[Idea Cafe's Financing Your Business]

What Kind of Financing is Right for You?

A buffet of options, but definitely a matter of individual taste. One man's sushi is another's dead fish. Start by chewing over some of the issues that can affect your choice of financing. Here you can figure out which sources can satisfy your appetite for size and speed.

Educate yourself on the various flavors of financing available, and the pros and cons of each: debt, equity, asset and other sources. And be sure to test your own attitudes toward the consequences of using various funding sources. Venture capital sounds glamorous and exciting. But ask yourself if you'll be happy with the loss of control that giving up a sizable chunk of equity entails. And how you'll like sitting on the sidelines while others rush to take your baby public -- or sell it off -- in three or five years, making a killing in the process. On the other hand, owning 30% of a $100 million business may be a whole lot better than owning 100% of a $100,000 business stunted by lack of capital.

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Table of Contents

1. Financing Issues

2. Where to go for Financing:

3. Which recipe for getting money tastes right to you?: Self-Exam

4. Rhonda's Tips

5. Resources

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1. Financing issues to chew over

Leverage
How much debt are you comfortable taking on? A highly-leveraged company is one with a high proportion of long-term debt, relative to the amount of owners' equity. One time-honored rule of thumb is that each dollar of early-stage equity can support a dollar of debt, assuming the debt is anchored by collateral. When you leverage equity with debt, your business can expand more quickly. Some financial advisers recommend a 1-to-1 ratio, while others can stomach a 2-to-1 ratio.

Control
How much are you willing to give up? Interest charges on loans can increase your costs and shackle you to years of monthly payments. But equity investors chip away at your control over the company. They will want to know what's going on, give advice, and in some rare cases, can even remove you from running the company.

Company structure
Are you an "S" corporation, a "C" Corporation or an LLC? (Check "Words You Need to Know" if you don't know what these are.) These corporate structures place limits on the number and type of investors you may have. Institutional investors, such as venture capital firms, will usually need you to change to a "C" Corporation.

Taxes
Was that a loan or an investment? If the amount of your owner's equity isn't enough to support your level of debt, the IRS may reclassify it as an equity investment. That means your interest payments won't be tax-deductible, since they'll be considered dividends to shareholders. For example, raising $1 million from investors who "lend'' you $950,000 and give you $50,000 will be frowned upon. The IRS generally accepts a 3-1 debt-to-equity ratio at face value. Between 3-1 and 7-1 makes them nervous, while above 7-1 can set off their alarm bells.

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2. Where to go for financing???

How much money do you need?

If You Need at least $2 million, then consider:


If You Need at least $1 million, consider: If You Need at least $100,000, good bets are: If You Need $25,000 to $100,000, go for: If You Need less than $25,000, your best bets are:

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How much time do you have?

If you need money this week, better use:

If you need money this month, you can apply for:
  • A bank loan
  • New Line of Credit
  • SBA Low-Doc bank loan
  • SBA Microloan
  • Loans from friends and family
  • Loans from personal sources
  • Asset/Receivables financing
If you need money within two months, look into:
  • SBA 7a Loan Program for $100k+
  • Investments from Personal Sources
  • Investments from Friends and Family
For money within 6 - 12 months, go to:
  • Any Investor Sources
  • Public Offerings
  • Private Placements

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3. Self Exam: Which recipe for getting money tastes right to you?

1. You've taken out a bank loan to finance your growing courier business, requiring a hefty monthly payment. But some of your clients are slow payers, and you often face a cash flow crunch.

A. You feel you're doing the prudent thing others would kill for. Your loan is at a reasonable rate, so what if every month you have to hustle to make the payment and you end up yelling at the kids; that's just the cost of doing business. Hey, at least you're the boss.

B. This monthly payment schedule is financial water torture, and you dread the end of every month when your loan is due.You'd welcome an equity investor the way you'd greet a $50 million lottery ticket, even if you had to explain your every business decision.

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2.You have 15 credit cards. You decide to charge all the supplies and equipment for your graphic design business, and get cash advances up to the $5,000 credit limit on each for cash flow. You're suddenly $75,000 in debt.

