Whether your business is a start-up or a mature business, one of the most critical activities you’ll face is raising capital. One of the best, and often the most overlooked sources of capital are private investors. And while often times money is raised through friends and family, my view is to stick with accredited investors that are in the deal business each and every day. If you do tap friends and family for capital, make sure that the relationship can handle a total loss scenario.
An intergal part of the capital raising process is your “prospectus,” which is different depending on where you go for your capital needs. If you are going to a bank, or a non-bank lender (such as an SBIC), you’ll want to have a crisp executive summary that provides the lender with information about your business and the use of funds. Some points that the executive summary should cover include a short history of the business, overview of the transaction (working capital, purchase new equipment, refinance existing debt, buyout of a partner), what products you sell, who your customers are (if applicable, think top ten customers and the last three years of sales for these customers), who your suppliers are (top five or ten suppliers and amounts purchased over the past three years), manufacturing process (as applicable), industry and competition (a SWOT analysis), sources and uses of funds, capital structured (pre and post financing), and summary of financial performance with applicable discussion and analysis.
If, on the other hand you are seeking to raise some type of junior capital, such as equity or subordinated debt, from private investors, you will need to have a private placement memorandum.
Think of the private placement memorandum as the executive summary on steroids. The private placement memorandum, or PPM, provides your prospective investors with the information that is needed to assess the trade-off between risk and return. You will need to articulate what the “deal” is; i.e. what type of security you are issuing, the terms, restrictions and covenants of the security. The PPM should also articulate the risks of the transaction, which includes risks inherent in the business, industry, potential conflicts of interest, risks specific to the security being issued, and corporate structure. The key to this risk section is to not sugar coat it and to not try to mitigate the risks in this section. Put yourself in the shoes of you prospective investor – what information would you wan to know?
Raising capital is not easy, but can be rewarding, aside from actually raising the money. Going through this process will require to think about and talk about your business in ways that you might not have had to in the past. And while you may think you have the best business or business idea (in the case of a start-up) in the world, when exposed to the the light of seeking capital, you will begin to see and think about your business in news ways.
Raising capital, particularly private capital, can take a long time. Depending on what type of relationships you have and how much initial work you do, expect to take six months or more to complete your offering. Even closing on a simple bank financing can take six to eight weeks from start to finish.
Raising capital can also be expensive. In the case of a traditional bank financing, your costs can often be rolled into your financing. Likewise with private placements, except for any placement fees you may pay, your costs can be paid or recouped out of the proceeds of your closing. The biggest risk, however, is the risk of bused deal expenses – your upfront expenses that get paid regardless of whether your transaction closes or not. As an example, your private placement memorandum can cost as much as $20,000 when prepared by an attorney, and bank financing expenses can include commitment fees, appraisal fees, and environmental assessment fees.
At the end of the day, raising capital is something that can be done. Like a lot of things in life, it takes know-how, persistence, and a little luck.
