 |
| Financing A Business |
If your business is to grow, it's usually necessary to find larger amounts of financing than you can find through personal savings, loans from family members and credit card advances.
Businesses are financed in a variety of ways, each of which has advantages and disadvantages:
Bank Financing
Bank financing is the most common type of financing for businesses - especially small businesses. In most instances a lender making a conventional loan will require the borrower to give what's called collateral to make the loan. Collateral may consist of a pledge of accounts receivable (money owed to the business), inventory, real estate, and other tangible and intangible property. It's also quite common for lenders lending to privately owned companies to require the owners to personally guarantee repayment of the loan and to sign one or more promissory notes.
Term Loan
The term loan is the simplest form of commercial bank financing. With a term loan, you borrow a specific amount of money that is paid back over a specific period of time (usually more than a year). A term loan is usually repaid in equal installments of principal and interest. However, some term loans reduce or eliminate principal payments until the loan is due, at which time the entire outstanding principal amount is payable.
Line of Credit
A line of credit is a non-binding commitment by a lender to lend up to a specific amount of money from time to time. Lines of credit usually don't exceed one year but may, at the bank's option, be renewed yearly.
Revolving Credit Loan
A revolving credit loan is similar to a line of credit. The lender commits to loan up to a specific amount from time to time as required by the borrower. Usually the loan is payable in full within a year or less. The terms of a revolving line of credit are almost always set forth in a formal loan agreement. Unlike a line of credit agreement, the bank is obligated to lend the amount requested by the borrower provided that, at the time of each request, the borrower is in compliance with all the terms and conditions of the loan agreement. Amounts borrowed and prepaid may be reborrowed during the term of the agreement so long as the total amount of borrowed funds at any one time isn't more than a preset maximum amount. Revolving credit loans often have other requirements regarding renewing the loan or requiring repayment of the entire amount of the loan.
Securities Offerings
A security is an interest in an enterprise that is intended to provide a return to the purchaser, and can be in the form of a:
- Note
- Bond
- Investment contract
- Certificate of interest in a profit-sharing agreement
- Any other arrangement that amounts to an investment that is expected to provide a return to the investor
If a company is offering securities, the securities must be registered with the Securities and Exchange Commission (SEC) and with the states in which the securities will be offered, unless there is an exemption from registration.
There are a number of federal and state exemptions from registration depending on factors such as the:
- Amount of capital being raised.
- Number of persons offered securities.
- Number of persons actually purchasing securities.
- Depth of disclosure regarding the business and financial condition of the company offering securities.
Venture Capital
Venture capitalists are firms or individuals who invest in startup or mature businesses not ordinarily in a position to publicly issue securities in exchange for capital. Venture capital financing may be an excellent means of getting the financing quickly, with far fewer up-front costs than those associated with a typical securities offering. Venture capital firms may purchase equity, make loans or both. A venture capital firm's goal is to have the company in which they invest go public within a four to seven year time frame or be sold to another company within that period. When the company goes public or is sold, the venture capital firm will sell all or part of its stake in the company - hopefully at a large profit.
Although a venture capital transaction will almost always involve an offering of securities, the business and financial expertise of the venture capital investor will usually permit the offering to go forward, with less expense on the part of the company offering the securities, because the venture capital firm will conduct its own detailed due diligence (extensive exchange and investigation of information about the company).
Because venture capitalists ordinarily invest in higher risk companies and a significant percentage of their investments will not be successful, they usually demand a greater return on their investment. As a result, they often require the financed companies to give up a significant percentage of their equity - whether immediately or at a later date- through exercise of options or warrants granted to the venture capital firm as part of the deal. Venture capitalists also often vote one or more designees of the venture capital firm as members of the company's board of directors.
Getting Help from a Lawyer
If you're seeking significant amounts of money from someone other than Mom or Dad, you should get a lawyer to help you. The securities laws are complex and stringent. If you violate them, you may be required to give back investors' money or suffer other penalties if your business goes down. A good corporate or securities lawyer, in addition to helping you comply with the law, will also be able to give you advice on issues that all start-up companies face.
Sherrie Bennett is the former director and staff attorney at the University of Washington Student Legal Services in Seattle.
|
