Raise capital to boost your business
- January 27, 2010
Insufficient capital is among the top reasons for the failure of small businesses. But oftentimes, business owners must rely on outside money to get their business off the ground. The Virginia Department of Business Assistance estimates that 95 percent of new businesses are financed through personal funds and loans.
That means new business owners should evaluate how much money they are willing to invest and how much more they’ll need. Creating a business plan is vital to understand this. In addition, loan officers and investors will want to see a detailed financial plan before committing any money.
Make sure you understand your startup costs and how much you’ll need to keep your business running. Common startup costs include:
• Securities on leases
• Office furniture and supplies
• Production equipment
• Legal and accounting fees
• Licenses and permits
• Insurance premiums
• Design/architectural fees if applicable
Continuing costs (money you will need to borrow until company is profitable)
• Cost of sales
• Sales and marketing
• Extra money for unexpected emergencies
• Salaries and benefits
• Facility operating costs (water, heat, etc.)
• Administrative costs
Starting out with “bootstrap financing”
If you are a new business owner, your means for raising capital may seem risky — but it will be impossible to persuade lenders or angel investors to spend money on you if you aren’t willing to spend your own. Most startups rely on:
• Savings. Think personal bank accounts, stock portfolios and even retirement savings.
• Family and friends. If your family members and friends are willing to invest some money into your business, you can do this without much paperwork or legal concerns. However, consider what will happen to these relationships if you are late or unable to repay them.
• Credit cards. If you choose this route make sure you find low-interest credit cards and become familiar with the terms of each card.
• Home equity. This may seem risky, but it’s an easy way to raise thousands of dollars quickly.
Subtract the amount you can personally invest in the company from the capital you have determined you will need to start and run your company. This is the amount you will need from outside sources.
Under this type of financing, loans are repaid over a set time period with interest. Under these loans, business owners do not give up any ownership of their company. Loans are often considered short term, less than a year, or long term with a repayment period of up to seven years.
You need to prove to lenders that you have a solid business plan and a detailed outline of anticipated expenses needed to get your business off the ground and keep it running. Lenders will consider your:
• Business idea and plan
• Personal investment in the business
• Credit history and personal net worth
• Conditions that could affect your success (industry, economy)
• Character and commitment to the business
There are many different avenues to secure debt financing, some tougher than others. Following are various lenders businesses should consider:
• Commercial lenders. Banks know that lending to small businesses is risky. To obtain a loan, the bank will require collateral, a good credit history or a guarantor of the loan. Often, a personal guarantee is required to secure the loan. The U.S. Small Business Administration and the Virginia Small Business Financing Authority offer guarantees to lenders to encourage them to give loans to small businesses.
• Loans from friends or relatives. Ensure these loan terms are put into writing.
• Equipment purchases. Sellers of large equipment will often allow payment to be received over time rather than upon sale. Some furniture and equipment companies offer repayment schedules that don’t start until a few months after the purchase. These can be beneficial for a startup company.
• Accounts receivable financing. Under this arrangement, business owners sell their outstanding accounts receivable (invoices from customers) to banks or businesses (factors) for a certain percentage of the money due. This allows for a fast infusion of cash.
If you are willing to give up some ownership and voting rights in exchange for quick cash, equity financing could be for you. Keep in mind, however, that most venture capitalists and angel investors are looking for a high, fast rate of return. This type of funding is most likely suitable for high-tech and biomedical businesses.
In looking for equity financing, your job is to convince venture capitalists that investing in your business will make them money.
Appealing to these investors will be different than appealing to a bank. Both a bank and an angel investor will want copies of basic legal and organizational documents, financial statements and tax returns. The loan officer at a bank will mostly be interested in the cash flow of your business model to ensure it generates enough revenue to pay back the loan.
But angel investors and venture capitalists will be more interested in the growth potential of your business. Equity investors will spend more time reviewing your projections and strategic options than your historical financial information. Angel investors also are more willing to wait — often five to 10 years — for a return on their investment.
There are two types of private-equity investors:
• Individual angels.
• Private-equity investors — a group of private investors who pool their money together so their investment is larger and their risk less.
The most successful capital-raising processes rely on both angels and funds. Typically institutional or fund “rounds” of equity are preceded by one or more angel investments. Individual angels, angel clubs and pledge funds are typically looking at six-figure investments in companies with $2 million to $10 million in revenue that can grow to $20 million before another round of equity financing is needed or the company anticipates being sold.
Larger private-equity funds are usually looking for seven-figure investments in companies that can grow to more than $50 million in revenue. There are also mezzanine funds that provide investment capital in small deals, being reflected between the bank debt and pure private equity on the company’s balance sheet.
Good resources for finding equity investors include:
• Active Capital (http://www.activecapital.com), an Internet database by the U.S. Small Business Administration, which was created to connect small businesses with capital.
• “Pratt’s Guide to Private Equity Sources,” a reference book that lists private-equity firms.
