Software of the Month Club 1996 May/Software of the Month Club 1996 May.iso/mac/ISO9660/ZIPFILES/SBA962.ZIP/F211.SBE

Text File | 1996-02-15 | 9.8 KB | 203 lines

@141 CHAP 9
                 ┌─────────────────────────────┐
                 │  VENTURE CAPITAL AND OTHER  │
                 │SOURCES OF START-UP FINANCING│
                 └─────────────────────────────┘

Outside financing is to entrepreneurs what steroids are to
body builders and NFL linemen -- in either case, you can't
get nearly as big nearly as fast on your own -- and there
can be some nasty side effects.

If you need to raise funds from other parties to start your
business, the types of capital that you will be attempting
to raise will fall into two categories -- Equity capital
(such as common stock or preferred stock in a corporation,
or an interest in a partnership); or Debt capital, which in-
cludes all types of loans, whether secured or unsecured,
from the bank or from your mother.  Most new businesses
find it hard to raise equity capital, except those that
are so promising that they are able to find venture capital
investors to provide such financing.

Venture capital firms are investment firms that specialize
in making equity capital available for businesses that have
very high potentials for growth.  They usually are interest-
ed in a small business only if it has demonstrated market
acceptance for its products or service by generating sub-
stantial sales over a significant period of time and the
competence of the business's management in managing other
people's money (since you will be managing theirs).  They
are generally only interested where such a firm has an ex-
plosive growth potential, as well.

Venture capitalists expect to make 10 or 15 times their or-
iginal investment in 5 years or so.  Since most small bus-
inesses do not possess this kind of potential, the typical
mom-and-pop store, no matter how well-run and profitable,
is not a realistic candidate for venture capital investment.
They are usually looking for a well-balanced management
team with technical, marketing and financial expertise,
poised for rapid growth and expansion.  Thus, if you are a
typical small business person, you will be wasting your
time and theirs if you approach venture capital investors
for financing to get your business started.  (Besides,
most "vulture capitalists," as they are often called, will
demand your firstborn child and a 40% return on their in-
vestment, just for starters.)

            ┌───────────────────────────────────────┐
            │KEY POINT: Venture capital accounts for│
            │only a tiny fraction of small business │
            │loans.  Don't totally rule out the pos-│
            │sibility, but just realize that getting│
            │venture capital financing is definitely│
            │a long, long shot, for most startups.  │
            └───────────────────────────────────────┘

Most institutions that you should approach for financing,
such as banks, will only consider making loans to a fledg-
ling business (and not equity investments), thus the follow-
ing is a discussion primarily of sources of debt capital.

  (a) Bank Loans.  It may not hurt to try, but most new bus-
inesses will find it quite hard to get a bank loan.  An ex-
ception would be where you have a fairly large equity in-
vestment in the business or can put up collateral, either
assets of the business or outside collateral, like a mort-
gage on your home.  As a rule of thumb, you can usually get
a bank loan only if you can demonstrate to the bank loan
officer that you don't really NEED a loan.

Nevertheless, If you are planning to apply for a bank or
SBA loan (see below), get a copy of the book entitled THE
LOAN PACKAGE (you can order it by phone from the publisher,
Oasis Press, at 1-800-228-2275).  You can use THE LOAN
PACKAGE to prepare a professional-looking loan application
package that will create a favorable impression with bank
loan officers or any other potential lenders who look with
favor on someone who gives the appearance of being highly
organized and who submits a slick-looking loan application
package.

  (b) SBA Loan Programs.  The Small Business Administration
(SBA) primarily is a guarantor of certain loans which are
made by banks, savings & loans and certain other lenders,
such as SBIC's and MESBIC's.  (See paragraph (g) below.)
It has a very limited budget for making direct loans it-
self.  And forget about "grants" to small business startups
(despite what you may have heard on those late night TV
"infomercials") -- they don't exist, in the real world.

SBA loan programs include:

    . GUARANTEED LOANS.  Most SBA loans are of this vari-
      ety, where banks or other lenders make the loan.
      The SBA may guarantee 90% of smaller loans, but not
      over 85% of larger loans.  Such loans usually re-
      quire the borrower to put up a reasonable amount of
      equity and are secured by fixed assets, real estate
      or inventory (or all of the above). They are usually
      limited to 7 years for working capital loans, 10
      years for fixed assets, or 25 years for construction
      loans.  Apply directly to the lender, not the SBA.
      The maximum size loan the SBA will guarantee is of
      $750,000, and as a practical matter, lenders usually
      are not will to process such loans for amounts of
      less than $25,000.  Loan rates are based on the
      going prime rate, with a rate of 2 1/4% over prime
      for loans of less than 7 years, or 2 3/4% for longer-
      term loans.

    . DIRECT LOANS.  If you are unable to obtain suffic-
      ient conventional financing or SBA-guaranteed loan
      funds, you may in some cases be able to obtain a
      direct loan from the SBA of up to $150,000.  Howev-
      er, these direct loans are hard to get, and can
      only be made if the SBA has funds available.  In
      recent years, the funds available for lending by
      the SBA have been quite limited, so that eligible
      borrowers are frequently turned away because the
      SBA simply doesn't have any money to lend.

    . OTHER SBA PROGRAMS.  From time to time, the SBA is
      engaged in various other types of small business
      loan programs, such as seasonal lines of credit,
      economic opportunity loans to entrepreneurs who
      are physically handicapped, minority loans and the
      like, which change frequently. Consult your banker
      or your local SBA office if you think your firm
      may qualify for one of these special financial as-
      sistance programs.

  (c) U.S. Dept. of Housing and Urban Development (HUD).
HUD makes Urban Development Action Grants (UDAG) to cities
in economically distressed areas.  The cities are then able
to use these UDAG funds to make second mortgage loans to
private developers who are able to leverage these loans by
borrowing 3 to 5 times such amounts from private sources.
Such loans and grants are made for the purpose of encourag-
ing business investments in depressed areas.  However, this
program is no longer being funded, except in a few cities
that still have left-over funds, and is virtually defunct.

  (d) U.S. Dept. of Commerce.  The Economic Development Ad-
ministration (EDA) of the Dept. of Commerce makes direct
loans and makes loan guarantees to businesses in areas with
low family incomes or suffering from high unemployment, to
promote creation or retention of jobs for residents of such
areas.  To qualify for such financing, your business must
be located in an EDA redevelopment area and you must be
able to demonstrate that the venture will directly benefit
local residents and will not create over-capacity for the
industry in question locally.

  (e) Rural Economic and Community Development Service (for-
merly the Farmers Home Administration).  This agency works
much like an SBA for rural areas, or in towns of under
50,000 population.  Like the SBA, it guarantees up to 90%
of the amount of loans made by banks or other private
lenders.  It does not make direct loans.

  (f) Other Federal Loan Programs.  Other major federal
loan programs to businesses include Federal Land Bank
Association loans to businesses providing services to
farmers, for purchasing land and equipment and for start-
up working capital, and a similar loan program for loans
of up to 7 years is provided through the Production Credit
Association and the Federal Intermediate Credit Bank.

  (g) SBICs and MESBICs.  In addition to direct loans and
guarantees from government agencies, don't overlook pos-
sible loans (or equity financing) from Small Business In-
vestment Companies (SBICs) and Minority Enterprise SBICs
(MESBICs) as possible sources of financing.  Both are li-
censed and regulated by the SBA to provide equity capital,
long-term loans, and management assistance to small busi-
nesses.

SBIC and MESBIC loans are usually subordinated to loans
from other creditors and are typically made for 5-7 year
terms.  Both types of investment companies are privately-
owned and thus tend to favor loans to established companies
with significant net worth, rather than new business start-
ups.  SBIC lenders will usually want a loan that is conver-
tible into stock of your corporation, often up to 49% of
the total stock; SBIC lending, like venture capital funding,
does not come without a significant price.

MESBICs serve only those small firms that are owned by mem-
bers of economically or socially disadvantaged groups.

  (h) Relatives.  Finally, if all other sources of finan-
cing fail to work out for you, do like many other people
and borrow from Mom or Dad to get started.  Just be pre-
pared for an unhappy family situation if the business does
poorly and you can't repay the loan.... If that happens,
you'll have to console yourself with the thought that it
could have been worse -- you could have defaulted on a loan
from Bruno, your friendly local loan shark and thumb-
breaker....to whom your body is the only collateral he
needs.