By: Janice Wilken - Partner, Ice Miller LLP
In these difficult economic times, many companies are wondering where they can find money to help start or grow their businesses. The 2010 Indiana CEO Survey found that executives are less confident in 2010 than in 2009 that sufficient private funding is available to help businesses succeed. This conclusion requires an analysis of the types of funding (both debt and equity) that may be available to businesses.
Traditionally, the first place to find money when starting a new business is from friends and family. Investments by family and friends are made in large part based upon the relationship between those individuals and the entrepreneur, but the entrepreneur needs to be careful to comply with federal and state securities laws. This usually means that the company should make sure the investors are accredited investors and should conduct the offering in compliance with a private offering exemption under Regulation D of the federal securities laws. Regulation D contains limits on the number of investors and the amount of financing a company can receive in order to fall within one of the many exemptions. Most importantly, the company cannot commit fraud and cannot engage in a public solicitation of investors. Family and friends are still providing capital during these economic difficulties, however the amounts of the investments may have diminished as individual investment and savings accounts have been affected by the volatility in the equity markets.
If you do not have close friends or families with the available cash to invest in your business, "angel investors" can be a great source of capital. Angel investors are high net worth individuals that can provide relatively large tranches of capital through equity or convertible debt investments. Typically, angel capital is the second round of capital that start-up companies receive and can provide capital in the range of $500,000 to $2,000,000 depending on the needs of the company and the willingness of the "angels" to invest. Although angel investors are more selective in these economic times, angels are still investing and are looking for the right opportunities and the right companies. Once again, when raising money from angels, the company must comply with federal and state securities laws and structure the offering to comply with one of the private offering exemptions.
Venture funding is another source of capital that can be very advantageous for start-up companies. Venture capital firms typically receive preferred stock, meaning that the holders of the stock will have priority over common stockholders in dividends and distributions (including distributions following a sale of the company's assets). Generally, venture capital firms will require a seat on the board, veto rights on major decisions such as additional financing and sale of the company, and a high return on their invested capital. There are numerous venture capitalists looking to deploy money right now. They are more selective in these economic times, but the venture capital firms typically do have the money to invest. Venture funding is one of the key types of financing that provides the necessary capital infusion to allow a company to take the next step.
Private equity capital is generally available for more mature companies that are looking to expand and grow. Private equity investments can take a variety of forms (typically preferred stock) and generally involve a buy-out or a purchase of a majority equity interest in a company. As with venture funding, there are numerous private equity funds with millions of dollars to deploy right now.
Traditional debt financing from institutional banks is available to companies as well. The credit markets have suffered through the banking crisis and the recession, but the current administration's policies have encouraged banks to loosen the reigns to start lending money again. It remains to be seen whether that will work. A bank will generally require a security interest in the company's assets including inventory, real estate and/or accounts receivables, a pledge of stock and/or a personal guaranty. Bank financing will also require meeting certain financial covenants.
Mezzanine financing is an option that companies often use in connection with bank financing where the bank does not provide sufficient funding to meet the company's needs. Mezzanine lenders typically take a debt instrument that is subordinated to the bank's position but senior to all other debt of the company. Mezzanine financing is often expensive and typically requires the company to comply with certain financial covenants.
In summary, there are a number of different types of financing available to companies. Although investing activity is not at a high point at this time, companies seeking funding should be aware of all of the options.
Janice Wilken, Partner, Ice Miller LLP
Janice Wilken's primary area of concentration is corporate law. Ms. Wilken has acted as lead counsel in financing transactions for a large multi-national manufacturer and in a number of merger and acquisition transactions, including public company transactions. She also handles securities law compliance matters for several public companies and provides general corporate advice to companies of all sizes. She can be reached at: