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of U.S. retail sales, although overcrowding has recently slowed the franchis-
ing movement.

Research and Development Arrangements
Like other alternatives in this list, R&D arrangements offer variations.
Basically, however, an R&D limited partnership grants R&D funding to a
company perfecting a technology. The limited partners stand to gain through
tax benefits and substantial royalties. Depending on the details of the agree-
ment, the company responsible for developing the technology also has op-
tions: to eventually buy the technology, to develop and market the
technology, or to join with the limited partners to form a new company.
R&D is an effective way to get promising technology off the ground, espe-
cially when a strong entrepreneurial management is not available.

Venture Capital Firms
These sources are professional investors and independent middlemen who
chiefly manage and invest other people™s money. The limited partners in
funds tend to be institutions, including pension funds, insurance companies,
universities, and corporations. Although most wealthy private investors have
abandoned professional funds, a number of family endowments still invest.
(As pointed out earlier, professional venture capital firms are not the best
source of funding for small companies or start-ups.) Professional fund man-
83
Alternative Sources of Capital


agers seek bigger companies that may develop into $50 million to $100 mil-
lion businesses within three to five years. To generate returns to investors,
these funds must work with fewer, larger deals, those with “superstar” pos-
sibilities that can cover the losses from the high percentage of failures inher-
ent in investments. These funds try to outperform the venture capital
industry, and rarely get involved in deals with a deal size less than $7 million.


Cash Management and Tax Strategies
Cash management activates immediate cash flow, involving techniques de-
tailed elsewhere in this list, such as bartering and factoring. Cash manage-
ment techniques often enlist tax strategies to create cash, such as taking tax
deductions for depreciation of fixed assets (computers, perhaps, or other
equipment and furniture).

Private Placement (Exempt Offerings)
The private placement is the issuance of treasury securities of a company to
a small number of private investors. A private placement is an offering of
senior debt, subordinated debt, convertible debt, common stock, preferred
stock, warrants, or various combinations of these securities.

Government Financing (Loans and Grants)
Small business is big business in the United States, responsible for a whop-
ping 51 percent of the gross national product (GNP), 60 percent of all new
jobs created, and 47 percent of all domestic sales. Begun in 1953, the SBA”
an independent agency of the federal government”has become the largest
long-term source of financing in the country. Through 7(a), the SBA™s
General Loan Program, loans are made by private lenders with the govern-
ment guaranteeing 70 to 90 percent of the loan up to $750,000. The 7(a)
Loan Program accounts for 90 percent of the SBA™s loan business. (The SBA
generally defines “small” as having under 100 employees if a company is en-
gaged in manufacturing or wholesale; if in retail or service, a company™s an-
nual sales must not exceed $3.5 million. These definitions qualify 99 percent
of all businesses in the United States.)
The SBA array of programs includes the 502 Local Development
Company Program, directed in rural areas to long-term, fixed-asset financ-
ing, and the 504 Certified Development Company Program, directed to
long-term, fixed-asset financing through nonprofit certified development
companies (CDCs). CDCs are companies sponsored either by private inter-
84 UNDERSTANDING THE ANGEL INVESTOR


ests or by the local or state government. Other SBA programs operating
under 7(a) include the GreenLine Program, the Vietnam-Era and Disabled
Veterans Program, the Handicapped Assistance Loans, the Women™s Pre-
qualification Loan Program, and the Low Doc Loan Program for loans
under $100,000 to companies with less than $5 million in annual sales and
fewer than 100 employees.
Also operating under the aegis of the SBA is the SBIC Program. There
are fewer than 100 active SBICs operating in the United States. This program
is the only entity under U.S. banking legislation that can lend money and
own equity in small businesses. SBICs borrow the capital that they, in turn,
must lend only to small businesses that operate on a thin margin. However,
SBICs like to see assets that can be liquidated if the business fails, and they
require entrepreneurs to invest a substantial portion of their net worth
and/or postpone salary. SBICs will engage in some subordinated debt.
SBA loans can cover inventory, machinery, working capital, and acquisi-
tion of commercial property. In applying for a loan, the small business owner
must meet the requirements of both the SBA and the lender, having to supply
among other documents a current profit and loss statement, a balance sheet,
a schedule of business debt, a current personal financial statement, a business
plan, and collateral. The government rarely lends money directly to the en-
trepreneur, and the SBA provides no grant money for business start-up or ex-
pansion. Most lenders opt out on anything less than $50,000.


