While poor
management is cited most frequently as the
reason businesses fail, inadequate or ill-timed
financing is a close second. Whether you're
starting a business or expanding one, sufficient
ready capital is essential. But it is not
enough to simply have sufficient financing;
knowledge and planning are required to manage
it well. These qualities ensure that entrepreneurs
avoid common mistakes like securing the
wrong type of financing, miscalculating
the amount required, or underestimating
the cost of borrowing money. |
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. |
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. |
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 loans,
seasonal lines of credit, and single-purpose
loans for machinery and equipment. Banks
generally have been reluctant to offer long-term
loans to small firms. The SBA guaranteed
lending program encourages banks and non-bank
lenders to make long-term loans 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. |