amount loaned--or the principal--within a specified time period, and (2) to pay interest on the principal. In fact, you are probably more familiar with debt capital than you think. Common types of debt include credit cards and mortgages.
How do you know if debt capital is for your company?
While the terms under which the loan agreement is made are often in writing and are legally enforceable, lenders seek to protect their investment by lending debt capital only to those entities which demonstrate the ability to repay it at a desirable interest rate. In some cases, lenders further protect their investment by offering secured debt capital. If secured debt capital is not repaid according to the agreed terms, a lender may have the right to take possession of the securitized assets--or assets that were promised to the lender in the event that the loan was not repaid. Therefore, debt capital is most appropriate for those companies that can demonstrate stable cash flow and/or those companies that have a significant asset base.
What are the types of debt capital?
Debt capital ranges from credit cards and lines of credit to bank loans and high yield debt. The type of debt that is best for your company depends on many factors. For example, relevant factors include the amount of capital your company needs, the size of your company, and the financial state of the company (including the existing capitalization of the company, or how your company is currently financed).
Where can I find debt capital?
Depending on the type of debt your company seeks, there are numerous sources of debt capital, including commercial banks, credit unions, the government, credit card companies, community organizations, and specialty finance companies.
What are other financing options besides equity and debt?
The list of other financing options is very long, but can be classified into the following categories:
Other Founders and Managers
Family and Friends
Strategic Partners and Entities
Nearly all entrepreneurs utilize personal resources to start a business. For example, many entrepreneurs start their business out of their homes, using their own administrative resources such as their own telephone, computer, furniture, vehicles, etc. In addition, before entrepreneurs secure customers and/or receive outside funding, they typically work for "free," meaning that they are not compensated in the traditional sense for the time that they work. Moreover, some of them use their savings to pay for the initial launch costs like product development or marketing expenses. In fact, successful serial entrepreneurs often use the financial gains resulting from their previous ventures to launch new companies.
Other Founders and Managers
During the initial stages of a company's life cycle, an entrepreneur can sometimes depend on her fellow founders and managers to support the business. For example, other founders may be able to contribute their own personal resources to the venture. Additionally, often other founders and managers will work for significantly less and/or deferred monetary compensation than they would otherwise require when helping to launch a business.
Family and Friends
The support of their family and friends is often very helpful when starting a business. Family and friends can contribute assistance similar to those described in Personal Resources. For example, a woman beginning her own catering firm may ask her daughters to act as servers for the first few engagements. Alternatively, a budding software entrepreneur receive a computer system as a birthday present from her family. Additionally, some entrepreneurs are lucky enough to turn to Family and Friends for significant financial support. The Friends and Family of very well-connected entrepreneurs are often business people themselves and can offer not only financial assistance, but also relevant business advice and industry expertise.
Customers are the most traditional source of capital. A new company will receive money--or revenue--for the products and/or services that it has provided to its customer. Ideally, the amount of the revenue is greater than the cost of producing the products and/or services. The difference between the revenue and the cost is profit, which can be plowed back into the company to fund its growth. High margin products and/or services, or goods for which the profits are relatively high as compared to the costs, are often good sources of capital.
Many of today's high-growth companies incur expenses either (1) prior to being able to deliver a product or (2) at an initial level that cannot be covered by the initial revenues. However, these companies are sometimes able to secure advance revenue, or payment from customers for products and/or services that are to be delivered in the future. Also, many companies in their initial stages of development offer high margin services, the profits of which are used to fund product development and other expensive processes.
Suppliers can be a source of capital when they deliver a product or service necessary for a new company's development before receiving payment. For example, if a new company orders and receives 5 computers for its employees in June and is not required to pay for them until October, the computer vendor is effectively a source of short-term capital. This type of financing, which involves the Accounts Payable line of a company's balance sheet, is a form of debt capital.
Federal, state, and local governments have many programs that promote entrepreneurship and the advancement of technology through the disbursement of grants and awards and other types of assistance. These programs number in the thousands and are very diverse, and the eligibility of a company for these resources can depend on the company's stage, industry, location, business description, owner, and other factors.
Strategic Partners and Entities
Many new companies are boosted by the support of partners that have a strategic interest in their development and success. Strategic partners can include large corporations, research universities, community groups, as well as other entities. These partners can provide assistance in the form of capital, personnel, office space, intellectual property, intangibles, etc.
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