A. So what? You're new in business and can't qualify for a regular bank loan. High interest payments, nervous creditors, and living on the edge is worth it to run your own business. Hey, with your talent and connections, you'll have the money paid back in no time flat, right?

B. You're a wreck, unable to concentrate on your business for worrying over the credit card bill. Every month you make the minimum payment -- all you can afford -- and start to grind your teeth in your sleep.

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3. Your toy firm needs money to launch a new line of action figures. Because you're unable to obtain a bank loan, you have a factor buy your accounts receivable; he takes a 25% commission on their $75,000 value.

A. Fast money is the best money. Christmas is coming and if you don't launch those new alien fighters now, you'll miss the main toy-selling season. And these X-Power-Turtle-GrungeRangers have the makings of a major hit!

B. Expensive money is the worst money. If you give a factor a 25% commission, you'll have killed your profit margin. Better to wait a year and hope the market for action figures holds up.

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4. A potential customer, the city's major department store, likes your tie-dyed potholders so much they place a major order. Knowing you're relatively new in business, they agree to pay half up front, but they demand so much of your output (and your time), you have to cut back on orders for other customers.

A. Great. Nothing's better to finance a business than good old fashioned revenues. And now your product is getting great exposure, soon you'll be able to go national. You've arrived!

B. Whoa! The store is notorious for dropping items that don't sell quickly, and their up-front payment only covers your costs, not profit. You've alienated other customers and put all your eggs in one very shaky basket.

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5. You're opening a computer cafe serving gourmet coffees. You've tapped your savings and gotten a loan from mom, but are still $50,000 short. Your next-door neighbors, both business executives, offer to make you a personal loan for the $50,000.

A. No reason to go to a bank when your neighbors are so generous. Regular or decaf?

B. You wake up and smell the coffee. You're constantly expecting to see your creditors eyeing you over the rose bushes, wanting to know why you missed the last few payments or telling you to turn the cafe into a karaoke bar. It's getting so you don't want to go home.

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6. Your older brother and aunt, excited by the success of your start-up catering business, want in. They've got money and time on their hands. Excited by the opportunity for expansion, you allow them to become equity investors .

A. You welcome the extra input, money and advice -- more hands make light work. Anyway, you've always liked your brother, and your aunt is a really smart gal.

B. Deja vu. In a distressing reminder of how he behaved in grade school, your brother brags about the business as though the idea was his, and starts nagging you about what you're doing wrong. Your aunt, unfamiliar with the catering industry, becomes the loudest silent partner you've ever seen.

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7. You need to boost your gourmet food company to the next level, so you turn to a friend of many years, who runs a successful mail order gift business. As a Strategic Partner, she invests in your company and includes your line in her snazzy catalog. Sales go way up, and she only owns 20% of the company. Unfortunately, she's pretty secretive, and while she knows everything about your business, she won't let you know anything about hers.

A. You figure she just needs time to develop trust and know you won't steal her company secrets. Giving her time to get comfortable is a small price to pay for the increased bottom line.

B. "Hey, I thought this was supposed to be a partnership!" Knowledge is power, and she's got all the knowledge. You don't like being the junior partner regardless of the money.

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8. Every day you bless the angel who lent you $100,000 to turn your idea for a mobile blood analysis kit into a patent and a business plan -- and then left you alone. Now you need to produce prototypes. You've got cheap space in a business incubator at the local university lined up, but you need capital to buy equipment and hire staff. You ask a local SBIC devoted to medical technology for a $200,000 investment, but they want to install some of their staff in top management.

A. What a relief: on top of the money, you'll get some technical and professional input. And their people are probably better than anyone you could find. This project was already beginning to surpass your abilities.

B. "Leave me alone!" The only thing worse than a nosy investor is a nosy investor who wants spies in the business and has ties to a government agency. You'll pass on all the extra paperwork of dealing with a quasi-government agency, and take your chances of finding the money and the help you need elsewhere

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9. A venture capital firm invests $2 million for a majority stake in your regional publishing company, which specializes in high-tech trade magazines. Within a few months, they bring in a professional magazine publisher who replaces you as CEO, giving you the face-saving title of Executive Vice President. The new chief redesigns your publications, multiplies your advertising revenues and sells the company to a New York media giant 18 months later for mucho millions. He's featured on the cover of BusinessWeek. Your share of the sale is 3%, and BusinessWeek never mentions your name.

