Funding New Ventures
This article will focus on the different sources of funding for new ventures, especially small businesses. One of the greatest challenges for new ventures is the ability to secure capital that will allow the company to grow. There is no magic formula, and the management team will need to evaluate and assess which options are beneficial for the company. Each business will need to weigh the pros and cons of each option in order to determine what would be best. There are two options that these businesses may consider: debt financing and equity capital. The role of commercial banks, the Small Business Administration, angel investors, and venture capitalists will be introduced and discussed.
Keywords Angel Investors; Capital; Debt Financing; Equity; Equity Capital; Investments; Non-profit Microlenders; Patient Capital; Startup; Venture; Venture Capitalists
Entrepreneurship: Family Business Strategy
One of the greatest challenges for new ventures is the ability to secure capital for investments that will allow the company to grow. All projects will reach a point at which sufficient cash flow is necessary in order to go to the next level. It could be after a period of time or it could be because the venture is popular and the company is growing at a rapid rate due to demand. Regardless of the situation, the company's management team will need to determine when and how they will invest in efforts such as purchasing new equipment, hiring new staff, and putting more money into marketing initiatives. Raising money can be a difficult task if the company has not established a reputation or is still new.
When determining the amount of capital needed, the decision makers must analyze the situation and decide how much and what type of capital is required. Since the situation is not the same for all businesses, there is no magical formula. Some businesses may only need short term financing for items such as salaries and inventory, while other businesses may need long term financing for major items such as office space and equipment. Each business must develop a customized plan that will meet its unique needs.
Securing capital is a choice made after weighing the pros and cons of various options. There are three popular means of obtaining funding for new ventures: borrowing from financial institutions, partnering with venture capitalists, and selling equity/ownership in exchange for a share of the revenue (Goel & Hasan, 2004). All financing options can be classified into one of two categories: debt financing or equity capital.
Debt financing includes bank loans, personal and family contributions, and financing from agencies such as the Small Business Administration. Loans are often secured by some type of collateral in the company and are paid off over a period of time with interest. On the other hand, venture capitalists and angel investors provide funding in the form of equity capital. Both are given ownership in the company in exchange for money. Pierce (2005) offers some advice which may be of assistance when assessing which option may be best for the company. Some of the tips include:
- A Small Business Administration program may not be the best option if the company needs less than $50,000.
- Debt financing is usually cheaper and easier to find than equity capital. Debt financing requires that the borrower make monthly payments regardless of whether or not the business has a positive cash flow.
- While equity investors do not expect much, if any, return in the early business stages, they require information regarding a company’s status. In addition, they expect the company to meet the established goals.
- Any business type can usually acquire debt financing, but businesses with fast growth and high potential are usually the recipients of equity capital.
- Angel investors tend to invest money in companies that are within a 50 mile radius, and the amounts of funding tend to be in the range of $25,000 and $250,000. Angel investors may be friends, family, customers, suppliers, brokers, or competitors.
- It is difficult to secure venture capital funding, even in a good economy.
Two Options of Financing
Debt financing and equity capital options both require the business owner to complete detailed documentation prior to the award of financing. The owner should be prepared to produce quarterly balance sheets, background information on the company, and projections.
If the company cannot finance the expansion through personal investments, the management team will need to develop a business plan that meets the criteria for potential lenders. Commercial banks may be the first choice, especially if the owner has a relationship with a specific lender. Since traditional lenders tend to be conservative, good rapport and an established relationship will be beneficial when applying for a loan. It is important for potential borrowers to understand the mindset of potential lenders. Most lenders tend to focus on five important factors when deciding whether or not to extend credit, and business owners need to be prepared to address them. The five factors are:
1. Character — what are your personal characteristics? Are you ethical and have a good reputation? Will you do everything possible to pay the loan back?
2. Capacity — will your business be able to generate sufficient cash flow to pay the loan back? Do you have access to other income?
3. Collateral — do you have collateral to cover the loan in the event that the venture does not perform well? Is there a qualified individual willing to co-sign on the loan?
4. Conditions — have you researched the environment to see if there are any circumstances that could negatively impact your business (i.e. nature of product, competition)? How will you deal with these situations if they arise?
5. Capital — what are you personally willing to invest in the venture? Most lenders are not willing to invest in ventures if you have not made a major investment in the future of the project. Why should they invest in the venture if you are not willing or able to?
Small Business Administration (SBA)
If a commercial bank is not an alternative and the entity is a small business, the Small Business Administration may be another option. The business must satisfy the agency's criteria and not be able to secure financing from other sources. The Small Business Administration (SBA) is an independent agency of the Executive Branch of the federal government, and it is responsible for assistance to small businesses in the United States. There are four types of assistance this agency can offer, and they are advocacy, management, procurement, and financial assistance. Financial assistance can be granted through the agency's investment programs, business loan programs, disaster loan programs, and bonding for contractors.
Business Loan Programs
- There are three loan programs; the Small Business Administration sets the guidelines while other entities, such as lenders, community development organizations, and microlending institutions, make the loans to small businesses. In order to reduce the risk to these entities, the SBA will guarantee the loans. In reality, an SBA loan is a commercial loan with SBA requirements and guaranty.
- In 1958, Congress created a program for the group of privately owned and managed investment firms recognized by the Small Business Administration as Small Business Investment Companies (SBICs) called the SBIC Program. SBICs partner with the government and use their own capital with funds borrowed at reduced rates to provide...
(The entire section is 3502 words.)