Stanton Financing Guide

Venture Capital, is it right for you?

First a short definition of venture capital. Venture capital is often viewed by the entrepreneur as a high interest loan. This isn’t really the case. Venture capital is just money made available to you for starting your business, in exchange for ownership in the company. In most cases the VC firm will also offer you management advice and guidance. It is also sometimes referred to as “angel financing” a term you’ll find laughable if you do business with the wrong firm.

The way it works is you approach a venture capital firm and pitch your idea to them. It doesn’t have to be a business you are starting, it can also be a business you are trying to buy .

The firm will usually have a board of seven to ten people meet with you and discuss your idea. Then they make a recommendation to the full firm, or a segment of a larger venture capital firm, and decide if they should give you the money.

Most of the cases I’ve seen the firm retains 40% ownership if you pay them what they demand every month. If you fall short a couple of payments they take 60% control of the company and you get 40%.

There will also be certain covenants when you have the majority ownership. You will only be allowed to spend a certain amount of money wihout approval from the firm.

Sound fairly straight forward right? You pitch the idea along with the amount of money you’ll need and you’re expected earnings over a five year period. You show them how you’ll increase sales, cut costs, and manage the company better than anyone else could ever dream. They in turn give you a pile of money and free advice. What a deal!.

Here’s what really happens.

You approach the venture capital firm and meet with the board. You show them how you’ve invented a process of combining milk and apples into a potion that will cure cancer, and serve as an alternate to gasoline for 3 cents per gallon.

One of the board members is very enthusiastic. She thinks you’re on to something that with a little management and marketing guidance from the firm could be really big. The other six grumble about the risk of alar and other problems associated with apples.

After a few weeks they grudgingly decide to meet with you again. The guy that was excited about your idea sits quietly and the other members have softened a little to your idea but still have serious concerns, blah blah blah. After the meeting is over your ally will come over and talk to you alone. She’ll tell you she was really pulling for you and you may have to give up a little more control or equity, but she’s in your corner and thinks she can get it done for you.

If your idea really is good, you’ll get the money. If they detect you’re not 100% confident and that you don’t posess business savvy they’ll try to control as much of your business as they can in most cases. In other cases they’ll give you tons of freedom, but watch over your shoulder and count every penny.

When you fail to make a couple of the payments (and they will be considerably higher than bank payments) they’ll take control of the company. Then they’ll run it with such a heavy hand you’ll be forced to either sell to them, or get bank financing and buy your company back at a healthy profit to the venture capital firm.

So is it really that bad? It can be. You have to research the VC firm or angel investor much more diligently than you would a bank or other lending institution. You must stick to your gains and get the best deal you can. This means you’re going to have to be patient, and you certainly will want to talk to at least to other VC firms. In short, you have to play their game.

So what should you look for in a venture capital firm?
I’d recommend one that’s been around for more than fifteen years. Some of the VC lenders have became jaded since the dotcom bust, and honestly it’s hard to blame them.

On the board there should be at least one or two entrepreneurs who made their money the old fashioned way. Hard work and perseverance. If it’s full of former dotcommers you’ll probably want to steer clear. The biggest reason for this is they may have no management or real business experience. The fact that they had a great idea and were able to capitalize on it before the bust doesn’t make for the next Jack Welch. It would also be a plus if they had a senior level manager in a big company. These guys know how to work a bureaucracy and what the traps are.

If you’ve done your homework and really believe in yourself and your idea, let the confidece shine through. That doesn’t mean be arrogant. It just means, hold your ground until you get the best deal possible.

Eric Gurr is a senior editor at smbresource. He has owned and managed small to medium sized businesses and started two successful businesses.
He can be reached at egurr@intralinkinc.com

http://www.smbresource.com

If there were only two reasons for a business to fail they would be poor financing and poor management or planning. You can’t over-emphasize the importance of financing your business. Financing the business is not a one time activity as some might think. It is necessary whenever the need arises such as when expanding, modernizing etc. At this stage you need to understand the importance of exercising extreme caution and plan the utilization of capital. A wrong decision here can haunt your for the life of your business.

Are You Sure You Want To Raise External Funds?

For start-ups, it’s understandable that you need to raise capital through loans. But what about expansions and upgrades? Make sure that external financing is an absolute must before you apply. It is critical that you organize your finances at transitional stages but only after you make sure that you can’t do it yourself, either permanently or for some time. Equally important are the criteria of risk, the cost of not financing and how well it contributes to specific and overall goals of the company.

FINANCING TYPES

Equity Financing: Equity financing involves selling off of your shares (mostly partially) in return for cash and giving away that portion of ownership and rights to profits. Equity financing can be sought from private investors or venture capitalists. This brings about proper capitalization opening access to debt financing. Equity finance doesn’t need to be returned like loans unless your partner wants to withdraw.

Debt Financing: Debt financing is loan financing against some kind of guarantee of repayment. The guarantee can be collateral, a personal guarantee or a promise. Lenders restrict the use of debt finance to inventory, equipment or real estate. You need to properly structure the debt and the rule of thumb for doing so is giving long term debt for fixed asset loans and short term for working capital. The reason is that fixed assets generate cash flow over their lifetimes and have the benefit of lower interest rates as opposed to working capital loans.

Sources of Finance:

You can choose finance sources depending on your circumstances and the amount required.

1. Family and Friends: Small and short-term working capital requirements can be financed quickly through your own resources or through family and friends. The benefit here is the absence of the interest component (mostly.) This method of raising finances is handy even in early stages of business. You should be mindful, though, that disputes over money are the main reason that close relationships turn sour.

