Not All Money Is the Same
There are two types of financing: equity and debt financing. When
looking for money, you must consider your company's debt-to-equity
ratio - the relation between dollars you've borrowed and dollars
you've invested in your business. The more money owners have invested
in their business, the easier it is to attract financing.
If your firm has a high ratio of equity to debt, you should probably
seek debt financing. However, if your company has a high proportion of
debt to equity, experts advise that you should increase your ownership
capital (equity investment) for additional funds. That way you won't
be over-leveraged to the point of jeopardizing your company's
survival.
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Equity Financing
Most small or growth-stage businesses use limited equity financing. As
with debt financing, additional equity often comes from
non-professional investors such as friends, relatives, employees,
customers, or industry colleagues. However, the most common source of
professional equity funding comes from venture capitalists. These are
institutional risk takers and may be groups of wealthy individuals,
government-assisted sources, or major financial institutions. Most
specialize in one or a few closely related industries. The high-tech
industry of California's Silicon Valley is a well-known example of
capitalist investing.
Venture capitalists are often seen as deep-pocketed financial gurus
looking for start-ups in which to invest their money, but they most
often prefer three-to-five-year old companies with the potential to
become major regional or national concerns and return
higher-than-average profits to their shareholders. Venture capitalists
may scrutinize thousands of potential investments annually, but only
invest in a handful. The possibility of a public stock offering is
critical to venture capitalists. Quality management, a competitive or
innovative advantage, and industry growth are also major concerns.
Different venture capitalists have different approaches to management
of the business in which they invest. They generally prefer to
influence a business passively, but will react when a business does
not perform as expected and may insist on changes in management or
strategy. Relinquishing some of the decision-making and some of the
potential for profits are the main disadvantages of equity financing.
You may contact these investors directly, although they typically make
their investments through referrals. The SBA also licenses Small
Business Investment Companies (SBICs) and Minority Enterprise Small
Business Investment companies (MSBIs), which offer equity financing.
Apple Computer, Federal Express and Nike Shoes received financing from
SBICs at critical stages of their growth.
Debt Financing
There are many sources for debt financing: banks, savings and loans,
commercial finance companies, and the U.S. Small Business
Administration (SBA) are the most common. State and local governments
have developed many programs in recent years to encourage the growth
of small businesses in recognition of their positive effects on the
economy. Family members, friends, and former associates are all
potential sources, especially when capital requirements are smaller.
Traditionally, banks have been the major source of small business
funding. Their principal role has been as a short-term lender offering
demand financing, seasonal lines of credit, and single-purpose financing for
machinery and equipment. Banks generally have been reluctant to offer
long-term financings to small firms. The SBA guaranteed lending program
encourages banks and non-bank lenders to make long-term financings to small
firms by reducing their risk and leveraging the funds they have
available. The SBA's programs have been an integral part of the
success stories of thousands of firms nationally.
In addition to equity considerations, lenders commonly require the
borrower's personal guarantees in case of default. This ensures that
the borrower has a sufficient personal interest at stake to give
paramount attention to the business. For most borrowers this is a
burden, but also a necessity.
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