Posts Tagged ‘Capital’
March 5th, 2011 | 
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Most entrepreneurs often feel that venture capital should be raised prior to or immediately at the onset of a business. However, this is not often the case. Venture capital, as discussed in previous articles, can be raised in several different stages. In order to finance your growing business, you can skip the steps regarding startup/seed capital and move directly into mezzanine capital. This is especially true if you business is operational, profitable, and has an extensive operating history.
When looking for venture capital it is often difficult to determine when and what type of capital is required. Again, the most advanced your business (and the more profitable) the easier it will be to secure an investment from a venture capital firm. In some instances, it may be appropriate to raise capital only when your business intends to undergo an aggressive expansion. This will not only ensure that you will have an easier time raising capital, but your business will also meet the growth criteria required by venture capitalists. However, this is not only the case. In regards to companies that have proprietary technology or a highly unique business model, it may be appropriate for you to being to raise venture capital prior to the onset of operations.
As has been a common theme throughout these articles, there is difficulty in obtaining private capital – and by having either an established business that is growing, proprietary technology, or a highly unique business plan – you will be in a much better position to acquire funding from private investment firms.When determining when to raise capital, you may want to consult with your certified public accountant prior to entering this process. In our next article, we will discuss the general costs of raising capital.
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Many venture capitalists and angel investors are turning to a unique form of investing that focuses on providing both capital appreciation and a recurring stream of income for small business and startup investments. When looking for venture capital you can potentially use this type of debt-equity hybrid which allows you to obtain the capital you need to launch your business while concurrently offering less of an equity percentage to an investor.
Royalty based financing is a sort of hybrid that combines debt and equity into security. It should be noted that the best candidates for royalty based financing capital are businesses that have very high margins and moderate overhead. As your business will be required to provide sizable cash disbursement, companies that have low margins cannot afford to payout large percentages of gross revenues. Companies that offer services, technology businesses, software firms, and specialty service companies are prime candidates for royalty based financing as they will be able to afford the debt portion of the note.
This type of financing, in most circumstances, is subordinated debt, which means that other loans will take precedence over this note in the event that the business fails and assets are liquidated.Free government grants are available for almost everyone. Learn which grants to apply for. The advantage for an investor is that they can quickly recoup their initial investment if the business does very well and receive large capital appreciation on his or her equity participation.
As venture capital firms have strived to reduce the risks associated with their investing, more and more firms are turning to debt-equity hybrids like royalty based investing in order to ensure that they receive an ongoing cash stream that assists with recouping their initial investment into your business.
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Not only is the capital raising process difficult, but it can also be very expensive. As we have discussed earlier, when looking for venture capital you may or may not need a private placement memorandum. This document can only be produced by an attorney. The costs related to developing a private placement memo can range from ,250 to ,000 depending on the complexity of the investment, the experience of the attorney drafting the document, and whether or not there will be filings required with the SEC or your state’s securities regulatory agency. Additional cost factors also include having a proper business plan prepared. The cost of a professionally developed business plan can range from 0 to ,000 depending, again, on the complexity of your business, the amount of capital that you are seeking, and the number of financial metrics that need to be calculated in order to properly pitch it to a VC firm. If you hire a capital introduction firm then you may need to provide a significant percentage of the capital raised to this firm. As we have discussed earlier, capital introduction firms and private placement brokerages specialize in directly raising the necessary capital from investors for your business. These fees can range from 5% to 10% of the aggregate amount of capital raised.
Finally, there are the ancillary costs of looking for venture capital. You will need to factor in travel costs, hotel costs, car rental costs, and other costs associated with meeting with venture capitalists. Printing costs (for the materials to be presented to VC firm) should also be considered. Most professionals indicate that the costs associated with raising venture capital (assuming that you do not use a capital introduction firm) are about 3% to 5% of the aggregate amount of capital sought.
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As we have discussed earlier, and as has been the theme of this website, looking for venture capital is a very difficult and costly process that often requires the assistance of professionals. We recently discussed the concept of the capital introduction firm in a previous article. In this discussion, we are going to expand on that concept. A private placement broker or capital introduction firm specializes in working with venture capitalists in order to get your business funded. In many instances, a reputable and high end private placement broker will take on your case at no cost to you – except if they are successful in raising capital. Typically, and as said earlier, private placement brokers and capital introduction firms take a percentage rate of their successful capital raising efforts.
Many firms work on a “best-efforts” basis which means that even if they only raise a part of the capital you are seeking then they will be owed the fees. However, these fees can be highly negotiable. If you work with a venture capital introduction firm then it may be possible for you to trade some of the cash fees associated with their work for a percentage of your business. However, the percentage of the business that they are seeking may be more than expected. Depending on the potential for your company, it may be in your best interest to pay the fees owed from capital raising services directly rather than providing a capital introduction firm with a percentage of your business.Prior to engaging a venture capital introduction firm or private placement brokerage you should make sure that they are properly licensed by the Securities and Exchange Commission. All firms that engage in this type of activity need to be registered with the SEC and in many instances they must be licensed with the state’s securities regulation bureau.
There are a number of different alternatives to looking for venture capital. Rather than dealing with a large scale venture capitalist, many individuals seek the assistance of friends/family or angel investors. Angel investors work in a very similar capacity to that of venture capitalists with one major exception. Angel investors are individuals or small groups of individuals that make much smaller investments into startup businesses and new businesses. While the average venture capital transaction usually exceeds million to million, angel investors often seek to provide 0,000 to ,000,000 of financing.
Angel investors not only provide capital, but they often act as a mentor to the entrepreneur or CEO of their investment. Additionally, angel investors may be more keen on investing in established industries or providing funding to a trusted manager that can run a strong traditional operating businesses. However, much like venture capitalists, angel investors are seeking a substantial return on their investment as well. The risks associated with investing in small or startup businesses are substantial. As such, they too are seeking annual returns of investment of 15% to 30%. This, however, is not a steadfast rule. If the business that the angel investor is providing financing for is established, they may be willing to accept a lower return on their investment. For instance, if an angel investor is providing capital to purchase a well known fast food franchise, they may accept a lower ROI as they understand that these franchises are highly established businesses.
Additionally, the terms of return are very negotiable with that of an angel investor rather than that of a venture capital firm. In any instance that you are working with a potential funding source, it is imperative that you have an attorney assist you with the negotiating process. There may be several legal issues that will need to be addressed in order for an angel investor to make an investment into your business. Angel investors typically do receive smaller equity percentages of businesses than venture capital firms.