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Alternative Forms of Business Finance

June 15, 2010 by Frank Goley, Business Consultant

Especially during a Recession a business must look at alternative forms of business finance. But more importantly, understanding what types of business finance are available to your business is crucial in your fund raising efforts. When traditional business finance fails to meet your needs, alternative finance is a viable option. Here is a detailed listing and explanation of alternative forms of business finance.

Boot Strap Finance and Leveraging Financial Instruments

§  Founders Investment

§  Friends/ Family *

§  Business Associates

§  Personal Savings**

§  Leverage a Mortgage***

§  Life Insurance Loans on Cash Value**

§  Retirement Fund Loans****

§  Credit Guarantees

§  Letters of Credit

§  Pre-Commitment Letters

§  Pre-Sale Commitment Deposits

§  Insurance Guarantees

§  Customer Deposits

*:  Set limits and rules; ensure done with attorneys; expectations clearly documented; worst case scenario disclosed; not at the undue expense of your friends or family.

**:  Be very careful; not at the unnecessary expense or distress of your family.

***:  Non-Debt Home Equity Venture Funds:  Pledge your Home Equity Appreciation (or Depreciation) to an Investor who supplies cash.  No loan payments, an equity deal.

****:  401(K) Small Business Financing:  To avoid penalties and the personal 401(K) borrowing limit, the Business Owner transfers retirement funds to a specialty 401(K) Plan for new Businesses, which allows the Business Owner to tap the full account balance.  Use of these funds is considered an investment rather than a loan.  There are no limits on borrowing, and it carries no tax penalties or minimum payment limits.

Note:  Company Founders need to bring at least 10% Cash to the table to start a Company successfully and 20% owner contribution is optimal.  Boot Strapping and leveraging can help you get in the 10-20% Cash Contribution range.  See the following sections on other Alternative Funding avenues you can utilize in the early development of your Company.

Joint Venture and Strategic Alliances

§  May obviate the need for other sources of Finance.

§  Shared resources, at a lowered cost and lower risk.

§  Understand clearly the Opportunity Lost Value if pursued as separate entities.

§  Carefully evaluate:

ü  Each party’s objectives

ü  Likelihood of Success

ü  Appropriate Structure

ü  Terms

ü  Roles

ü  Determine if the Relationship is preferable to financing the deal independently.

§  Evaluate the Following Key Elements of a Joint Venture:

ü  Objectives

ü  Anti-Trust Issues

ü  Resources

ü  Funding

ü  Technology

ü  Management & Personnel

ü  Location & Logistics

ü  Corporate Culture Fit

ü  Form of Relationship

ü  Control

ü  Exit

ü  Termination

ü  Liquidation/ Liquidity Vehicle

ü  Buy-Sell Agreement

Angel Investors

§  Informal, yet sophisticated investors, who specialize in early, seed investing.

§  Angels are great to use in the very early stages to develop your Company to where a Venture Capital Firm would be more apt to invest.

§  Much faster to acquire than VC money.  Can obtain funds often in 1-2 months.

§  ROI expectation often less than VC; 20% annual compounded ROI is a good starting point for Angel Investment.

§  Deal can be structured any way the entrepreneur and the angel want to set it up; very flexible.

ü  Combination of Equity & Debt is common.

§  Angels can be located with local Newspaper ads; in VC Clubs, breakfast clubs or networking events.

ü  Can find angles through attorneys, accountants, consultants, financial planners, brokers, etc.

§  Angel or VC?  Here is some guidance in determining whether your finance needs require Venture Capital Investment or an Angel Investor:

ü  Amount of money being raised for the current round:  Less than $1M should be Angel, unless you find a VC Fund that finances seed rounds and/ or you have a pre-existing relationship with a particular VC (and there’s a strong fit).

ü  Determine the total amount of money that needs to be raised over the life span of your Company:  If you can get to good, positive cash flow for less than $3M, angels will probably be best.

ü  Type of Company:  VC looks for enormous investment opportunity, returns and economies of scale, verses linear scale companies.  Angels are less aggressive and happy with smaller companies and smaller investments.

ü  Experience:  First-time entrepreneurs without much of a track record will find it easier to attract Angel money.

ü  Your Network:  VC ties often come through personal and professional networks.  Develop strong ties prior to approaching a VC Firm.  Angels are great on referrals but not necessary.

ü  Hunt for your Lead Investor:  Typically have 3 rounds of private finance with rounds 2 and 3 following a strong, successful lead investment.  Be picky about finding the original, lead Angel.

Online Investor Networks and Online Lending

§  Venture Capital Network is the original and probably the best. The Go Big Network is another good one.

§  These networks pool investor’s monies and venture opportunities.§  Beware of proprietary protections and privacy concerns.

§  Be careful not to shop your deal excessively, as that will diminish your future success on subsequent finance rounds (private equity is a small world and they want fresh deals).

§  Can be a good stepping stone to VC Funding.

§  Often offer helpful resources, online chat rooms and professional relationship introductions.

§  Borrowing Online:  The web has a lot of alternative small business finance options.  One is On Deck Capital:  they look more at your Company’s Cash Flow than your Credit Score and Tax Returns.  They collect small daily debits instead of monthly payments.

Venture Contract Funding and Venture Capital Factoring

§  Use your executed contracts and customer commitments to leverage into Cash in the Growth stages of your Company.§  Expensive terms, but temporary duration.

Hard Money / Bridge Finance and Mezzanine Finance

§  Often Real Estate based but can cross collateralize into a variety of Assets (personal & business).

§  Higher Interest Rates; can have an Equity Participation component; can obtain funds in a few days to a month; the terms of the loan can be very limited (30 days to a year).

§  Less red tape; easier underwriting; stream-lined process.

§  Contingent on Appraisal / Valuation of Quick Sale Value.

§  Hard Money & Bridge Finance often require strong owner equity in the deal (20-30%).

§  Mezzanine Finance helps you leverage a higher LTV/LTC (80-95%), is equity based and has a high interest coupon.

§  Experience and Track Record is a must.

§  Consider them as short-term Rent Money.

§  Needs to be a lucrative deal to support the expensive terms (Interest Rates 10-18% with Equity Sharing in some instances).

Franchises

§  Does the Franchise offer Coop Purchasing?  This will help to free up money by driving down costs.

§  What discounts can you obtain through the Franchise?  i.e. Software Purchases.

§  The Name Brand of a Franchisor can bring credibility and trustworthiness to the table when you are negotiating a Bank Loan.  i.e.  Is your Franchise a bankable brand?

ü  Especially applicable during bad economies when Commercial Loans are especially hard to obtain.

ü  Don’t forget about using the SBA Guarantee to reduce the Bank’s risk.

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