22 Mar 16 Alternatives to #VentureCapital
Despite what the court of public opinion says, venture capital funding isn’t all that sexy. Sure, it’s a way to source capital, but it has so many downsides, many a small business has intentionally steered clear of the shark-invested VC waters. In reality, most companies likely don’t fit the mold for most venture rounds–my guess is that 90% or more don’t have the hockey-stick in their growth projections that creates a VC feeding frenzy. So most businesses are relegated to what is too frequently seen as the scrappy sidelines of corporate finance. Luckily, technology, new legislation and creative thinking have combined forces to assist today’s entrepreneurs on the financing side in ways business owners may never have thought possible 10 or 20 years ago. What follows is a brief discussion of 16 financing alternatives to your next business venture. I’ve also included links and name-drops to a few reputable companies and market leaders in each space.
Friends & Family
If you’ve a rich uncle, you should be slapped if you don’t call him grubbing for dough. It might be convenient to have access to this type of capital, sourcing financing from friends and family can be a double-edge sword. It can be generally easy to obtain financing from this group than from complete strangers with no trusting relationship attached, but the benefit to this type of financing is also its detriment. Trusting relationships mean that if a deal goes south and the family/friend investor doesn’t get his/her money back, a relationship may be the price paid for easy money. Weighing the risk of financing through friends and family needs to be performed with the following question in mind: “is my relationship with this person worth [the amount of money they’re willing to invest in the business].” If the answer is no, then the ultimate reward may not be worth the risk and sourcing some of the other 16 options may be your next best bet.
A private placement offering is perhaps one of the oldest forms of legitimately sourcing capital. In a private placement, a private offering memo, often referred to as a Private Placement Memorandum or PPM, is a crafted document that includes a business plan, full & complete risk disclosures and a host of other investor “warnings.” It also includes the cap table (or the structure of the deal) and how shares are being sold in the offering. Again, a PIPE also requires your company shares to be at least registered with the SEC.
Thanks to the JOBS Act, the rules of such offerings have changed slightly. The most impactful has been the ability to circumvent the need to avoid general solicitation in a private offering. While the rules have opened somewhat for advertising broadly, the rules geared toward structure of such deals need to be strictly observed. Best to get in touch with a reputable law group to ensure any private placement offering documents meet the requisite rules for how you wish to approach your investor groups. Such an offering requires knowledge and understanding of your targeted investor, the structure of your deal and, as always, the ability to sell your business plan to investors while still maintaining transparency about what could go south. It can be a tough balancing act, but that’s the price you’ll have to pay to source such financing.
One of my personal favorite groups to source PPM doc creation: RegD Resources out of Colorado. Their services are fairly priced and highly professional.
Crowdfunding itself may ultimately prove overhyped and insufficient if the law isn’t fully implemented like the regulators have promised. Until then, some aspects of crowdfunding remain active, alive and well. The most beneficial of the various crowdfunding methods is rewards or donation-based crowdfunding. While crowdfunding any project could include an act of charity, a donation or a gift, the for-profit projects and companies that emerge on Kickstarter, IndieGoGo and Rockethub are more likely to provide a pre-paid product or service in exchange for a donation. It’s less philanthropic and plays with companies boasting strong management, a quality product or service in high-demand and a broad audience.
But, businesses have greatly benefited as well. Because the financing is non-dilutive, founders are able to keep 100% of the long-term upside to their business after the financing is complete. But, perhaps the biggest boon to the entrepreneur is that most of the Kickstarter projects of the world would never even be considered by the traditional venture or angel groups. Without Kickstarter, many would have died as an idea on the vine.
Unlike its rewards-based counterpart, equity crowdfunding requires the forfeiture of at least some stake in the company in exchange for capital. Sites like EquityNet, Crowdfunder and others simply act as platforms where interested companies can now generally solicit their private placement or offering documents to a touted network of thousands of accredited investors (i.e. an investor with >$1MM in liquid assets outside the value of his/her home).
