HOW AND WHERE TO GET MONEY FOR YOUR STARTUP OR SMALL BUSINESS
Startups and small businesses often seek some form financing to inject their companies with much-needed cash. But we find that many clients often restrict themselves to outdated capital sources.
This article will explore some financing options that are available to a wide range of industries. We invite you to review these and consider whether you can employ these methods to reduce the transactional costs of your finance arrangement.
the basics
Small business finance comes in two flavors: debt and equity finance. Debt finance creates a relationship between the company and one or more creditors through a loan. It is usually evidenced by a loan agreement, a promissory note, and some type of security agreement or instrument.
Equity finance, on the other hand, refers to a capital raise accomplished by the sale of shares (or membership interests) in your company. Keep in mind these two are not mutually exclusive options. In fact, many companies use both sources of cash to leverage their assets and hedge their risk. This article will explore both kinds of finance, which may be available to your company.
Small Business Investment Companies
The Small Business Administration oversees Small Business Investment Companies , which are privately-owned investment funds. These companies provide loans to small businesses in a wide range of industries. The funds are privately-raised, along with contributions from the Small Business Administration itself. The SBIC program has funded over $21 billion of capital to American small businesses in the last five years.
Mezzanine Financing
Mezzanine financing provides the best of both worlds. Well, in a way. Mezzanine finance combines both debt and equity finance to provide a healthy risk profile for companies that aren’t quite ready to give up equity from the start. A mezzanine arrangement is structured as a convertible loan. In the event you default on the underlying loan, the lender can convert the outstanding principal into equity of your company. The arrangement is attractive, but you can end up with a business partner that you didn’t quite bargain for.
Venture Capital and Angel Investors
VC firms provide capital for early-stage startups and small businesses with a propensity for rapid growth or demonstrated exponential development. VC firms often specialize in a niche development area so your business will be heavily scrutinized by tried and tested professionals. Venture capital may be attractive for entities that lack sufficient financial history for substantial institutional bank lending.
Angel Investors, on the other hand, are wealthy individuals that provide finance for early-stage startups and small businesses. This investment may come in the form of convertible debt or equity.
Bank and Credit Union Term Loans and Revolving Lines
Institutional banks and credit unions can provide debt financing options for small business owners. The underwriting requirements will be fairly stringent; therefore, some small business owners find that institutional loans are either difficult to obtain or are actually quite expensive (high rates and origination fees). In addition, institutional banks may require a healthy collateral portfolio in exchange for funding, which may present an issue for early stage companies. In any case, a term loan is a structure that will be familiar and palatable to most small business owners. The loan matures one a specific date, at which time the principal will be due. In addition, monthly interest payments are also often required.
Revolving lines or “revolvers” are also available from institutional banks and credit unions. The difference between revolvers and term loans is that the former are not due to mature at a specific date. In addition, the funds can be reborrowed. For example, a small business with a $1M line of credit can borrow $500,000. When it repays those $500,000, it will again have $1M to borrow. In other words, a line of credit allow the borrower to have, at any given time, the maximum line value in the red but once it repays those funds, the full value of the line of credit will once again be available to re-borrow.
Factoring and Accounts Receivable Finance
Factoring is a type of debt finance that involves the sale of accounts receivable (at a discount). On the other hand, accounts receivable finance, is a structure that uses accounts receivable as collateral for an underlying business loan. Both types of finance are particularly common for exporters and similar business models.
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