| Equity
Financing
Equity financing requires that
you sell an ownership interest in the business in exchange for
capital. The most basic hurdle to equity financing is finding
investors who are willing to buy into your business; however,
the amount of equity financing that you undertake may depend
more upon your willingness to share management control than upon
the investor appeal of the business. By selling equity interests
in your business, you sacrifice some of your autonomy and
management rights.
The effect of selling a large percentage of the ownership
interest in your business may mean that your own investment will
be short-term, unless you retain a majority interest in the
business and control over future sale of the business. Of
course, many small business operators are not necessarily
interested in maintaining their business indefinitely, and your
personal motives for pursuing a small business will determine
the value you place upon business ownership. Sometimes the
bottom line is whether you would rather operate a successful
business for several years and then sell your interests for a
fair profit, or be repeatedly frustrated in attempts at
financing a business that cannot achieve its potential because
of insufficient capital.
Here are the most common small business options for equity
financing:
Venture
Capital: Venture capital ("VC") firms
supply funding from private sources for investing in select
companies that have a high, rapid growth potential and a need
for large amounts of capital. VC firms speculate on certain
high-risk businesses producing a very high rate of return in a
very short time. The firms typically invest for periods of three
to seven years and expect at least a 20 percent to 40 percent
annual return on their investment.
Venture capital firms are
located nationwide, and a directory is available for $125
through the National Association of Venture Capital http://www.nvca.org
, 1655 N. Fort Meyer Dr., Arlington, VA 22209, (703 524-2549).
In addition, other sources for venture capital can be found
through bankers, insurance companies, and business associations.
Small
Business Investment Corps.: The federal government
sponsors its own public venture capital organization through the
Small Business Investment Corporation (SBIC) program. An SBIC is
a privately owned and operated small business investment company
that partners with the federal government to provide venture
capital to small business. Using a combination of private funds
and funds borrowed from the federal government, the SBICs
provide equity capital, long-term loans (up to 20 years, with a
possible 10-year extension), and management assistance to
eligible small businesses. Loans and securities for less than
five years are unusual and the cost of money on loans and debt
securities is regulated by the Small Business Administration.
Private
Investors/Business Angels: A less-formal source for
external equity financing is through private investors, called
"angels," who are seeking new business investments for
a variety of economic and personal reasons. Angels can be a very
good source of money if you are looking for outside investors
but you are not interested in, or not a likely target for, a
venture capital firm. Although angels tend to be less demanding
in their financing terms than venture capital firms, you should
still exercise great caution in ensuring that your
"angel" financier doesn't turn out to be a devil in
disguise. Some angels may offer loans at very low interest rates
simply to help a new business or the community; others may
expect specific rates of return on an equity investment.
**The Small
Business Administration has its own angel network on the
Internet called ACE-net.**
Initial
Public Offerings: You may have read about how some
small company became an overnight success story by deciding to
"go public" through an initial public offering (IPO)
of its stock. Going public simply means that a company that was
previously owned by a limited number of private investors has
elected, for the first time, to sell ownership shares of the
business to the general public.
The public sale of ownership interests can generate funds for
working capital, repayment of debt, diversification,
acquisitions, marketing, and other uses. In addition, a
successful public offering increases the visibility and appeal
of your company, thereby escalating the demand and value for
shares of your company. Investors can benefit from an IPO not
only because of the potential increase in market value for their
stock, but also because publicly-held stock is more liquid and
can be readily sold if the business appears to falter or if the
investor needs quick cash.
Nevertheless, IPOs
largely remain a financing option limited to rapidly growing,
successful businesses that generate over a million dollars in
net annual income.
The use of IPOs is limited primarily because: (1) there is a
very high cost and much complexity in complying with federal and
state laws governing the sale of business securities (the cost
for a small business can run from $50,000 — $500,000); (2)
offering your business's ownership for public sale does little
good unless your company has sufficient investor awareness and
appeal to make the IPO worthwhile; and (3) management must be
ready to handle the administrative and legal demands of
widespread public ownership. Of course, an IPO also means a
dilution of the existing shareholders" interests and the
possibility of takeovers or adjustments in management control
are present.
Alternatives
to Going Public: While many small businesses sell
interests in their companies that are "securities," as
defined by federal or state laws, the transactions are often
exempt from registration regulations because the offerings are
sufficiently small in dollar amount, and they are restricted to
a limited number and/or type of investors. These exempt offers
of securities are called "limited private offerings"
and they can avoid much of the cost and delay of a public
offering. Unfortunately, to qualify for any of the exemptions,
you must fit the criteria for both federal and state security
laws.
Franchising:
"Franchising" is the transfer of the right to sell a
trademarked product or service through a system prescribed by a
"franchisor," who owns the trademark. Franchising has
been one of the fastest growing areas of new business
development during the last 15 years and there are currently
over half a million franchise businesses in the U.S. While
traditional franchise businesses such as gasoline stations, auto
dealers, and soft drink bottlers continue to grow, the most
rapidly expanding industries for franchises are service
businesses involving recreation and leisure activity and
business services.
Franchise arrangements are usually either: (1) product and trade
name franchises or (2) business format franchises. The former
involves product distribution arrangements within a specified
geographic territory. For example, a gas station can be a
product and trade name franchise. A business format franchise
includes not only a product and trade name, but also operating
procedures such as facility design, accounting and bookkeeping
procedures, employee relations, quality assurance standards, and
the overall image and appearance of the business. For instance,
restaurants and convenience stores are often business format
franchises.
ESOP's:
You may be able to find equity financing within your own company
if you have employees and you are willing to share some
ownership control with them.
An Employee Stock Ownership Plan (ESOP) is a qualified
retirement benefit plan in which the major investment is
securities of the employer's company. In an ESOP, employees can
purchase shares of stock in the company by paying cash or by
agreeing to reductions from salary or benefits. The employees
become part owners of the business and you have additional funds
for other business purposes. In addition, the company
contributes to the ESOP by either making an annual cash
contribution to the plan for the purchase of company securities
or by directly contributing stock to the plan. Either way, the
company's contribution results in the cash price of the stock
being returned to the company. The company gets a tax deduction
for the ESOP contribution while effectively retaining the cash.
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- Debt Financing |