A. You're delighted, and rich. Your publications are reaching the wider audience they deserve, your employees have more secure jobs. And your golf game is really improving.

B. So you've got a great bank account, but your dream was stolen out from under you. He's not only taken your job, but the credit you rightfully deserve. Money isn't everything.

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10. That $1 million private placement you did two years ago financed the development of your idea for a CD-ROM -- a giddy digital spin through the vineyards of Europe, narrated by a famous cartoon character, which sold terrifically. Now you need $3 million to get started on the next three CD-ROM's in the series. You decide on a public offering.

A. Cheers. You uncork a bottle of the good stuff and toast the smell of other people's money.

B. Pass the Pepto. No amount of money is worth the hangover that comes with stockholders demanding ever-better quarterly reports, nosy financial reporters, arrogant investment bankers and that stack of forms from the SEC.

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Scoring:

If you answered "A" for:
Questions 1-4: You're comfortable with risk; maybe even a very high degree of risk. Your optimism helps you cope with the ups and downs and sleepless nights of business. You like your independence, so you're generally better off choosing debt financing rather than equity investors. Just be careful you don't get in over your head.

Good financing choices for you if you answered "A":

If you answered "A" for:
Questions 5-6: You're comfortable mixing your personal and business lives, and don't care if people near and dear to you know intimate details of your financial situation. Or you've got very discreet friends and family.

Good financing choices for you if you answered "A":

If you answered "A" for:
Questions 7-10: You're comfortable giving up some independence for greater financial success. Your primary business goals aren't control and flexibility, but money and getting your product out. You don't mind admitting you know you don't know everything. You're a good candidate for equity investors.

Good financing choices for you if you answered "A":

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4. Rhonda's Tips

Business planning expert Rhonda Abrams adds her tips and insights on choosing a type of business financing that's right for you.

Money costs. Sometimes it costs money, in the form of interest, closing costs, etc. And sometimes it costs a percentage of ownership in the company, in the form of equity. You don't get money for nothing. So you have to decide what kinds of costs you're willing to pay. Are you willing to have debt hanging over your head -- a payment to make every month whether you're making money or not? Or are you willing to hand over a piece of your company instead?

In some cases, of course, you don't have much of a choice. Especially when you're new in business there may be only a few options open to you -- often either investors or high cost credit cards.

The best way to finance a business is to "bootstrap" it -- growing slowly through revenues. You keep all the equity and you don't have much debt. This is only possible with businesses with small start-up costs, such as consulting, and when you can still keep your day job or have low personal expenses as well. It means, however, that your company will have a slow growth curve unless you're very lucky.

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5. Resources

For the SBA:
Small Business Administration
409 3rd Street SW
Washington, D.C.
800-827-5722

For a nonprofit matching service:
Angel Networks
Technology Capital Network
MIT Enterprise Forum
201 Vassar Street West, #59
Cambridge, MA 02139
617-253-2337

For seed capital:
Seed Capital Network Inc.
8905 Kingston Pike, Suite 12
Knoxville, TN 37923
615-693-2091

For a listing of venture capital firms, mostly SBIC's:
National Association of Investment Companies
1111 14th Street NW, Suite 700
Washington, DC 20005
202-289-4336

For a directory of more than 800 venture capitalists:
Pratt's Guide to Venture Capital Sources
40 West 57th Street, Suite 802
New York, NY 10019
212-765-5311

For an IBM-compatible database of venture capital firms and contacts:
AI Research Corporation
2003 St. Julien Court
Mountain View, CA 94043
415-852-9140

For the SBA's directory of SBIC's:
Small Business Administration
Investment Division
409 3rd Street SW
Washington, DC 20416
202-205-6600

For information on accountants:
American Accounting Association
5717 Bessie Drive
Sarasota, FL 34233
813-921-7747

For a legal referral service:
American Bar Association
750 Lake Shore Drive
Chicago, IL 60611
312-988-5000

For information on financial analysts:
Institute of Chartered Financial Analysts
P.O. Box 3668
Charlottesville, VA 22908
804-977-6600

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