What are some alternative sources of financing?
Discussions About Alternative Sources of Financing
We realize that not all companies are venture-fundable. As we first discussed in a previous Articles, venture capital is a unique form of financing and needs these three elements in a deal: It must have rapid growth, get really big sooner rather than later, and remain profitable for a long time. Our Web site is not intended to explore and discuss other sources in great detail. But we do intend to give a broad view of this topic and refer you to additional resources.
Dealing with Corporate Venture Capitalists
Corporate strategic investing differs from conventional venture investing that we have discussed so far. Unlike venture capitalists, corporate investors can eventually be a part of the liquidity event, as they could buy you out. Generally, a corporation’s goals are strategic: to enhance their innovation, gain early exposure to new markets, and invest in new technologies. In the eye of the Perfect Storm, over 350 corporations were involved in corporate venturing. By the end of 2002, only about 150 were “somewhat alive.” Early stage ventures are not always of interest to corporate investors. But Cisco built an empire by investing in high-tech start-ups and acquiring them. Cisco completed seventy-one acquisitions from 1993 to 2001, and twenty-five in 2000 alone.
R&D limited partnerships are possible source of funds for high-tech entrepreneurs, where corporate partners invest in the technology development and share the upside by splitting royalties. But Richard Siegelman, general partner at Kleiner Perkins, provides this sage advice: “Get pure financial players first. Then the outside strategic investor will know it can’t twist your arm. Also, the strategic investor’s agenda may make it hard for VCs to come in later. Use a VC, then raise money from a strategic investor at a higher valuation.”
Small Business Investment Companies
Small Business Investment Companies (SBICs), which we first discussed in a previous Article, operate like a hybrid among a group of angels, a venture capital firm, and a bank. These privately owned and funded investment companies are licensed and regulated by the SBA. They use their own capital, along with funds borrowed from the SBA, to provide equity investments and long-term loans to small businesses.
Their “bread ‘n butter” is working with early stage ventures, and working closely with informal and formal angel investors at a very local level. From 1960 through 2001 the SBICs have made about 125,757 investments, for a total of $33 billion. Since 1992 when the first steps were taken to rejuvenate the SBIC program, total capital under management has grown from $3 billion to $17 billion, in 407 funds. In 2000 the SBA provided $5.6 billion in financing through some 400 SBICs. The average was around $1.2 million in financing; the majority of their investments—56 percent—went to ventures that were three years old or less. Some notable companies that got SBIC help in their early years include Federal Express, Apple Computer, Teledyne, Cray Computer, America Online, Staples, and Outback Steakhouses.
Federal Funding for Technology Transfer
According to one entrepreneur, who in 2002 received $2 million from the Advanced Technology Program (ATP) of the National Institute of Standards and Technology (NIST), “In the dot-com heyday, people turned their nose up at government funding. It’s much more accepted now.” And the recent increase in worldwide terrorist activity has pressed the need for the United States to quickly develop high-tech countermeasures.
For this reason President George W. Bush appointed E. Floyd Kvamme, a partner from Kleiner Perkins, as a co-chair of the President’s Council of Advisors on Science and Technology (PCAST). In 2002, PCAST prepared reports on advising the new Department of Homeland Security (DHS) how the government will meet the needs of technology transfer through Cooperative Research and Development Agreements and intellectual property licenses. PCAST’s proposal stresses the need for a streamlined technology transfer system to help bring to surface quickly new technologies that could be used in the DHS. The opportunity for an entrepreneur is that such a new development encourages participation by innovative companies that otherwise avoid government funding and contracts.
If you intend to raise a relatively small amount of money from a relatively small number of sophisticated investors, you might be able to use one of the exemptions from federal and state securities law. These exemptions allow you to do what is called a private placement. The Small Business Investment Incentive Act of 1980 increased the opportunities in private placements. More than $60 billion was raised in 2002 in the United States through private placements. A private placement is selling stock directly to a few private investors instead of the public at large. It can be faster than going to the venture capital community and less expensive than an initial public offering.
There are primarily three sections of operative rules under Regulation D of the Securities Exchange Act of 1993: Sections 504, 505, and 506. They deal primarily with the amount of capital you can raise, the time period in which you may raise the capital, whom you can approach, and how you can approach potential investors. You can raise money through an investment banker who specializes in private placements or consider going alone. Investment bankers can charge anywhere from 3 to 25 percent of the total amount raised. For more information, we refer you to a workbook that explains the basics of raising capital through private placements and that can help you through the process.
Asset-Based Financing and Debt Capital
Asset-based lending is financing that is secured with assets that have an easily determined value. Ventures can leverage a variety of assets as collateral, including accounts receivable, inventory, property plant and equipment, and securities. The financing can take the form of anything from loans to revolving lines of credit to equipment leases. A study by the New York City-based Commercial Finance Association found that companies had $343 billion in outstanding asset-based financing in 2000.
Start-up financing is very dependent on paid-in equity capital by the founders, their credit histories, and heavily collaterized banking financing. In fact, 62 percent of the Inc. 500 CEOs who raised additional financing borrowed money from a bank. One report found that about 91 to 98 percent of the small businesses in the United States have had access to credit for financing their businesses. The economic slowdown can actually benefit entrepreneurs, since we now have the lowest cost of capital in forty-five years. This, and the “democratization of credit” in recent years, means that more people have access to credit through home equity loans and credit markets. They can convert their personal assets into cash and into paid-in equity to launch new business ventures. Also there are the SBA’s main lending program and loan guarantees. The maximum loan guarantee is $750,000 and the average loan amount is $178,000. Funds can be used for working capital and typically have seven-year terms.
Somewhere in between debt and equity financing is “debt capital.” This is also known as trade credit, project financing, cash flow financing, purchase order financing, trade capital, trade financing, supplier credit, and factoring. It is reflected on the balance sheet statement as “accounts payable,” as it is in essence a loan for 30 to 120 days. Venture bridge financing, bridge loans, and mezzanine financing are all short-term financing. They are usually loans backed by equity and used by a start-up to pay for operating expenses during negotiations for a second-stage round of venture capital investment.
Understand that all forms of asset-based financing require careful planning. As Warren Buffett said, “Leveraging a company is like driving your car with a sharp stick pointed at your heart through the steering wheel. As long as the road is smooth it works fine. But hit one bump in the road and you may be dead.”