In a recent conversation with some of the founders of Equitynet, I discovered that most of the currently-funded, equity crowdfunding deals are being financed by less than ten accredited investors and the average is around five or so. In reality, it’s not a crowd at all, but as it currently stands equity crowdfunding sticks to the traditional model of the good ole’ boys network.
If and when the full repercussions of the JOBS Act eventually do hit mainstream investors, there will be an increasing need to take crowdfunded companies public. We’ve discussed some reasons for this in previous posts, but mainstream (Title II, Title III & Title IV) equity crowdfunding represents an interesting opportunity, but growing pains still remain in the crowdfunding industry at large.
Due to the current yields, there is a cold desire for investors to jump into the debt market. In theory, both debt and equity crowdfunding could play a large role in major residential and commercial real estate deals, but it’s likely not going to pick up on the debt side until the Fed stops the printing presses and overall yields begin to increase.
Until then, personal and alternative small business lending is being facilitated by the likes of Lendoor, Prosper and LendingClub. Most of these lenders for small business have emerged from the consumer world of P2P finance. While crowdlending is as non-dilutive as rewards crowdfunding, the financing fit for most companies seeking capital this way is not likely to be there. As a capital-sourcing option, it is, however likely to continue its upward climb in growth, albeit more slowly than its equity counterpart.
Am I lambasting too much? Probably. Will there be successes here? Because the size of any financing amount will be at least partly dependent on the borrower’s ability to pay, there will also be a natural cap on the lending amounts in crowd-lending, which won’t bode well assisting in market growth.
Direct Public Offerings
Alternative and direct public offerings are typically not a good fit for most, but they can still a way to produce the capital necessary to take your venture to the next level without traditional venture capital. Some of the other items discussed below will require a public offering in order for them to be used legitimately. An RTO or reverse merger is a pre-requisite for some of the alternatives to VC funding.
Private Placements in Public Equity
Similar to a traditional private placement a Private Placement in Public Equity (PIPE) solicits financing from a group of well connected private investors with the plan that such financing will be immediately placed in a public vehicle (or in escrow until a transaction is complete). It’s the financing side of a typical alternative public offering. Shares offered in PIPEs are often provided to private investors at some type of discount to sweeten the deal. PIPEs can be used for existing public companies seeking additional capital, but who may be having a hard time raising it through the market.
The structure and options available in a PIPE deal can be both broad and deep. And while PIPEs have their risks (Mark Cuban’s disdain for them was the ultimate contributor to his censure by the SEC), they’re less risky than their 100% non-public, illiquid PPM counterparts, but they’re typically only used by companies that are already lackluster and are paying more for the financing than they should (since PIPEs are usually financed at a discount). Still, equity buyers love them while existing shareholders may spurn. Warren Buffet likes them because they’re typically offered at a discount and the price is fixed–no moving the price up as more equity purchases are made through the public markets.
PIPEs have their place and that often includes better terms for the entrepreneur and existing shareholder than a typical venture capital deal.
One sure-fire institution that works with lenders to provide guarantees against the loans of American small business is the Small Business Administration. Because the SBA is run by the federal government, they can typically provide favorable terms and they regulate the rates charged by their partner institutions for lending (typically prime + x%).
The filters have become more strict than in the past thanks to the weather still clearing from 2008, but the SBA still remains one of the go-to sources for obtaining small business debt financing.
Alternative Small Business Lending
Entrepreneurs can attempt to walk into a Chase or Wells Fargo to get financing, but without significant collateral or a good historical context to your business story, you’re more likely than ever to get turned down. The tightening of the belt on many traditional financial institutions has benefited some of the latest start-ups aiming to provide alternative debt financing to small business.
One such firm we’ve worked with directly is Lendio. Lendio has about 40 partners that provide alternative financing options for small business, outside of the traditional bank ecosystem. Their lending partners work to provide affordable debt financing for small business. The terms are typically pretty favorable and the options are even better than some of the other available methods we discuss here. Lendio has a number of competitors all who’ve jumped on the new alternative debt financing wagon for SMEs.
I often look at angel investors as those who fill the gap between friends/family and venture capital. Depending on the group, they’re often going to be shrewd like the VCs only with less money to commit. The angel community is much more dispersed, non-committal and difficult than the VCs. Raising money from them is a bit like herding cats.
