Financing Your Small Business

Financing Your Small Business

James E. Burk Richard P. Lehmann

The idea for Financing Your Small Business came, in part, from the entre­preneurial seminars we have done in the past several years for IBI Global. While serving as faculty instructors, we have encountered literally thou­sands of students seeking to finance their small business. There have been successes and failures along the way. Many of the so-called failures learned from their mistakes and reinvented themselves, becoming stronger and wiser than before.

There are many reasons a small business may seek financing. If you are one of those people with an idea on a napkin, ready to seek fame and for­tune, you may need to raise capital before you simply quit your day job and launch your business from ground zero. Among the things you may need at this point are:

• a feasibility analysis to determine the viability of your idea;

• corporate organizational documents (articles, bylaws, minutes);

• a summary business plan (or at least an executive summary);

• federal (and perhaps state) tax identification numbers;

• a corporate bank account; and,

• local licenses (if required).

If you have already started a business by using your own cash (sometimes called bootstrapping), you may need to raise additional capital to:

• lease office space;

• purchase office equipment;

• develop a prototype of your product;

• hire a president, chief operating officer (CEO), or chief financial officer (CFO);

• design a logo to establish a branding and marketing program;

• file for trademark or patent protection on intellectual property (IP); and,

• pay yourself a salary.

The list could go on.

We have noticed that some of the books on financing a business focus on the narrower sense of the word—financing through debt. In this book, we

Address a broader sense of the term to cover both debt and equity. You can finance your business by borrowing, selling a part of the company, or a com­bination of both.

Our goal in writing this book is twofold. First, we want to provide you with a variety of simple techniques and resources to increase your chances of obtaining financing. Second, we want to provide you with the benefit of our experience in this field to help you avoid some of the pitfalls that can derail your business and steal your time.

At various points in the text, we have inserted “How To...” boxes to pro­vide a quick reference to the topics discussed. After all, this book is a prac­tical guide to financing your small business.

The chapters that follow suggest resources, as well as a sequence for raising capital for your small business. The rules are not cast in stone, but are instead merely suggested guidelines.

The first topic discussed is what type of company or organization you should form in order to raise capital and the various attributes of those enti­ties. The choices include C corporations, S corporations, limited liability companies (LLCs), limited partnerships (LPs), and sole proprietorships. While you can operate your business as a sole proprietor (that is, no legal entity formed around your business), it may be more difficult for you to attract capital and your personal liability is greater.

Once you have determined the legal entity to use, how and when to draft a business plan for the company is explained, as well as the various parts of a business plan—including the part most investors always read. Then, some of the mistakes that occur in start-up businesses are discussed.

Equity financing is the topic of the next section. Most entrepreneurs rec­ognize the equity categories—common stock, preferred stock, and LLC membership units. There is also a discussion of some hybrid variations on the traditional equity forms of investments. Following the discussion of equity, the book explores the various types of debt instruments of your company that can be offered to investors.

There are pros and cons for a young company to take on debt financing, and Chapter 4 explores some of those circumstances. Information on com­binations of debt and equity that have shown some popularity in the cur­rent market is provided.

Once you decide on the type of company and the form of the invest­ment, your next step may involve selling securities. In a private placement to qualified investors, federal and state securities laws come in to play. The elements of legal compliance in private securities offerings is discussed in Chapter 5. Most emerging companies raise their initial capital through pri­vate placements—not publicly registered offerings. In this book, there are only passing references to public offerings, sometimes called IPOs, since they are rarely available to small companies as a financing alternative.

Once the private placement market has been explored, the book touches on some later stage financing alternatives, including franchising and licens­ing, combinations of debt and equity, and loans with equity kickers. The current market is seeking more and more investments that combine some degree of liquidity with an equity upside.

The next section introduces the types of investors that look at early stage companies, such as friends, angels, and venture capitalists, how they are dif­ferent, and what they look for in investments.

When you are pitching your company before potential investors, you need certain skills to effectively present your case and obtain the funding. The mechanics of a good presentation, the use of presentation software, and tips for speakers are explained in Chapter 8.

Next, we discuss the elements of corporate record keeping and selected issues of corporate governance. The impact of corporate governance has recently come to the forefront of public scrutiny with the rash of public company financial scandals.

In the next segment, some guidelines for choosing your professional advisors are provided. Compliance with securities laws can trap the unwary. Thoughtful entrepreneurs are well-advised to choose competent professionals to help them navigate the law and lore of this legal specialty. The guidelines suggested should take some of the mystery and pain out of this process.

Finally, we provide some of our favorite reference sources for further reading and study. The literature and the information available on the Internet sites on this subject is vast. We give you a sampling of both in the reference section and throughout the book. The appendices contain a number of forms that provide a taste of the documentation required for legal compliance.