Introduction to Small Corporate Offerings

From the executive suite at the top of the Exxon Building to the newsstand in the lobby. everyone is in the same fix. Nobody has enough money to take advantage of all the business opportunities available to him. At every level of every company, management is faced with deciding which projects to fund and which to forego.

Simply put, business is nothing more than the search for, and use of capital. What really happens when an idea becomes a product is that the person with the idea found the money to develop the prototype, and then found more money to develop a manufacturable product, and then found even more money to manufacture the product, and then found even more money to market the product. If the product sells, he will have to find money to increase manufacturing and distribution capacity. Each step in the process max’ require capital from a different source under different conditions.

Successfully competing for capital involves two things. The first is understanding what sources of capital are appropriate for which projects, and at which stages within the project. And the second is developing a strategy to convince investors that your project is the best investment available.

Capital comes in two basic types. It is either equity, meaning the investor has become a part owner, or it is debt, meaning the investor expects to be paid specific amounts of at specified times until an agreed amount has been paid. Equity is also defined as what is left over after all debts have been paid. Because of that, the equity holder generally has some say in how a company is run. How loud a say depends on how much of the company he owns--how much he has invested in the company. Since the lender’s investment is protected to some form of collateral, he has less of a say in the day-to-day management of the company.

This pamphlet is meant to introduce the entrepreneur and do-it-yourself capitalist to the richly varied and some what confusing area of entrepreneurial finance. Our basic belief is that there is a financial tool for every worthwhile proposal. The secret is to recognize what that tool is and how to use it. Because it is at once the most powerful and least understood of all the financial tools, a great deal of space is devoted to Small Corporate Offering Registrations or SCOR.

Before committing to a SCOR, entrepreneurs should evaluate the following options:

Friends, Family and Associates

Friends, Family and Associates are, next to personal savings and credit card debt, the most prevalent form of small business financing. However, there is a definite limit to how much can be raised from those sources.

Debt

Debt and the Small Business Administration seem to go hand-in-hand. The first place most small business people look for capital, even though it is the lender of last resort. SBA loans generally require 1/3 equity ownership. The cost of applying for a loan includes: fees for legal services, filing fees and a funding fee of 2% of the guaranteed amount. Loans must be fully secured and personally guaranteed. Audited financial statements are generally required for loans in the $l million range. Businessmen attempting to get loans for businesses with generally poor track records such as retail, restaurants and specialty businesses, have a much harder time convincing lenders to part with money than people in other types of businesses do.

Venture Capital Firms
Business Angels

Business Angels are Usually self-made millionaires who understand your business and want an active role for their money. Before the stock market made its phenomenal run, it was estimated that some 500,000 business angels invested some $20 billion a year in entrepreneurial companies. There are probably considerably more than that now. They don’t advertise and are hard to find, although if you know your industry, some names should come to mind. Be prepared to have your business gone over with a very fine comb.

Matching Services

Matching Services are a relatively recent development in capital formation has been the matching service. These come in two varieties. One is a computerized system which attempts to match entrepreneurs and investors according to their requirements. The other has a dog and pony show format in which entrepreneurs present their company’s case to a room full of potential investors.

Small Business Investment Companies (SBIC)

The Small Business Investment Company is a small business development company which is owned by a financial institution (a variation of the SBIC is the Minority Enterprise Small Business Development Company). To be attractive to this funding a business must have had more than two years of profits exceeding $2 million. SBICs typically do mezzanine financing (funding used to move a company from development to production stage). SBICs typically lend money, although they have recently been encouraged by the SBA, which licenses them, to make equity investments as well. Their terms are similar to those of the venture capital firms. They will accept subordinated debt as long as it has conversion rights to between 5% and 25% of the outstanding capitalization. They also require board control and other rights negotiated into the terms and conditions of the investment. Like venture capital companies, they require a firm exit strategy.

Private Placements

Private Placements have been around forever, literally. People have always asked people they know for money. With advances in transportation and communication, steps had to be taken to make sure investors were limited to people who knew the company and its management. For that reason, general advertising and solicitation were prohibited. That is no longer the case. Since the 1994 adoption of the qualified investor exemption California and the SEC, people have been able to advertise for investors. They are supposed to restrict sales to people who meet specific wealth (no sophistication test). Now 38 states have adopted some form of accredited investor exemption which permits a tombstone announcing an investment opportunity, but restricts delivery of the terms of the deal to investors who meet, the accredited investor requirements set out in Rule 501 of the Securities Act. strictly speaking, such deals are limited to $1 million in a 12 month period, since the only exemption available at the federal level which permits general solicitation is Rule 504. However, that may be too fine a point for most issuers using this exemption to fathom.

Other exempt offerings

For example, the state of Texas has something like 28 exemptions from registration. While not all of them are available to all companies and while not all of them are applicable to all ventures, a prudent business person should call the state securities board and request a list of exemptions. From the federal point of view, intrastate exemptions are covered in Section 3(a)(11) and Rule 147 of the Securities Act. They permit public solicitation of investors. While the federal government imposes no investor qualification to meet other than the investor has to be a resident of the state, the states themselves may impose suitability standards. To be eligible, the company must conduct at least 80 % of is activities within the state. That means that 80% of its gross revenues and assets must be in the state and 80% of the net proceeds of the offering are to be spent in the state. For a period of nine months from the close of the offering, the securities can be resold only to residents of the state.

Grants and Local Development Agencies
Secondary Sources of Funding

Secondary Sources of Funding are are more sources of operating funds rather than capital.

Vendor finance, joint ventures and strategic relationships

Vendor finance is basically another way of saying "slow pay." The supplier isn’t paid until the goods he provided are sold.

Strategic alliance is a current buzzword which generally means that several subcontractors band together to offer a complete package of services to the end user.

Leasing, Factoring and Chattel Mortgage

Lease back has been a popular way for larger companies to convert real estate into an infusion of cash. The company sells a building and then leases it back from the purchaser. Smaller companies can use the same technique for big ticket, specialized equipment. Each time something is sold, depreciation may be taken on the purchase price.

Factoring is selling receivables at a discount to get cash now.

A chattel mortgage is a loan secured by specific assets, usually items in inventory. To guarantee the lender’s position as a secured creditor, a chattel mortgage must be very specific and must be rewritten every time the collateral changes, i.e., if part of the inventory is sold, or if inventory is increased.

Other ways of raising money against inventory are field and public warehousing. In field warehousing the lender takes physical possession of a portion of the borrower’s warehouse and puts the collateral inventory under lock and key in that portion of the warehouse. when inventory is sold from lender’s warehouse and the lender gets the money and passes the borrower's share on.

In a public warehouse, the collateral is transferred to a public warehouse and is sold from there with the lender taking his share before passing the remainder to the borrower.

Stewart-Gordon Associates, Inc.
P.O. Box 781992
Dallas TX 75378-1992
voice (972) 620-2489
fax (972) 406-0213
e-mail Tom Stewart-Gordon