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While poor management is cited most frequently
as the reason business fail, inadequate or ill-timed financing is
another major reason. Whether you're starting a business or
expanding one, sufficient ready capital is essential. But it is not
enough to simply have sufficient financing; knowledge and planning
are required to manage it well. These qualities ensure that
entrepreneurs avoid common mistakes like securing the wrong type of
financing, miscalculating the amount required, or underestimating
the cost of borrowing money.
There are two types
of financing: equity and debt financing. When looking for
money, you must consider your company's debt-to-equity ratio - the
relation between dollars you've borrowed and dollars you've invested
in your business. The more money that owners have invested in their
business, the easier it is for the owner to attract financing.
If your firm has a high ratio of equity to
debt, you should probably seek debt financing. However, if your
company has a high proportion of debt to equity, experts advise that
you should increase your ownership capital (equity investment) for
additional funds. In this manner, you won't be over-leveraged to the
point of jeopardizing your company's survival.
Equity Financing
Most
small or growth-stage businesses use limited equity financing. As
with debt financing, additional equity often comes from
non-professional investors such as friends, relatives, employees,
customers, or industry colleagues. However, the most common source
of professional equity funding comes from venture capitalists. These
are institutional risk takers and may be groups of wealthy
individuals, government-assisted sources, or major financial
institutions. Most specialize in one or a few closely related
industries. The high-tech industry of California's Silicon Valley is
a well-known example of capitalist investing.
Venture capitalists
are often seen as deep-pocketed financial gurus looking for
start-ups in which to invest their money, but they most often prefer
three-to-five-year old companies with the potential to become major
regional or national concerns and return higher-than-average profits
to their shareholders. Venture capitalists may scrutinize thousands
of potential investments annually, and only invest in a handful. The
possibility of a public stock offering is critical to venture
capitalists. Quality management, a competitive or innovative
advantage, and industry growth are also major concerns.
Different venture capitalists have different
approaches to management of the business in which they invest. They
generally prefer to influence a business passively, but will react
when a business does not perform as expected and may insist on
changes in management or strategy. Relinquishing some of the
decision-making and some of the potential for profits are the main
disadvantages of equity financing. You may contact these investors
directly, although they typically make their investments through
referrals. Debt
Debt Financing
There
are many sources for debt financing:
banks, savings and loans, commercial finance companies, and the U.S.
Small Business Administration (SBA) are the most common.
State and local governments have developed many programs in recent
years to encourage the growth of small businesses in recognition of
their positive effects on the economy. Family members, friends, and
former associates are all potential sources, especially when capital
requirements are smaller.
Traditionally, banks have been the major
source of small business funding. Their principal role has been as a
short-term lender offering demand loans, seasonal lines of credit,
and single-purpose loans for machinery and equipment. Banks
generally have been reluctant to offer long-term loans to small
firms.
The SBA guaranteed lending program encourages
banks and non-bank lenders to make long-term loans to small firms by
reducing their risk and leveraging the funds they have available.
The SBA's programs have been an integral part of the success stories
of thousands of firms nationally.
In addition to equity considerations, lenders
commonly require the borrower's personal guarantees in case of
default. This ensures that the borrower has a sufficient personal
interest at stake to give paramount attention to the business. For
most borrowers this is a burden, but also a necessity.
The
information on this site is not intended to constitute legal advice
or to substitute for obtaining legal advice from an attorney
licensed in your state. This web site is not intended to be
advertising under applicable laws and ethical rules. These
materials have been prepared by the French American Chamber of
Commerce with the expertise of our staff and members for
informational purposes only and are not legal advice. Anyone
viewing the information should not act upon it without seeking
professional counsel. The information contained in this website is
provided only as general information which may or may not reflect
the most current legal developments.
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