The decision to raise capital to help fuel growth is an important one. As a business begins to experience the results of their efforts in the form of increasing sales, it often becomes apparent that the infrastructure previously sufficient to sustain sales is no longer sufficient. An additional investment in resources including equipment, personnel, technology, inventory, etc. is often required to support growing sales. An overly conservative approach to this challenge could result in missed opportunities and a bottlenecked organization. On the flip side, being overly aggressive or optimistic can lead to being overleveraged or unnecessarily diluting ownership.

• Business Plan
  While most business owners are so busy running their company the thought of dedicating the time and resources to developing a business plan can be overwhelming and seem like an ineffective use of time. This is a misconception. Taking the time to research the market, industry, and competitive landscape while thoughtfully calculating a strategy to grow your business is an essential process that can differentiate truly successful firms from mediocre. Is the growth opportunity truly sustainable or is this a temporary surge of business? What is needed to capitalize on the growth long term? What are the expected profits associated with the projected growth? Growth is not always profitable. Is the projected growth going to enhance the market value of the business? This is not always the case.
  


• Debt vs. Equity
  There is a big difference between debt and equity financing. Debt financing involves an obligation to repay a defined amount of money usually secured with personal and business collateral. It has a defined interest rate (fixed or variable), and a specifically outlined payment schedule. Terms can vary substantially and are negotiable, but usually driven in part by market conditions. While business assets are often pledged as collateral no ownership rights are usually transferred. The documents typically used to secure debt financing are a promissory note and security agreement. Debt financing is traditionally considered less expensive than equity. Equity financing involves transferring an ownership interest in the company to the party providing the funds. There is often a delicate balance that needs to be negotiated between the business owners concerns related to dilution of ownership and loss of control vs. the investors return on investment motivations and risk mitigation. The ownership interest can come in a variety of forms. You should consult an advisor knowledgeable in securities transactions to assess your specific situation and negotiate a structure that will work for you.

Lenders (Conventional/SBA)

Lenders come in all shapes and sizes and they can be as different as night and day regarding their approach and appetite for small business lending. Identifying the right lender is essential to avoiding unnecessary challenges and emotional turmoil associated with the financing process. All lenders apply some sort of underwriting criteria to their loan portfolio to minimize risk of default and satisfy regulatory requirements. Some of the criteria allied includes 1) loan to value ratios, 2) collateral pledged as security, 3) debt coverage ratio, and 4) borrower’s credit score.

Conventional lenders lend money based on their opinion of how the proposed loan will fit within the lender’s existing portfolio of loans, assessing the risk factors in comparison to their current loan portfolio to gauge decisions. The loan may be serviced long-term by the originating lender or it may be packaged and sold to the secondary market. Conventional lenders have underwriting standards that typically require relatively high collateral requirements to satisfy the loan-to-value standards.

The SBA (Small Business Administration) is a government agency/program design to help promote investment in small business. The SBA guarantees a portion of the loan for the lender. The guarantee can be up to 70% of the loan amount. This means that the lender’s risk is substantially reduced, reducing the pressure on the borrower to provide collateral that could otherwise be considered impractical. SBA lenders are often conventional lenders that have chosen to participate in the SBA program. Depending on the volume of SBA loans lenders can earn the status of Certified Lender or a Preferred Lender. The Certified Lenders Program (CLP) is designed to expedite the loan application process received from lenders who have a successful SBA lending track record and a thorough understanding of SBA policies and procedures. CLP lenders will perform a complete analysis of the application and, in return, SBA commits to a fast loan decision. SBA reviews the lender's credit analysis as opposed to conducting a second analysis. SBA still makes the final credit and eligibility decision but, by completing a credit review instead of an independently conducting analysis the approval turn around time is shortened. As a Preferred Lender, SBA delegates loan approval, closing, and most servicing and liquidation authority and responsibility to the selected lenders. Preferred lenders are nominated based on their historical record with the Agency. They must have demonstrated a proficiency in processing and servicing SBA-guaranteed loans.

The borrower interacts directly with a loan originator at the local lending institution in the same way as they would for a conventional loan, but the paperwork is a little different. When considering an SBA loan look for an SBA “Preferred” lender. Working with a preferred SBA lender will help the process go more smoothly.

Account receivables factoring

Many businesses extend credit to customers on net terms for goods or services provided. The collection of this credit is usually considered reliable due to the recurring nature of most customers’ relationships and/or the business relationship with customers. These unpaid balances are referred to as Accounts Receivable. “Factoring” is the selling of accounts receivable or invoices to a third party as a method to secure immediate, working capital.

A factor company purchases receivables by giving the business owner an advance payment up front. This advanced payment is usually 70 - 90% of the total value of the receivables. After charging an administrative fee (2% and up) the remaining balance is released upon full receipt of payment for the receivables/invoices. This is a financing method that allows a business to make potentially larger sales with the working capital to continue operations and further growth.

