Chapter 14: Small Business Finance: Using Equity, Debt, and Gifts
sophisticated investor
as defined by the SEC, people who "have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment"
the 3 primary reasons to use outside equity in your business
1) you will reduce your own exposure to financial loss 2) your business will not have increased costs in the form of interest 3) bringing outside investors into an existing business can often re-energize it by providing new ideas, procedures, and proceses
forms of personal gifts
Cash Picking up the tab Accelerated cash outs Free use Free work (unpaid labor - very popular) Overpayment (favored status, sweetheart deals) Forgiveness (also, deferral) Piggybacking
Advantages fo outside investing
Gain mentors/coaches Don't have to pay interest
Risk of outside investing
Losing control of your company
Is gift financing getting something for nothing?
No - its always more than just a gift
Can a sole proprietorship sell equity?
No - then you won't be a sole proprietorship anymore.
interest
a charge for the use of money, usually figured as a percentage of the principal
corporation
a legal "artificial" entity that is formed by filling specific documents with a state government
debt
a legal obligation to pay money in the future
growth potential
a primary concern for equity investors
venture capitalists
a professional in their industry
community development organization
an organization authorized by the SBA to make insured loans to small businesses that are expected to increase economic activity within a specific geographic area
accredited investor
as defined by the SEC in Title 17, Chapter II Part 230, subsection 230.501 of the Code of Federal Regulations (CFR): "Any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person: banks, business development companies, companies worth more than $5 million, an executive of the firm making the offering, or an individual with a personal net worth of more than $1 million.
gift capital
capital resources that neither provide any ownership not require any repayment to the giver
downsides to using equity
equity is (1) expensive and (2) guaranteed to create problems of control and decision making
unsecured debt
loans that do not allow a lender to seize specific assets in the event of nonpayment (requires court action, a lawsuit, or forced bankruptcy to collect unpaid debt)
secured debt
loans that provide the lender with the legal right to seize specific assets in the event of nonpayment.
four areas in which you can benefit from bootstrapping
minimize overhead costs maximize returns from employee expense minimize operating costs maximize the results of marketing
dividends
payments of profits to the owners of corporations
two general sources of gift financing
personal (friends and family) institutional (reduced taxes, grants)
gift tax
some of the most complicated taxes in the IRS code
risk
the level of probability that an investment will not produce expected gains
gain on investment
the percentage amount that the payout of an investment differs from original cost calculated as: (Payout - Investment + Dividends)/Investment
diversify
to invest in multiple investments of differing risk profiles for the purpose of reducing overall investment risk
partnership
two or more people cooperating to conduct a business enterprise
bootstrapping
using low-cost or free techniques to minimize your cost of doing business; the practice of using one's own capital and funds generated by operating the business to finance start-up and growth; the process of finding creative ways to exploit opportunities to launch and grow businesses with the limited resources available to most startup ventures; getting necessary things done using what you have right now
the three ways governments encourage small business borrowing
1) direct cash loans 2) guaranteed loans made by commercial banks 3) reduced taxes by allowing interest to be deducted
two reasons why many small business owners avoid using debt as a source of capital
debt has repayment obligations that specify exactly how and exactly when the debt must be repaid. debt gives lenders legal right to enforce payment under the contract terms without any consideration of the business's ability to pay at the time payment is due.
harvest
recover value through a sale of a firm or its assets (aka exit)
debt capital
money borrowed for the purposes of investment in a business
small business investment company (SBIC)
private business that is authorized to make SBA-insured loans to start-ups and small businesses
microlender
SBA-approved partners who offer SBA-guaranteed microloans to eligible small-businesses. These loans require much less paperwork than regular SBA or bank loans, and are for amounts under $50,000
gift
valuable assets or services donated to the business without any obligation to repay or give up any ownership interest
angel investor
a wealthy individual who invests in companies in relatively early stages of development
equity capital
money contributed to the businesses in return for part ownership of the business
outside equity
money from selling part of your business to people who are not and will not be involved in the management of the business
limited liability company (LLC)
a legal form of business organization that is created by filling required documentation with a state government. LLCs have a choice, under federal tax law, of being taxed as either corporations or partnerships
accelerator
an organization that supports start-ups, typically of a particular type with a financial investment, free or inexpensive office space, mentoring, a variety of free or low-cost support services, and other resources. The goal of an accelerator is to accelerate a start-up from its earl stages to being ready to pitch for investment. Most accelerators take an equity stake in the companies they help