May 20, 2015
By HunterMaclean Attorneys
Special to Business in Savannah
Growing a business requires capital — proving the old adage that it takes money to make money. Traditionally, small businesses have turned to the Small Business Administration (SBA) and to banks for loans, but today’s expanding financial landscape provides more options to businesses looking for ways to fund their growth. These include modern innovations such as crowdfunding, peer-to-peer lending, and microloans, as well as more established financial avenues such as equity investments and mezzanine loans.
While traditional bank loans require a strong history of profit, cash flow projections, and a desirable credit score, alternative sources of funding may not necessarily hinge on the same documentation or financial standing. Banks also require that appropriate assets and collateral be in place in order to reduce its risk, while the alternative financing sources might not. Generally the more risk assumed by the lender, the higher the interest rates will be. Traditional bank loans are also longer term and spread out over many years, whereas alternative loans may have a smaller repayment window.
Equity investments present a unique opportunity for businesses looking to expand and are perhaps the most common alternative to a bank loan. As opposed to debt, equity financing raises capital by selling a share of ownership in the business. Because nothing is actually borrowed, business owners don’t pay interest on money received and do not need to make regular payments. However, equity financing can come down to a ratio of capital versus control because investors may expect a place on the board, voting rights, and/or a percentage of profits. This option can be well suited to business owners who don’t necessarily have a lot of cash flow but stand to grow their company substantially with the right investment.
Smaller equity investments often come from individuals who qualify as “accredited investors” according to the Securities Exchange Commission (SEC) by meeting one of the following requirements: the individual (i) has an annual income of more than $200,000, or a joint annual income of $300,000, in each of the previous two years and reasonably expects to maintain this level of income; (ii) has a net worth greater than $1,000,000, individually or jointly, or (iii) is a general partner, executive officer or director of the issuer of the offering. By offering an investment only to accredited investors, the business avoids many of the registration and reporting requirements mandated by the SEC, which can be costly and time consuming. Larger equity investments often come from private equity firms or venture capital companies, who will require greater control and evidence of the businesses growth potential.
Mezzanine financing, named for its association with mid-level risk, constitutes another alternative. This type of loan leaves the option open for a debt to be converted to equity interest in a company if the loan is not paid back according to its terms. These loans are typically subordinate to a bank and require no collateral; however, because there is no collateral, the investor will expect a higher interest rate and a shorter repayment period Mezzanine financing is ideal for a smaller business growing toward a regional or national presence, especially because it requires little equity up front. This is also a good option for businesses that have explored all of the more traditional loan options and are ready to take the next step.
Finding the right financial solution can be a complicated process for entrepreneurs expanding a small-sized enterprise into larger markets. As in all business matters, the decision of what outside financing a business owner should pursue relies on weighing all the options. This includes considering what is given up and what is gained, ensuring the end result compensates for any control lost. Remember that investors want the businesses they subsidize to succeed. As a company grows and revenue increases, all parties benefit; banks and shareholders alike have a vested interest in the company’s success. In the end, each business must carefully evaluate available financing options to determine what will best serve its business and goals.
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