Leasing Equipment
Partnering with a leasing company to sell and lease back equipment can be an effective technique to generate funds for your business. There are a number of benefits associated with leasing equipment such as expensing payments for equipment as opposed to capitalizing the expenditure. There are restrictions that should be taken into consideration to determine the tax implications of expensing vs. capitalizing the cost of equipment. You should consult with a tax advisor knowledgeable about your specific situation to assess your options.

Structure of venture capital firms

Venture capital is a form of private equity investment in early stage companies with the interest of generating a return through rapid growth and an eventual sale of the company. Venture capital typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms.

Venture capital firms are typically structured as partnerships or limited liability companies (LLC). The general partners or managing members act as the managers of the firm and will serve as investment advisors to the venture capital funds raised. Investors in venture capital funds are comprises both of high net worth individuals and institutions with available capital, such as state and private pension funds, university financial endowments, foundations, insurance companies, and pooled investment vehicles, or mutual funds.

When considering an investment, venture capitalists review the technical and business merits of the proposed company. Venture capitalists invest in a proportionately small percentage of the businesses they review. They actively work with the company's management by contributing their expertise and resources gained from helping other companies with similar growth challenges.

Venture capital firms manage the risk of venture investing by creating a portfolio of complimentary early-stage companies in a single venture fund. Many times they will co-invest with other professional venture capital firms.

Venture capital plays an important role in the development of emerging business in our economy. Over the years venture capitalists have nurtured the growth some of the country’s high profile and success companies resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft and Genentech are famous examples of companies that received venture capital early in their development.

Angel investors are generally defined as high net-worth individuals who invest in entrepreneurial companies, usually at an early stage. Like venture capital firms, many angel investors provide cash to early stage companies in exchange for an equity position in the company. The typical investment size of an angel investor is smaller than venture capital firms making them a good potential resource for companies that have moderate cash requirements. Some angel investors are members of angel groups, allowing them to increase their access to investment opportunities and giving them the possibility of investing jointly with other angels to hedge their risk. ABMI maintains relationships with various active angel networks and can assist in the preparation and presentation of opportunities to identified angel groups and/or individuals.

Private Equity

Private equity is a source of funding for a business from a privately or publicly held that specializes in investments in businesses. There are thousands of private equity firms in the marketplace with various investment preferences and acquisition criteria. Some private equity funds prefer early stage companies some preferred more mature businesses. The private equity firms also have various industry targets that drive the investment appetite. As with other funding sources appetites can change as the market changes or the fund evolves through its normal lifecycle.

The Origin of a Private Equity Fund
The process that Private Equity Funds go through in starting a fund is carefully structured and begins with soliciting investment commitments from investors. This stage is typically called "fund raising." A Private Equity firm will begin by prospecting for investors with a target fund size. It will distribute a prospectus to potential investors and may take from several weeks to several months to raise the required capital. The prospectus will generally outline the type of industries the fund will target and basic investment criteria that will be applied in addition to the anticipated holding period. The fund will seek commitments of capital from institutional investors, endowments, foundations and individuals who seek to invest part of their portfolio in opportunities with a higher risk factor and commensurate opportunity for higher returns. Once the firm has raised enough commitments, it will start making investments in portfolio companies.

Length of Investment Private Equity Groups help companies grow, but they will generally plan to exit the investment in three to seven years. An early stage investment make take seven to ten years to mature, while a later stage investment may only take a few years. By nature of the investment funds, it is important for the PEG to allow for a liquidation opportunity to the limited partners.

Investment Focus
Private Equity Groups (PEGS) may be generalist or specialist investors depending on their investment strategy. PEGS that are generalists, invest in a variety of industry sectors, or geographic locations, at different stages of a company’s lifecycle. A PEG that specializes may seek investments in one or two specific industry sectors, or selected geographic areas.

A PEG may invest before there is a real product or company organized (so called "seed investing"), or may provide capital to start up a company in its first or second stages of development known as "early stage investing." Alternatively, a PEG may provide needed financing to help a company grow beyond a critical mass to become more successful ("expansion stage financing").

PEG’s may invest in a company throughout it’s life cycle providing funding to help the company grow to a critical mass to attract public financing through a stock offering or help the company attract a merger or acquisition with another company. This form of funding is referred to as later stage investing. At the other end of the spectrum, some PEGS specialize in the acquisition, turnaround or recapitalization of public and private companies.

PEGS in the Marketplace

Over the past twenty years, private equity activity has increased in the marketplace. Three factors seem to be driving record growth in private equity activity. First, the shares of many public companies have been relatively inexpensive compared to the value of their assets and revenue. Second, capital available to private equity firms has increased substantially as major investors such as pension funds, seeking higher investment returns allocate more of their portfolios to private equity. Third, until the current credit crunch began in mid-2007, the global market for the debt that is borrowed to help finance the acquisitions had been growing, permitting more borrowing at better rates.

