By Jeff Schein
© 2004
www.companyworkshop.com
The choice of financing is an important determinant
of whether a
product reaches the market, or whether an existing business can
survive. The choice of financing is an important part of being
an
entrepreneur and business owner, and the ability to raise cash
when
you have no or limited history takes skill and creativity. There
are a
number of sources of financing. The suitability of the alternatives
depends on what stage you are at, and will change as the company
matures from stage to stage. The following outlines the most typical
forms available.
Yourself, Family and Friends
The most obvious and common start is for people to self finance.
That means they either draw down on their savings or they use
personal debt such as credit cards, credit lines or equity mortgages
to finance their business. Family and friends are often used as
a source of financing. Although they are not always in a position
to properly evaluate the business venture, family and friends
have long-time relationships and experience with the entrepreneur
and are knowledgeable about his/her reliability and ability.
Strategic Partner
Strategic partners can not only provide a source of financing,
but often they can provide an area of expertise that the entrepreneur
does not bring to the table, such as operational or marketing
skills. Naturally, the pitfall of a partner is that you do not
maintain full control over the company and that sometimes there
is a falling out between the partners. So it is important that
you do your homework and choose your partner carefully.
Angel Financing
Angles tend to be freelance financers interested in loaning smaller
amounts of money, say between $50,000 -$500,000. They can often
provide the seed capital required to develop an idea to get to
the point where a firm can obtain formal financing. Angel investors
will also invest in growing companies that may have a strong revenue
base, but are not yet established enough to get bank or other
financing. Another benefit of Angels is that they can bring a
lot of experience and industry contacts to the table.
Venture Capital
When firms approach venture capitalists, they are generally developed
to the point where a venture capitalist can add value. The venture
capitalists will generally sit on the board of directors, provide
expertise and provide funding based on the attainment of milestones.
They are generally interested in firms that can generate rapid
growth – and returns - over a few short years; your time
horizon is generally 3-8 years.
Trade Credit
One of the largest sources of short-tem financing, trade credit
occurs whenever you purchase from a supplier but do not need to
pay for the merchandise for 30 days (or whatever the terms are).
Trade credit can be expensive if you are foregoing discounts,
but a new firm may not have much of a choice.
Factoring
Factoring is also a popular source of financing for growing firms.
When you generate a receivable you may sell it to a factor who
will then collect the receivable for you. Typically, you will
get between 75%-90% upfront for the receivable and the remainder
when the factor collects, less a fee.
Asset Based Lending
Asset based lenders will lend to businesses that lack sufficient
cash flow to support unsecured financing, but have sufficient
assets that can serve as collateral. Typically, the assets are
accounts receivable and inventory, but can be equipment or other
similar assets. The lender relies on the assets to repay the loan,
not the cash flow of the firm. Fast growing firms who cannot get
sufficient financing from a financial institution will be a typical
client of an asset based lender.
Mezzanine Financing
Mezzanine financing is subordinated debt, a type of hybrid between
senior debt and equity. As Mezzanine financing is typically high
risk, it can be expensive. A typical target company generally
has been in business for a number of years and has an established
revenue base and positive cash flow stream. Often, a company may
have reached its maximum level of financing from a lending institution
and will obtain mezzanine financing to bridge the gap and finance
their growth. The Mezzanine financer will subordinate its debt
to the main lender.
Banks
By the time a firm can approach a bank they usually have been
in business for a couple of years, have developed solid revenue,
are earning profits and have a reasonable balance sheet. The bank
will provide daily operational financing as well as long-term
financing. Generally the cheapest form of financing, it can also
be the hardest to get.