Bartering
Bartering, the trading of products or services without the use of money or its
substitute, is another alternative business practice to financing your com-
pany. Bartering involves the exchange and subsequent good use between two
companies of each other™s slow-moving or “dead” inventory or services.
What accrues to each company is a commodity that may generate added
capital. More important, bartering conserves cash. Although bartering is not
for every business”such as those not needing additional customers”those
that engage in it find new barter partners through barter newsletters and
member directories.


Commercial Finance Companies
These firms handle riskier lending transactions and are open to higher lever-
age than banks. Most have an asset focus, for example, receivables, invento-
ries, and fixed assets. Commercial credit companies typically charge interest
rates of three to five points over prime, and all require substantial collateral
and/or personal guarantees.
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Alternative Sources of Capital


Banks
Traditional banks are creditors, specifically short-term lenders, granting 30-
to 90-day loans. They also may lend over longer periods (more than five
years), but banks are not investors. Banks generally require excellent credit
ratings and a perceived ability to repay the borrowed money. Depending on
the circumstances, they may also require a large percentage of self-financing.
However, currently, corporate lending interest rates are at their lowest in 45
years, having been lowered repeatedly for four straight years by the Federal
Reserve.


Initial Public Offerings
IPOs are generated when a privately held, usually emerging, company com-
plies with requirements and regulations, then registers with the SEC, makes
disclosures to the public, and issues shares for the first time. Investors receive
a share of company profits through the issuance of dividends but permit the
company to retain control”unless that control gets transferred to the share-
holders. As a public company listed on an exchange, the company must com-
ply with relevant federal and state laws.


International Sources of Capital
No longer the exclusive purview of large corporations, international trade
has flowed increasingly into the ken of small businesses. International
sources of capital have blossomed as a result, running the gamut from local
commercial banks to the federally, state, and locally funded Center for
International Trade Development. In addition, the SBA™s Export Working
Capital Program, like the SBA™s other programs, guarantees 90 percent of a
private sector loan up to $750,000. Although not exclusively for interna-
tional funding, the Department of Commerce™s Minority Business
Development Agency (MBDA) funds Business Development Centers across
the country. The Department of Commerce also supplies nonfinancial
aid through its National Trade Data Bank (NTDB), which contains inter-
national information valuable to exporters. What we have mentioned
here hardly scrapes the top layer of options open to the international
businessperson who, unfortunately, faces daunting regulations and
requirements.

Employee Stock Ownership Plans
Employee stock ownership plans (ESOPs) involve an internal buyout of a
company in which the employees buy shares and thus buy ownership.
86 UNDERSTANDING THE ANGEL INVESTOR


Hence, equity capital is raised fairly inexpensively by a knowledgeable and
dedicated workforce as it operates in its new capacity as company stock-
holders. Each employee™s share of stock thus becomes the company™s contri-
bution to the employee™s retirement fund.


Management Buyout
This involves another type of internal buyout of a company in which the
management buys shares and thus buys ownership. Such a buyout may have
been generated by the management™s concern for remaining in control of the
company™s future instead of having it bought by outsiders. Like employees
who buy ownership, managers know the intimate workings of the company,
putting them in position to leverage up the company.


Incubator-Based Financing
Incubators provide support within a close geographical locale for seed,
start-up, and other early-stage companies looking to expand. Such support
can come not only in funding but also in the form of a physical plant, office
management, and marketing services. Corporate or university based, incu-
bators help companies raise capital, offer technical assistance, and perform
valuation. A fully functioning incubator could house a number of growing
companies sharing a common business, for instance, in software. They also
might share space and equipment and even professional guidance. The stage
of development of incubators varies widely from state to state.
As the New York Times reported in January 1999, the number of incu-
bators operating in the United States reached 550 in 1998; of these, 30 of-
fered services but no physical space (“incubators without walls”). Forty-five
percent were located in urban areas, 36 percent in rural areas, and 19 per-
cent in suburbs. Forty-five percent had no particular focus, but one quarter
of the incubators focused on technology. Ten percent were dedicated to gen-
eral manufacturing, 9 percent to other specific industries, 6 percent to serv-
ices, and 5 percent to minority-owned businesses. That a few incubators
merely sustain “failed” entrepreneurs, as investor and author Geoffrey
Moore (Crossing the Chasm and Inside the Tornado) has pointed out, good
incubators, he reassures us, “attract . . . key resources”advisers, partners,
investors, and visionary customers.” Incubators, he has explained, “give a
structure to the bottom levels of basic needs so that entrepreneurs can focus
on the higher levels.” Incubators have continued to spread, and in 2004, ac-
cording to the National Business Incubator Association, 950 incubators are
operating in the United States.
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Alternative Sources of Capital