Equity financing can be tricky. Follow these guidelines for success:
• Find an experienced adviser — such as an investment banker, CPA or attorney — who can guide you through the steps to finding a private-equity investor.
• Don’t knock on too many doors because bankers and investors all talk among themselves. The most important thing is to be patient. The normal capital-raising process can take six months. Once funded, you’ll need to commit to a five- or seven-year company growth effort.
• Make sure you have good chemistry with your investors. If you don’t like them, don’t take their money.
• Make sure you know exactly how much money you want and how you will spend it.
• Be honest and open in your negotiations, and focus on your equity and “enterprise” value rather than earnings and ownership percentages. Ensure you keep professional advisers involved in the process.
The Virginia Small Business Financing Authority
The Virginia Department of Business Assistance helps businesses and nonprofit organizations raise capital through unique combinations of public and private financing through the Virginia Small Business Financing Authority.
Only small businesses with specific credit standards are eligible for financing through the authority. Businesses must meet one of the following criteria: have fewer than 250 employees, have less than $10 million in revenues for the past three fiscal years, have a net worth of $2 million or less, or be a nonprofit organization classified under the 503(c)(3) tax-exempt status by the Internal Revenue Service.
The authority, a political subdivision of Virginia, offers financing through three primary means.
• Direct lending. The authority works with banks and other lenders to provide direct loans for economic development transactions. The authority also provides direct loans through specific programs that promote environmental stewardship and that assist day-care centers and family home providers.
• Indirect lending. The authority provides loan guarantees to commercial banks to promote lending to small businesses.
• Conduit financing. The authority can issue non-exempt industrial development bonds for manufacturers and 501(c)(3) organizations.
For more detailed information on the authority visit http://www.vdba.virginia.gov or call (866) 248-8814.
U.S. Small Business Administration loans
The U.S. Small Business Administration does not offer direct loans, but helps small businesses raise equity primarily through guaranteeing loans for companies that otherwise would not qualify for loans from conventional lenders. Following are some of SBA’s primary loan programs. Visit http://www.sba.gov/services for more information.
7(a) Loan Program
The 7(a) Loan Program is the SBA’s primary loan because of its flexibility in structure, variety of uses permitted and availability. The SBA guaranty reduces the lender’s risk, because lenders can recover most of what it lent to a business if the business defaults on its loan.
Lenders must certify that the lender would not be eligible for the loan without the SBA guaranty.
To be eligible for the 7(A) loan program, businesses must be classified as small by the SBA. This varies among industries. SBA small business standards can be found at http://www.sba.gov/services/ by clicking on the “For Small Business Owners” link under “Contracting Opportunities.”
The proceeds can be used for a variety of business-related items, such as purchasing machinery, equipment, fixtures, and supplies, leasehold improvements, land and buildings, financing seasonal lines of credit or constructing commercial buildings. It can not be used for employee salaries, research and development or other investments.
This is provided for lenders who need a loan of $350,000 or less. The SBA will guarantee up to 50 percent of the loan. These loans do not require a SBA application.
This loan is available for veterans, Reservists, National Guard members and their spouses, and widows of service members or veterans who died during service or of a service-related injury. Money can be used for most business purposes and offer some of the SBA’s best interest rates.
CommunityExpress Pilot Loan Program
This provides business financing and management and technical assistance to businesses established in distressed or underserved markets. This features an expedited loan review and approval process
Export Trade Financing
These are short-term loans for businesses that export goods and services. The money can be used for manufacturing goods to export, buying goods and services to export or for purchasing inventory to export or that is needed to manufacture goods to export.
Certified Development Company Loans
These loans were created as part of an economic development program to help communities through small business growth. The long-term loans can be used for the purchase or renovation of land, buildings and equipment.
Small Business Investment Company Program
These are privately owned and managed investment groups that are licensed and regulated by the SBA. They provide an alternative to bank financing. They provide capital to small businesses through investment or loans, and their success is tied to the businesses they support. These firms also provide debt-equity investments and management assistance.
The Microloan program provides small loans that range from $500 to $35,000. The SBA gives funds to nonprofit organizations, which make loans to small businesses. Interest rates are negotiated with the organization. These can be used for normal business programs, such as capital, inventory and leasehold improvements.
Evaluating your company’s financial health
Once you’ve established your company, it is vital to ensure you have good financial reporting to determine your company’s financial health. You need to create performance indicators to monitor finances. For example, you might want to monitor sales growth, cash management, profit measures and customer feedback. There are software programs that can help small businesses manage their money, including Peachtree and QuickBooks.
The following are numbers that should be monitored weekly, as recommended by SCORE.
• Cash on hand
• New sales
• Accounts receivable (beginning balances, outstanding credit and cash receivables)
SCORE recommends that you monitor the following information monthly:
• Accounts-receivable average days outstanding
• Accounts-payable obligations