@141 CHAP 9 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � VENTURE CAPITAL AND OTHER � 쿞OURCES OF START-UP FINANCING� 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴� @Q "A banker is a person who will only lend @Q you an umbrella if the sun is shining." Outside financing is to entrepreneurs what steroids are to bodybuilders and NFL linemen -- in either case, you can't get nearly as big nearly as fast on your own -- and there can be some nasty side effects. If you need to raise funds from other parties to start your business, the types of capital that you will be attempting to raise will fall into two categories -- Equity capital (such as common stock or preferred stock in a corporation, or an interest in a partnership); or Debt capital, which in- cludes all types of loans, whether secured or unsecured, from the bank or from your mother. Most new businesses find it hard to raise equity capital, except those that are so promising that they are able to find venture capital investors to provide such financing. Venture capital firms are investment firms that specialize in making equity capital available for businesses that have very high potentials for growth. They usually are interest- ed in a small business only if it has demonstrated market acceptance for its products or service by generating sub- stantial sales over a significant period of time and the competence of the business's management in managing other people's money (since you will be managing theirs). They are generally only interested where such a firm has an ex- plosive growth potential, as well. Venture capitalists expect to make 10 or 15 times their or- iginal investment in 5 years or so. Since most small bus- inesses do not possess this kind of potential, the typical mom-and-pop store, no matter how well-run and profitable, is not a realistic candidate for venture capital investment. They are usually looking for a well-balanced management team with technical, marketing and financial expertise, poised for rapid growth and expansion. Thus, if you are a typical small business person, you will be wasting your time and theirs if you approach venture capital investors for financing to get your business started. (Besides, most "vulture capitalists," as they are often called, will demand your firstborn child and a 40% return on their in- vestment, just for starters.) 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� 쿖EY POINT: Venture capital accounts for� 쿽nly a tiny fraction of small business � 쿹oans. Don't totally rule out the pos-� 퀂ibility, but just realize that getting� 퀆enture capital financing is definitely� 쿪 long, long shot, for most startups. � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� Most institutions that you should approach for financing, such as banks, will only consider making loans to a fledg- ling business (and not equity investments), thus the follow- ing is a discussion primarily of sources of debt capital. (a) Bank Loans. It may not hurt to try, but most new bus- inesses will find it quite hard to get a bank loan. An ex- ception would be where you have a fairly large equity in- vestment in the business or can put up collateral, either assets of the business or outside collateral, like a mort- gage on your home. As a rule of thumb, you can usually get a bank loan only if you can demonstrate to the bank loan officer that you don't really NEED a loan. Nevertheless, If you are planning to apply for a bank or SBA loan (see below), get a copy of the book entitled THE LOAN PACKAGE (you can order it by phone from the publisher, Oasis Press, at 1-800-228-2275). You can use THE LOAN PACKAGE to prepare a professional-looking loan application package that will create a favorable impression with bank loan officers or any other potential lenders who look with favor on someone who gives the appearance of being highly organized and who submits a slick-looking loan application package. (b) SBA Loan Programs. The Small Business Administration (SBA) primarily is a guarantor of certain loans which are made by banks, savings & loans and certain other lenders, such as SBIC's and MESBIC's. (See paragraph (g) below.) It has a very limited budget for making direct loans it- self. And forget about "grants" to small business startups (despite what you may have heard on those late night TV "infomercials") -- they don't exist, in the real world. SBA loan programs include: . GUARANTEED LOANS. Most SBA loans are of this vari- ety, where banks or other lenders make the loan. The SBA may guarantee 90% of smaller loans, but not over 85% of larger loans. Such loans usually re- quire the borrower to put up a reasonable amount of equity and are secured by fixed assets, real estate or inventory (or all of the above). They are usually limited to 7 years for working capital loans, 10 years for fixed assets, or 25 years for construction loans. Apply directly to the lender, not the SBA. The maximum size loan the SBA will guarantee is of $750,000, and as a practical matter, lenders usually are not will to process such loans for amounts of less than $25,000. Loan rates are based on the going prime rate, with a rate of 2 1/4% over prime for loans of less than 7 years, or 2 3/4% for longer- term loans. . DIRECT LOANS. If you are unable to obtain suffic- ient conventional financing or SBA-guaranteed loan funds, you may in some cases be able to obtain a direct loan from the SBA of up to $150,000. Howev- er, these direct loans are hard to get, and can only be made if the SBA has funds available. In recent years, the funds available for lending by the SBA have been quite limited, so that eligible borrowers are frequently turned away because the SBA simply doesn't have any money to lend. . OTHER SBA PROGRAMS. From time to time, the SBA is engaged in various other types of small business loan programs, such as seasonal lines of credit, economic opportunity loans to entrepreneurs who are physically handicapped, minority loans and the like, which change frequently. Consult your banker or your local SBA office if you think your firm may qualify for one of these special financial as- sistance programs. (c) U.S. Dept. of Housing and Urban Development (HUD). HUD makes Urban Development Action Grants (UDAG) to cities in economically distressed areas. The cities are then able to use these UDAG funds to make second mortgage loans to private developers who are able to leverage these loans by borrowing 3 to 5 times such amounts from private sources. Such loans and grants are made for the purpose of encourag- ing business investments in depressed areas. (d) U.S. Dept. of Commerce. The Economic Development Ad- ministration (EDA) of the Dept. of Commerce makes direct loans and makes loan guarantees to businesses in areas with low family incomes or suffering from high unemployment, to promote creation or retention of jobs for residents of such areas. To qualify for such financing, your business must be located in an EDA redevelopment area and you must be able to demonstrate that the venture will directly benefit local residents and will not create over-capacity for the industry in question locally. (e) Farmers Home Administration (FmHA). The FmHA works much like an SBA for rural areas, or in towns of under 50,000 population. Like the SBA, the FmHA guarantees up to 90% of the amount of loans made by banks or other private lenders. It does not make direct loans. (f) Other Federal Loan Programs. Other major federal loan programs to businesses include Federal Land Bank Association loans to businesses providing services to farmers, for purchasing land and equipment and for start- up working capital, and a similar loan program for loans of up to 7 years is provided through the Production Credit Association and the Federal Intermediate Credit Bank. (g) SBICs and MESBICs. In addition to direct loans and guarantees from government agencies, don't overlook pos- sible loans (or equity financing) from Small Business In- vestment Companies (SBICs) and Minority Enterprise SBICs (MESBICs) as possible sources of financing. Both are li- censed and regulated by the SBA to provide equity capital, long-term loans, and management assistance to small busi- nesses. SBIC and MESBIC loans are usually subordinated to loans from other creditors and are typically made for 5-7 year terms. Both types of investment companies are privately- owned and thus tend to favor loans to established companies with significant net worth, rather than new business start- ups. SBIC lenders will usually want a loan that is conver- tible into stock of your corporation, often up to 49% of the total stock; SBIC lending, like venture capital funding, does not come without a significant price. MESBICs serve only those small firms that are owned by mem- bers of economically or socially disadvantaged groups. (h) Relatives. Finally, if all other sources of finan- cing fail to work out for you, do like many other people and borrow from Mom or Dad to get started. Just be pre- pared for an unhappy family situation if the business does poorly and you can't repay the loan.... If that happens, you'll have to console yourself with the thought that it could have been worse -- you could have defaulted on a loan from Squiggy, your friendly local loan shark and thumb- breaker....to whom your body is the only collateral he needs.