Almost all start-up enterprises need capital. By understanding the advantages and disadvantages associated with the different types of funding sources you can logically decide which one is best suited to your own situation.
Friends, Family and Self-Financing
Many start-ups begin with this type of financing. Trust, flexibility, and lack of formalities can make this an attractive option. We recommend investors use a subscription agreement that identifies the risks and expectations. The limited availability of funds, especially the second go-round to fuel expansion, personal liability, and the concentration of risk can be considered disadvantages. And should the deal go bad, the affect on your relationship with friends and family can be substantial. Food for thought…If you’re not prepared to risk your own savings isn’t this too risky for friends and family.
Bank Financing
Obtaining bank loans for early stage projects can be quite difficult. Banks like hard assets as collateral which makes this type of loan even more troublesome for publishers and Internet providers who may never have significant hard assets. Using personal property (house, boat, IRAs) as collateral may help secure the loan but is this type of loan worth that risk. That said, depending on your credit rating, account receivable financing is an alternative. So are special loan programs provided by the Small Business Administration. Keep in mind, although the SBA may be in a position to provide financing that would not otherwise be considered ”bankable”, you will need to put at least 5% of the loan amount up as a downpayment and perhaps as high as l5%-20%
Venture Capital
Venture Capital (VC) firms are a strong source of financing, especially for those companies in the high technology area. VCs typically purchase equity or an instrument that can be converted to equity. Because VCs typically specialize in particular industries, they may be able to provide expertise and offer strategic advice that increases a company’s chance for success. Participation by a high-profile VC could broaden management and offer the “stamp of approval” needed to attract new business and additional financing.
Partnering with a VC might include loss of control over the board of directors, and sometimes day-to-day management. VCs typically have short investment horizons requiring a relatively early-stage exit or “cash out” strategy. And, if you don’t make the numbers VCs are quick to pull the plug on additional funding and to call notes that may result in the loss of control over the company.
“Angel”…Private Placements
In this form of financing, a company’s securities are purchased by private investors (“angels” or “accredited investors”). These are typically high net worth individuals who are willing to take a chance on an early-stage companies with the hopes of a big payout down the road. You keep control of the company. Private placement investors usually do not acquire more than l0% of the company. They are “passive” investors.
Private placement memorandum are typically used to solicit private investors. This memorandum, with similarities to a formal business plan, describes the company and outlines the its prospects. A securities counsel can help you develop the formalized subscription agreement, ensuring that the private placement is exempt from the Federal Securities Act of l933, usually falling under Regulation D. In addition, the offering must comply with all applicable state laws.
Private investors can be contacted directly by entrepreneurs. Placement agents can also be used. Placement agents typically fall into two categories. An agent is usually a securities brokerage firm with membership in the National Association of Securities Dealers (NASD). Agents such as a media broker, with specific expertise with the publishing field and strong industry contacts, can also serve as “match makers” and intermediaries between the private investors and entrepreneur.
Companies raising under $l million are urged to consider a Small Corporation Offering Resolution (SCOR). There are numerous advantages under this Rule 504 of Regulation D as well as a simplified state registration process. A SCOR offering also has no limitations on the number or qualifications of purchasers for federal purposes and no restrictions on advertising. There are no resale restrictions for parties other than affiliates, control persons, or other insiders.
Initial Public Offering
A company ready to sell equity to the public has typically gone through a couple other forms of financing. While an IPO can provide numerous opportunities there are significant complexities and challenges.
“Going Public” has its advantages. It can provide access to large amounts of capital, an exit strategy for investors and employee shareholders, increased credibility in the marketplace, estate planning advantages, and an objective valuation for future mergers, acquisitions or sales.
On the flip side there are Securities and Exchange Commission Quarterly Reporting requirements, loss of majority control, exposure to the vagaries of the markets, restrictions on the purchase/sale of securities by insiders, increased insider trade risk, and a requirement that operations must be more formalized. It is also not uncommon for a company to spend close to $500,000 to go public.
Explore your options. Contact us today, (301) 253-5016 or e-mail us at [email protected]