https://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif 0 0 jeff https://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif jeff2002-08-28 16:51:322014-09-28 10:11:23Money: That’s What I Want. Sources of Capital for a Growing Business
Money: That’s What I Want. Sources of Capital for a Growing Business
If your only business is snowboarding, you need money for three reasons. First, your business should grow at least as fast as the industry, and that growth translates into more cash tied up in the business. Second, extreme seasonality and the extended dating customers are demanding requires more working capital. Finally, tough competitive conditions are probably reducing margins, leaving less cash flow for each unit of product.
Adequate working capital is never enough to make a company succeed. Survive and continue, yes- but not succeed. On the other hand, not having enough capital has destroyed many businesses that were otherwise viable. Another time we’ll talk about determining how much working capital you need. For the moment, let’s assume that’s done. The subject for today is where to find it.
Two general comments about raising money. First, the only thing we know for sure about your estimate of capital requirements is that it’s wrong. We don’t know it you’ll do better or worse than projected, but either way, your capital need is usually greater than anticipated. Most investors, when looking at a new business, assume that twice the capital projected will be needed. Allocating an additional 15 percent for surprises may make sense if you’re budgeting a project for an ongoing, established business, but it’s wildly optimistic for a startup or fast growth.
The second thing to recognize about raising money is that it takes longer than you expect and requires your continuous attention, especially if you’re raising equity. Plan to be distracted from running your business.
The smaller and less established your company is, the tougher it is to find capital unless it comes out of your pocket. Profitable, established companies have an easier time of it, but the options are essentially the same.
There are only seven places I know of where you can find capital.
· Your pocket
· Your friends’ and relatives’ pockets
· The bank (including bank like entities like the Small Business Administration)
· Asset Based Lenders
· Third party private investors
· Your customers and suppliers
· The public markets
Let’s look briefly at each one.
Nobody is going to invest in your business unless you do. As a result, most small businesses get started with the owner’s personal capital. It can be a home equity loan, savings account or an advance from your credit card, but it’s going to be your money.
Your Friends’ and Relatives’ Pocket
“Joe’s starting a business!” I’m putting up $5,000 and we’re all going to get rich!” People you know well are the easiest to approach, and the most likely to be supportive. Nobody likes rejection, and you get a lot when you’re raising money.
People who love and trust you may not ask the hard questions a banker or third party investor would ask. As a result, your expectations and theirs may not converge. Especially when taking money from friends and relatives, make sure the relationship is defined as rigorously as it would be with somebody you didn’t know.
Is the money a loan or equity? Do they expect dividends? A job? Are they really prepared for the possibility of losing all or part of the money? Can they truly afford it? How do they propose to get their money out of the business? By when? It’s hard not to accept cash when you are enthusiastic about your business and it is offered with so few strings attached. But spelling out the relationship now will save you money, time, headaches and friends latter.
A client of mine has an exciting new product. His partner is contributing his time, professional expertise and reputation, and some cash for a stake in the business. The agreement they’ve got calls for him to receive 25% of the “net profit” after allocation of direct expenses and “appropriate overhead.” It isn’t clear if he continues to receive such compensation after he leaves the company. We’re rewriting the agreement to eliminate the ambiguities. Imagine all the fun the lawyers could have arguing over what “net profit” and “appropriate overhead” means.
Banks are in business to earn some interest and a little fee income. They aren’t interested in sharing the risk of your business with you. The wise person who said “Banks will only lend you money when you don’t need it” was basically right.
What a bank will do is look at your company’s performance for stability and consistency. But even a small business that’s consistently profitable and been around for a while isn’t typically going to get an unsecured line of credit. The bank will require a security interest in inventory and receivables. They will probably also insist on a personal guarantee. From their perspective, a small business owner and his business are the same entity because the owner controls and flow of money between the company and himself.
A startup or company that isn’t stable and established won’t get a bank loan, though that doesn’t mean they can’t get money from a bank based on the owner’s personal assets.
Asset Based Lenders
An asset based lender functions much like a bank, but is willing to take more risk. They compensate for this by charging higher fees and interest, controlling access to the money according to a carefully defined formula, and tracking the assets they control as collateral very carefully. A bank looks at your cash flow as a primary source of repayment. That is, they analyze your company as a continuing entity. An asset-based lender is less concerned about profitability than about their ability to liquidate the company’s assets for at least as much as they have lent to you. Your business may collapse, but the asset based lender still feels they will get every cent they have coming to them.
Third Party Investors
The good news about a professional investor is that they will put you through a more rigorous legal, business, financial and market evaluation before making an investment. At their best, they will provide you with skills and experience that will help you build your business in addition to access to capital. The possible downside is that they will take control out of your hands, may have active involvement in the company, and will be looking for a big return. They will be in your business to make money.
It seems that everybody who knows the term venture capitalist thinks they are the place to go to finance a new business. But venture capitalists invest in, say, ten businesses expecting eight of them to fail to live up to expectations. That means they are only interested in you if you can demonstrate the potential for rapid growth with a clear competitive advantage or unique product. It also means they generally aren’t interested in investing $50,000. At a couple of million you may get their attention.
The reason is simple. The time and effort they put into making an investment is expensive. It represents too big a percentage of a small investment. Nor can they expect the returns they want to aim for on smaller deals.
Your Customers and Suppliers
A larger company who wants to work with you may be willing to provide some up front payments to get your product. Suppliers often offer terms to companies they hope to expand their business with if required by the competitive situation. At its best, you get terms from your suppliers such that you collect from your customers before you have to pay the supplier.
These business cycle dynamics can be an often overlooked source of working capital.
A client of mine that is producing interactive conference calls (almost like talk radio over the telephone) has found its large corporate customers so anxious to use the service that they are being paid in advance. Essentially, they can grow without raising any outside capital by utilizing the business cycle they have created.
The Public Market
The advantages of going public are that you get a higher valuation of your company, access to future funding, and liquidity for your personal equity in the business. The disadvantages are the reporting requirements of a public company, the fact that your company is something of an open book, the loss of flexibility, and the expense. I understand somebody else is doing an entire article on going public in this issue, so that’s enough said by me on the subject.
Those are your choices. Which one is right for you depends on how much capital you want to raise, what you want it for, the history of your business, and its prospects.