Asset-Based Loans and Factoring
Asset-based loans are virtually self-explanatory: loans granted on the basis
of a company™s assets, chiefly the company™s accounts receivable. The ac-
counts receivable become collateral. A lender provides funds as products are
shipped, expecting to receive a percentage of the value of those accounts. The
accounts themselves will continue paying as they normally do: to the com-
pany; not, however, to the lender. The company uses a predetermined por-
tion of the actual payments by the accounts to repay the debt. In this way, the
owner of an early-stage company is allowed to sell a portion of the revenue
stream rather than hurrying to give equity in the company or burden the bal-
ance sheet with debt.
In factoring”a type of financing based on accounts receivable”the fac-
tor (lender) accepts direct responsibility for the company™s accounts, taking
responsibility for the credit risks and collection of the receivables. Factoring
is more expensive than accounts receivable financing, although both require
extensive bookkeeping and neither comes cheap.


Self-Finance
Self-financing often supplements institutional financing and may be required
by a funding institution to assure a dedication to and interest in the com-
pany, invention, or venture. Self-financing may include the use of credit
cards, whose interest rates vary widely. According to a 1997 study imple-
mented by Arthur Andersen™s Enterprise Group and National Small Business
United, approximately 34 percent of respondents indicated the use of credit
cards for initial financing of the start-up. A good personal credit record will
determine how much money a credit card company is willing to offer. Credit
cards do offer one of the quickest and easiest means of obtaining credit.
Entrepreneurs have been known to apply for ten credit cards in one day, cre-
ating a $100,000 line of credit overnight.


Community Development Corporations
Nonprofit organizations staffed by civic and business leaders and sponsored
by individual citizens, church groups, and even bankers may submit appli-
cations to become CDCs. These community loan development funds, estab-
lished to improve community life, even have begun equity investing. Eligible
CDCs must have established 501(c)(3) tax-exempt status. The CDC must
describe its proposed collaborative partnership with neighborhood resi-
dents, local businesses, and financial institutions. A government agency then
designates which groups qualify, granting their contributors yearly tax cred-
88 UNDERSTANDING THE ANGEL INVESTOR


its of five percent for 10 years. The designated CDC launches employment
and business opportunities within a geographical area for low- and moder-
ate-income individuals. The CDCs require scheduled progress reports.
Established CDCs use past performance as a criterion for a venture™s receiv-
ing more funding.

Small Corporate Offering Registration
As William D. Evers makes clear in his “Primer on Securities Law Issues for
Non-Lawyers,” SCOR offerings “represent an abdication by the SEC . . . to
the states of jurisdiction over public or private offerings of $1 million or
less.” Forty-eight states have SCOR statutes for public offerings. The 50-
question Form U-7 is the required disclosure document. In many states, fi-
nancials must be audited. Connected to SCOR is the federal rule known as
Reg. A, which is expensive. Because of “SEC review and the required preci-
sion of offering detail for ˜full disclosure,™” Evers explains, “legal fees [reach
from] $25,000 to $60,000.” Furthermore, these figures do not include filing
fees and “Blue Sky clearing.” (For a discussion of securities law issues with
an emphasis on small business, see Appendix B.)
Thus, with all the nourishment that small businesses bring to the eco-
nomic dinner table, it is no wonder that the government understands the
need for supplying some coal of its own to stoke the economic fire. Despite
the government™s best efforts and good intentions, however, its very nature
precludes it from playing the role of venture capitalist. Venture capital in-

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