Seed Financing for Small BusinessNovember 15, 2012

Seed Financing

Generally, “seed” financing refers to a company’s very first round of financing and is typically for less than $1 million.  Many start-up companies need initial or “seed” financing before they have tested their concept with a strategic partner, launched their website or assembled their management team. Often, the founders may have overextended their personal resources and need to turn to others for additional start-up funding. The question is where can a new business find seed financing?

Friends and Family

Friends and family are usually the best source of financing for small business at the beginning of a company’s life. These are the people who know the founders, trust them and are likely to invest in the company despite the risk and regardless of what the business plan might say.  However, investors need to understand they are investing in an untested business with no track record or revenues. Founders need to make it clear to investors there are significant risks involved in investing in companies at this stage so there are no hidden surprises.

Bank Loan Financing

Banks offer a number of different options for funding a small business. In addition, the Small Business Administration (SBA) provides a number of financial assistance programs for small businesses that have been specifically designed to meet key financing needs, including debt financing, surety bonds, and equity financing. SBA does not make direct loans to small businesses. Rather, SBA sets the guidelines for loans, which are then made by its partners (lenders, community development organizations, and microlending institutions). The SBA guarantees that these loans will be repaid, thus eliminating some of the risk to the lending partners.

It’s important to understand however, when applying for a bank loan, there are a number of things that will be considered. These include your business plan, experience in the industry, management team, personal financial history and amount you intend to contribute to the business. Some popular options for loan financing include:

• The DC Certified Business Enterprise (CBE) Revolving Micro Loan Fund program is aimed at assisting small and disadvantaged businesses. The loan offers up to $25,000 of low-interest financing at a rate of a quarter point less than the Prime rate.
• SBA Express Loan Program provides up to $350,000 of low interest financing. The SBA Express Loan is designed to help small businesses receive financing more quickly than the traditional SBA 7(a) loan program.
• The SBA’s Patriot Express Loan Program provides up to $500,000 of low interest financing. The SBA’s Patriot Express Pilot Loan Initiative is geared towards assisting veterans and members of the military community in establishing or expanding small businesses.
• The SBA Short-Term Loan CAPLines Program provides up to $2 million of low interest financing. CAPLines is the umbrella program under which the SBA helps small businesses meet their short-term and cyclical working-capital needs.
• SBA’s 504/CDC Loan Program provides up to $4 million of low interest financing. The 504 / CDC Loan Program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings.

Angel Investors

An “Angel” investor is typically a high net worth individual that is seeking investments. Angel investors typically invest in their individual capacity in amounts of $100,000 or less for each investment. Angel investors often form groups for purposes of screening suitable investments. Angel groups provide companies an opportunity to reach a number of prospective investors in a relatively efficient manner. Angels typically expect preferred stock in the company in return for their investment, although, sometimes they will invest in convertible debt. It’s important to note however, the financing terms of Angel groups has become more complex and may not be more favorable than traditional venture capital transactions.

Venture Capitial

Venture capital refers to a type of private equity capital funded primarily with institutional funding, generally through a limited partnership. Venture capitalists are usually actively engaged with companies to help them grow. VC’s manage their investments in the companies through a firm that acts as the general partner of the limited liability partnership fund. Before approaching VC’s, it’s important the business has a clear plan that will pass the due diligence test including things such as management, board of directors, operations and have a business plan. Venture capitalists typically look for the following:

• Deals with high growth potential;
• Innovations with potential to revolutionize an industry;
• Teams with proven track records or proven business models;
• Businesses in industries the VC team has expertise.

Start-up and Growth

Whether starting a new business or growing an existing business, financing is one of the most challenging and important issues companies face. Knowing what opportunities for financing exists and having a clear roadmap for obtaining financing can mean the difference between success and failure of many businesses.

Ryan A. Hintzen

Attorney

The Hintzen Law Firm, PLLC