Basil Peters has some great outlines on his site relative to angel investing and general M&A. Your best bet for angel investing is to first target local angel groups and move out from there. From my experience, they’re often your very best critics and feedback sources before you source capital from elsewhere.
Traditional Private Equity
Private equity funds are getting larger and larger, as are their fees. The typical PE model involves a complete company takeover or majority position with a turn-around and flip in five to seven years. They’re not into financing your latest venture and very few will do minority interest for management buyouts. Most of them have their own highly-qualified management teams that like to step-in post-transaction. In other words, they that have the gold, make the rules.
But, depending on the deal structure, the reasons for financing needs, the timing and the particular industry niche, you may be able to attract some capital from traditional PE. But, because of the increasing size of the funds, your business better be of significant size as well, otherwise, you’ll not be worth their time.
Alternative Private Equity
As a solution to the traditional/institutional PE firms that are our there, many family office and alternative private equity groups have been cropping up. Some are highly-involved, extremely professional and are often more interested in opportunity than they are in deal structure or size. Finding such firms is generally a matter of picking up the phone and networking. They’re not only out there, but their numbers have grown in recent years as the market has improved as more lower-market investors are flush with cash.
One firm, I have to tout is EvolutionCP. We’ve not done a deal directly with the folks at Evolution Capital Partners, but I’ve been extremely impressed with their rapport and professionalism. After the last opportunity we introduced to them, they sent me a book they thought I might enjoy. That brand equity is easy to buy, but takes thoughtfulness to implement. Few firms are such hustlers.
Mezz funding is likely an adjective too broad in comparison to many of the other financing options previously discussed, but it remains a alternative option for companies seeking financing, particularly those who need debt or equity for a management buyout or some form of merger or acquisition. If you’re not using liquid public stock in your plan to grow by acquisition, then you’ll likely need a good financing partner. The term mezzanine speaks for itself. It’s a finance form that broadcasts itself as a bridge between what is had and what is needed to get things done. It’s typically not for start-ups or dreamers, but actually businesses with existing EBITDA.
The folks at Attract Capital are one of the most active in promoting their connections for acquisition finance using mezzanine funding. We’ve had several calls with their executive team and I’ve found their products and process up-to-snuff.
Similar to the self-directed IRA option mentioned above, ROBS financing allows for an individual 401K money to be used for a business owned and operated by oneself. ROBS is an acronym for Roll Over as Business Startups. The Wikipedia page does a great job outlining the process and options for this type of unique structure.
In financing a small business with a ROBS, you need to ensure your following the ERISA rules in how the money flows out of the 401K and particularly to the 401K beneficiary.
The factoring of receivables is an age-old method of supplying companies with working capital needs without sacrificing equity or being hampered by debt. In a factor financing business, a lender will generally pay up-front for quality receivables at about 90% to 95% of their face value. In doing so, the financier will likely collect on the A/R within 30 to 60 days.
I would like factor financing to payday lending. It’s not the best resort where other small business debt options are available, but it can help to provide funding for working capital constraints when no other options are available. Just don’t get used to this easy funding option if you deal a lot in A/R as it’s expensive. Just do the math on the APR if you’re shelling out 10% per month on a fairly secure accounts receivable claim. Typically companies that use factor financing graduate once they’re far enough along in operations that they don’t have a need to rely on outside financing for working capital. In growth scenarios, however, companies may be tapped and factoring receivables may be a good option.
One of the industry leaders in factoring is here in Washington: Universal Funding. Their CEO has run more than one factoring company and done very well. From what I know, if managed properly factoring companies virtually print money. And, if you’re an entrepreneur, it’s typically your money so it may be best to find other options.
Financing your business is all too often a necessary evil. It can take valuable time away from doing those things that matter most, in many instances, this means company growth can be halted. I hope some of the aforementioned options provide an interesting introduction into some ways you can use to avoid the venture capital trap and move your business to the next level of corporate growth.
What alternative or creative funding options did we miss? If you can provide any, please list them below and provide some detail.