Robert Van Arlen Newsletter
Family & Friends: Avenues for Raising Capital
Need money to for your business? Gene King, managing partner of Sequence Investment Partners, explains how to get started.
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Family & Friends: Avenues for Raising Capital for A Small Business
Raising capital for a small business can be an extremely difficult, complicated process. Often, the process is fraught with stress and confusion because the soon-to-be business owner simply has no idea where to turn when attempting to acquire money. You must know how to transform the vision you have into a reality–reality, however, can be expensive. Reality involves finding funding for your initial costs. This comes from four areas: your pocket, your bank’s pocket, your family’s pocket, a friend’s pocket and/or an outsider’s pocket.
1. Your Pocket
The obvious place to start when funding your new business would be your existing cash and/or credit. Cash would come from securities accounts, savings accounts and just plain cash on hand. Credit can be in the form of using credit cards, lines of credits in equity on homes or property, or borrowing from retirement plans such as 401k’s or IRA’s. Some consider cashing in retirement plans for ease of access to cash, but remember it is always much more cost effective to borrow from a retirement plan than to cash out the retirement plan. In almost all cases, a 10% penalty will be incurred from the IRS upon cash out and you will also have to pay income tax on all of the money (at your current income tax rate, i.e. an exorbitant percentage much higher than the interest you would pay on a loan). Instead, contact a bank and borrow against your retirement or possibly other securities you might own. (See # 2.)
2. Your Bank’s Pocket
Many start-up businesses receive loans from banks that serve as the majority of their initial capital. Unfortunately, the credit markets are currently tight and it’s very tough to obtain funding for start-up companies from banks unless you have excellent credit and extreme collateral. The Small Business Administration of the US Government (SBA) can be a source, but again, credit and collateral are a must. When you assess your collateral know that it can come from many sources such as your house, machinery (if you are starting a business that will have hard assets to be purchased or equipment you already own), land, and any property that has value. For many small business owners this is not an option-particularly if you are a service based company–so where should you go next?
3. Your Family’s and Friend’s Pockets
Once you have exhausted the first two options, you should turn to family and friends. Family and friends know you; they know your morals, character, ethics, and your ability to be successful; they understand your perseverance and determination to succeed better than anyone else.
Family and friends can provide funding in two manners: debt or equity. Debt is simply a loan that two parties agree to involving an amount, collateral (if any), and a repayment schedule. It is very simple and you can download loan documents from the internet. The equity/ownership piece is somewhat more difficult. The investor (friend or family member) will now be an owner of your company. You must first decide if you want other owners at this time as equity is the most cost effective way to start a business. It usually has no payments attached and helps tremendously with cash flow. It does, however, involve assessing the value, or equity, of your company.
What is your company worth? What’s your idea or service or product you will sell? Is it a service company? Is it a manufacturing company? How do you determine the value of your company? These are difficult and very tricky questions. There must be a value assigned to your company and there are hundreds of ways to determine the value. A good place to start is to make an assessment of what you think your first year’s revenues would be, and present that number as the worth of your company.
Once you have negotiated the worth (equity) of your company, you would issue the family member or friend membership shares with their capital contribution. This starts a capitalization table. Also, if you are using an LLC you will need an operating agreement so that the investor understands the rules of engagement with their new investment. If operating inside an LLC you will need to define the managing partner.
4. An Outsider’s Pocket
Selling interest to someone outside the realm of family and friends essentially entails the same process as ‘Family and Friends’ except you are selling interest in your company to individuals you do not know-often referred to as angel investors. Because you do not know these individuals this process will be much more formal and will entail using such investment devices as private placement memorandums (PPM). You may opt to have a friend or family member adhere to the same document so that when your family and friends run short of capital contributions you are ready for an outsider. A PPM type document is a document that outlines the terms of securities to be offered. Simply stated, a PPM is a formal description of the investment opportunity that includes certain federal securities regulations. It will usually contain the terms of sale, capital structure and historical financial statements, biographies of the management team, a description of the business, and potential risk factors associated with the business.
Gene King is a managing partner of Sequence Investment Partners in Charleston, SC. If you have questions or for media inquiries contact Mary Frash of Obviouslee Marketing at 843.225.5288 or mary@obviouslee.com.
Next Week
Next week Micheal Lane, author of the award-winning book, The Wisdom of Yawdy Rum, provides insight that is near and dear to my heart: “Dynamics and Tempo – Directions for Life.”
