Capital Sources for the Emerging Businesses

Capital Sources for the Emerging Businesses

Internal Financing - Owners, Family, Friends & Others
Earnings
Venture Capital
Commercial Lending; Government Sources
Strategic Alliances; M&A
Private Placements
"Going Public"

Internal Financing - Owners, Family, Friends & Others
Infusion of additional owner funds; benefit of maintaining control
Investment (or loans) by family members and friends
Possible investment by customers, suppliers, other business relations
Stock in lieu of cash for employees (I.E., raising capital by saving cash)

Earnings
Often not mentioned--internal earnings, cash flow, if sufficient and managed properly and effectively, can provide capital for limited development and growth
Typically, not sufficient for significant capital investment or improvement
Less dependable and predictable; inability to take advantage of opportunities as and when they arise

Venture Capital
Often misunderstood; Can be seed, early or later stage; Always involves longer-term, illiquid equity investment in a company believed to have superb growth prospects; brings capital to the company, typically in the form of convertible preferred equity and perhaps (not significant, subordinated) debt, as well as financial, market, management, "plan execution" and other expertise and discipline

Investors include "VC" firms (typically organized as limited partnership funds, which raise money from large institutional investors and very wealthy individuals), investment companies, investment funds, pension funds, insurance companies and wealthy individuals (sometimes called "Angels"); target compound (annual) investment returns in the 25%-to-100% range

Given risk and lack of immediate liquidity (or exit strategy), typically involves thorough due diligence, intensive financial projection and business planning work and aggressive negotiation; operating and control issues must be addressed

Commercial Lending; Government Sources
Banks and other institutional lenders can also provide a source of capital to growing businesses (beyond the development stage); satisfying stringent lending criteria--including providing security and ample cash flow for the timely repayment of principal and interest--is often difficult (or impossible) for many emerging businesses; while the environment appears to be getting better, banks still tend to look for asset and security-based lending, instead of "cash flow" or prospect-based lending; in the initial stages, unless "hard asset" security and/or appropriate personal guarantees are provided, forget it.

SBA and other government sources may also be available; there have been a variety of recent efforts to increase lending, and the ease of lending (and reduction of paperwork involved) to small businesses; can be extremely worthwhile if the company can meet the criteria; application process and criteria can often be extensive

Strategic Alliances; M&A
Capital can also be provided through relationships with customers and suppliers, and others the company does business with (or who are familiar with the company's business, products and services); also by acquiring or adding symbiotic or "additive" businesses, services or product lines, or by disposing of (or discontinuing) "drag" businesses, services or product lines

Joint ventures, licenses, distribution arrangements, cross ownership/support agreements

Combinations, mergers, acquisitions

This is a longer-term, deal-specific approach, typically appropriate solely for the more mature business

Private Placements
Capital can also be raised through the "private" sale of equity securities to a number of (typically unaffiliated, individual) investors, with or without a placement agent; depending upon circumstances, can be a cost-effective means of raising capital; be wary of the field of available placement agents (some, well qualified; others, attempt to lock the company up, take its money and move on)

Requires preparation, documentation (among other things, preparation of subscription documents and a private placement memorandum) and an (often extensive) offering and selling effort; must comply with federal securities laws and state "blue sky" laws

From a business perspective, has some elements of both public offerings and venture capital: Less expensive, less regulated, less documented than public offerings; possibly more expensive, but less negotiated, than venture capital; varies widely from deal to deal; in many cases, if not "pre-sold" or offered by a qualified, experienced placement agent, risk of non-consummation greater than other alternatives

Some disadvantages in common with public offerings (dilution, ultimate success risk, numerous new holders, securities regulation and shareholder lawsuit exposure, etc.)

"Going Public"
Typically, the underwritten sale of common stock to a large number of "public" investors through the means of a Registration Statement (which includes a Prospectus) filed with, cleared and declared effective by the Securities and Exchange Commission, a marketing program (the "road show" and a "red herring" preliminary prospectus) and, ultimately, pricing and closing, with sales of registered stock through retail and institutional brokers

Given the substantial expense and risks, and the extensive preparations and disclosures, involved, this route is clearly not for everyone

Where successful, can be an efficient means of raising substantial capital (now and in the future), providing liquidity, increased net worth, name recognition and other advantages (but risks and disadvantages must be considered as well)