2. US Small Business Administration: This is the most prominent source for debt financing. The SBA doesn’t lend money directly but organizes and guarantees loans through various lenders and sources under its umbrella. Local governments, banks, private lenders, etc. disburse loans immediately to businesses approved by the SBA. SBA loans are available for various business purposes and at the lowest interest rates available.

3. Venture capital: Raising venture capital is organizing financing through selling shares whose value equals the finance you require. Essentially this means selling a portion of the ownership and control rights. It is essential that a proper valuation of your business’s worth is made before the deal is done.

Financing a business shouldn’t be hard provided you have established your credentials as a good manager, have collateral/assets, a convincing cash flow statement, genuine need, a proven track record, good credit history and a robust plan. This should not just save your business from collapsing but also allows it to grow and succeed.

Tony Jacowski is a quality analyst for The MBA Journal. Aveta Solutions – Six Sigma Online ( http://www.sixsigmaonline.org ) offers online six sigma training and certification classes for lean six sigma, black belts, green belts, and yellow belts.

Many owners and managers struggle to get the small business financing necessary to operate and grow.

And while most people would universally agree that lower cost debt is better than higher cost debt, both end up having their place and purpose.

Low cost debt financing is reserved for low risk applications.

As the risk goes up, so does the cost of borrowing.

Pretty basic, right?

There is a twist however.

Most of the lower cost capital available for small business financing is based on personal net worth, personal credit, and income sources outside of the business.

So even though a business application of financing could be considered high risk, the business owner or manager may still be able to secure low interest rates based on their personal assets and income.

This creates the illusion that low interest rates are available for all small business applications, regardless of their size and relative risk.

Here’s where the trap comes in.

As the business grows, it will use up all the low cost financing leveraged from personal assets and will need to factor in higher cost small business financing sources to fund the capital requirements of the business.

At this point, the risk of the underlying business now starts to get reflected in the interest rates.

The problem is that hardly anyone ever plans for this to happen and the business leap frogs from low interest rate personal loans disguised as business loans into high interest rate personal credit cards.

If the business achieves short term profitability, there can still be low and medium range interest rate products available to fund growth.

But if the business startup period drags on, which is not at all uncommon, higher cost personal financing can quickly become the only capital available to cover short term losses and/or larger than expected start up costs.

To avoid falling into the low interest rate trap, consider the following steps when constructing your small business financing strategy.

>>> Be Ultra Conservative When Estimating Your Capital Requirements.

When you’re trying to start up a business, its all about being optimistic and getting things going so that you can make all kinds of money. Right?

In the excitement of planning a new venture its easy to delude yourself as to what the business start up is realistically going to cost to get going and become profitable.

A better approach is to be conservative with your small business financing requirements, factoring in all probable costs in more detail to increase accuracy.

Even if you think you’re being ultra conservative with your capital estimates, add another 20% to whatever number you come up with as a contingency fund.

Things can and will go wrong.

The perfect startup scenario is about the same odds as winning a lottery ticket, so you might as well go play your lucky numbers instead of banking on an overly aggressive small business financing plan.

>>> Understand The Limits and Criteria For Low Interest Rate Financing.

For startups, low interest rate financing comes from personal credit and government sponsored programs.

In either case, there are limits as to how much capital you can acquire.

The limits for government programs are normally well defined. Just don’t automatically assume that you qualify for the maximum amount.

Personal limits are going to be based on a combination of your credit score, your liquidat-ible personal assets, and the cash flow available to service the debt.

Short term profitability in the business will provide you with greater access to small business financing, but at a slightly higher interest rate compared to low cost personal financing.

The interest cost of incremental capital will continue to rise if the additional debt is not matched by corresponding amount of personal or business equity.

>>> Factor In The True Cost Of Borrowing

When creating your small business financing projections, make sure that you accurately estimate your cost of borrowed capital.

If your low cost money sources are not sufficient to cover off your capital requirements, then factor in higher cost sources available to you and see if the cash flow projections still work.

There is no value in creating an unrealistic cash flow projection.

It can only lead to poor business decisions which will not keep you in business very long.

If the cash flow numbers don’t add up, avoid the temptation to reduce your capital requirements or lower the average cost of capital just to make the numbers work.

The reality of good numbers may tell you not to proceed with your plans, which could very well be the best business decision you ever make.

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You have a great idea for a business but don’t have enough cash to get it off the ground? Funding is often the main component that keeps an entrepreneur from his or her dream. Have you been searching for government grants in the hopes of finding free money for your start up? Are you looking for investors and angels? Are you discovering there are no Venture Capitalists handing out start up funds?

The reality is that when it comes to funding your own small business, you need to be able to provide at least some of the financing yourself. Even if you qualify for an SBA (Small Business Administration) backed loan, you must still pitch in a good percentage yourself (20% – 30%).

And when it comes to grants, there really are no grants available for small start-ups. Sure, there are some here and there for $500 – $1000 for niche groups. But even a small business will have start up expenses upwards of $10,000. And Venture Capitalists are looking for multimillion dollar deals that will net them millions in return. They have no interest in helping the little guy with his little business.

So, where do you find funding?

Before I answer that all important question let me ask youDo you have a detailed business plan with exact dollar requirements spelled out (or very close educated assumptions)? That is your first order of business. Once you have a very good idea of your needs you will have a better idea of where to look for funding.

Most people don’t even know how to begin to figure their start up costs. Here is a list of typical start up expenses: