Capital

SOURCES OF CAPITAL

Debt Capital

Small businesses can obtain debt capital from a number of different sources. These sources can be broken down into two general categories, private and public sources. Private sources of debt financing include friends and relatives, banks, credit unions, consumer finance companies, commercial finance companies, trade credit, insurance companies, factor companies, and leasing companies. Public sources of debt financing include a number of loan programs provided by the state and federal governments to support small businesses.

Types of debt financing available to small businesses included private placement of bonds, convertible debentures, industrial development bonds, leveraged buyouts, and, by far the most common type of debt financing, a regular loan. Loans can be classified as long-term (with a maturity longer than one year), short-term (with a maturity shorter than two years), or a credit line (for more immediate borrowing needs). They can be endorsed by co-signers, guaranteed by the government, or secured by collateral—such as real estate, accounts receivable, inventory, savings, life insurance, stocks and bonds, or the item purchased with the loan.

When evaluating a small business for a loan, lenders like to see a two-year operating history, a stable management group, a desirable niche in the industry, a growth in market share, a strong cash flow, and an ability to obtain short-term financing from other sources as a supplement to the loan. Most lenders will require a small business owner to prepare a loan proposal or complete a loan application. The lender will then evaluate the request by considering a variety of factors. For example, the lender will examine the small business's credit rating and look for evidence of its ability to repay the loan, in the form of past earnings or income projections. The lender will also inquire into the amount of equity in the business, as well as whether management has sufficient experience and competence to run the business effectively. Finally, the lender will try to ascertain whether the small business can provide a reasonable amount of collateral to secure the loan.

Equity Capital

Equity capital can be secured from a wide variety of sources. Some possible sources of equity financing include the entrepreneur's friends and family, private investors (from the family physician to groups of local business owners to wealthy entrepreneurs known as "angels"), employees, customers and suppliers, former employees, venture capital firms, investment banking firms, insurance companies, large corporations, and government-backed Small Business Investment Corporations (SBICs).

There are two primary methods that small businesses use to obtain equity financing: the private placement of stock with investors or venture capital firms; and public stock offerings. Private placement is simpler and more common for young companies or startup firms. Although the private placement of stock still involves compliance with several federal and state securities laws, it does not require formal registration with the Securities and Exchange Commission. The main requirements for private placement of stock are that the company cannot advertise the offering and must make the transaction directly with the purchaser.

In contrast, public stock offerings entail a lengthy and expensive registration process. In fact, the costs associated with a public stock offering can account for more than 20 percent of the amount of capital raised. As a result, public stock offerings are generally a better option for mature companies than for startup firms. Nonetheless, public stock offerings may offer advantages in terms of maintaining control of a small business by spreading ownership over a diverse group of investors rather than concentrating it in the hands of a venture capital firm.

 PREV  1 | 2