The recent constriction of the global credit markets in the past year has reduced the number of private equity transactions, but industry leaders continue to believe that the private equity business model is not only sound, but powerful and resilient.

In 2007 Private Equity Funds raised $518 billion (Source: Private Equity Intelligence)

Evolution of PE Fundraising

(Source: Private Equity Council)

LBO VOLUME: Historical Overview

According to Private Equity Intelligence PEGS completed 2,238 transactions in 2007

(Source: Private Equity Council)

The impact Private Equity has on the Economy

Private equity plays an important role in American economy and can be credited for driving significant growth in terms of revenues, taxes, and jobs. In 2008, the World Economic Forum (WEC) commissioned the Harvard Business School to conduct a study of 5,000 transactions over a 25 year period. According to the research, the companies in the study on average were losing jobs at existing facilities at a rate one to two percent faster than the competitive companies prior to acquisition. After private equity investment or acquisition, employment rates rose to above the industry average in those same companies by year four under private equity ownership.

A 2008 study by Dr. Robert Shapiro and Dr. Nam D. Pham conducted for the Private Equity Council found that acquisitions by major, U.S.-based private equity firms between 2002 and 2005 resulted in a direct and positive impact on U.S. employment.

The 42 companies studied, had a combined employment of 310,420 at the time of acquisitions. Over a three year period, 26,214 net new jobs were created – an increase of 8.4 percent.

For manufacturing companies, employment increased 1.4 percent, while employment in the overall US manufacturing sector dropped by 7.7 percent during the same period. (Shapiro, Robert and Pham, Nam. “American Jobs and the Impact of Private Equity Transactions,” Private Equity Council, January 2008.)

PE Investment: Deal Value ($Billions)

Private Equity transactions attributed to $721 billion in total transaction value in 2007. (Source: Private Equity Intelligence)

Mezzanine Financing

Mezzanine financing is a tool that can be used to provide funds for a mature business that needs funds to help fuel a growth strategy or facilitate an acquisition of part or all of the business. Mezzanine financing, sometimes referred to as “Mezz”, can be a very effective method to accomplish goals for an existing business. Here is a brief overview of how it works. Many companies have a primary loan from a conventional lender with assets of the company pledged as collateral. This loan is referred to as Senior Debt. In the event that addition funds are needed to expand, the senior lender can (and should) be approached to solicit their willingness to provide additional funds. In the event the senior lender is unable to or unwilling to loan additional funds alternative sources are considered. Senior debt lenders are usually very resistant to relinquish their first lien position on the assets of the company. This can limit options for additional funding. The most frequently used approach to additional funding for later stage companies unable to secure additional senior debt, is to sell equity in the company. Equity (ownership interest) can be granted in a number of various forms including issuing common or preferred stock.

Mezzanine financing can be a very effective tool to obtain funding for a growth strategy while leaving the senior debt in place and avoiding significant ownership dilution.

Mezzanine financing can be describe as a subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of a company's common shareholders. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.

By nature of the subordinated position the mezzanine lender is less likely to be repaid in full after all senior obligations have been satisfied, in the event of default. To compensate for the higher degree of risk mezzanine funds are typically a more expensive form of financing than secured debt or senior debt.

Mezzanine lenders, typically look for their return on investment to be generated in four basic forms: (each investment can have components of any of the following or a combination thereof):

• Cash interest — A periodic payment sometimes referred to as “current pay” which is based on an annual interest rate on the outstanding balance of the mezzanine financing. The interest rate can be either fixed throughout the term of the loan or can be variable based on some standard publicly recognized rate such as LIBOR or the Prime Rate. This rate will vary depending on a number of factors but will usually be somewhere between 10% and 15%.
  
• PIK interest — Payable in Kind interest is a form of payment in which a portion of the Cash Interest is not paid in cash but rather collected by increasing the principal amount of the loan by the amount of the deferred/discounted interest accrued. For example a $20 million investment with a 5% PIK interest rate will have a balance of $21 million at the end of the period but may pay reduced cash interest.
  
• Equity — Mezzanine capital will typically include an equity stake sometimes called an “equity kicker” in the form of attached warrants or a conversion feature, similar to that of a convertible bond. The total Internal Rate of Return (IRR) on the investment including cash interest and PIK interest will be considered when negotiating the equity kicker.
  
• Closing Fee - Mezzanine lenders will also often charge an arrangement fee, or closing fee payable upfront at the closing of the transaction. Closing fees are primarily in place to cover administrative costs and as an incentive to complete the transaction. Closing fees typically range from 1% to 3% of the loan amount.