Financing Options for Small Businesses

In this day and age, the business of small business is under increasing threat from cyber criminals and others who would love to prey on small businesses using modern technology to make money. Law and economics advise that small business owners must begin to protect themselves by considering cyber threats, and developing strategies to mitigate these. There are three key principles that small business owners need to understand and apply:

small business|small business

Financing Options for Small Businesses

In this day and age, the business of small business is under increasing threat from cyber criminals and others who would love to prey on small businesses using modern technology to make money. Law and economics advise that small business owners must begin to protect themselves by considering cyber threats, and developing strategies to mitigate these. There are three key principles that small business owners need to understand and apply:

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Individuals and firms that elect to work with angel investors (i.e., wealthy individual investors) do so for one reason: they can raise “roundly” capital. Angel investors are sophisticated and experienced. In fact, most angel investors operate as private equity firms, retaining more than 50% of the investment in each deal. Angel investors have neither financial risk nor strict guidelines about their portfolio, making it easy for them to provide venture capital to growing firms. However, despite their advantages, angel investors should only consider investing in startups that clearly meet the following three requirements: a solid business plan, a significant management team and strong business development.

Most law and economics advisers recommend entrepreneurs obtain either a “round robin” or a “semi-round robin” equity injection. A “round robin” is given to a company in its initial public offering. A semi-round robin requires subsequent investments of additional financial capital from venture capital firms. A good attorney or small business consultant will be able to help you determine which type of financing is appropriate for your company. An attorney or consultant also will be able to help you realize any tax benefits that may be available to you through existing corporate governance policies and procedures. The investment may also be tax deductible, depending on the nature of the business and the type of securities used to finance the deal.

Outside investors are another major source of venture capital. These investors typically purchase shares from the firm at an upfront rate without having to shoulder any of the related costs. Generally, they provide more financial capital than either a traditional partnership or an individual investor, but retain the risk of non-recourse (the property and assets of the firm will be lost if it is unable to pay the dividends). Outside financing can be helpful for a firm that is in relatively good financial health, but outside financing should not be used if the firm is experiencing financial difficulties due to factors such as poor market timing or limited financial resources.

Private placements can provide seed money for relatively small businesses. Underwriters purchase a specific number of shares from the firm and then resell them to institutional and other financial investors. They retain complete control over the equity and therefore invest their own personal funds. Institutional investors use the proceeds to earn profits on their own while other third party resellers purchase the same shares for a profit.

Venture capitalists are investors that pool their financial capital with outside investors. They use the funds to acquire new firms, pay existing firms for shares in their companies, or make investments in certain industries. The proceeds from this type of funding are not immediately returned to shareholders since they are given based on the performance of the partner firm.

Investing in options is another popular method of obtaining external financial capital for a small firm. This involves issuing notes that will be traded in either a preferred or an option position. If the option is held to maturity, the profits are shared between the stock holders. Options generally have higher trading commissions than bonds and are less correlated with actual equity market prices. For this reason, they offer higher earning profits to investors, but there is also a greater chance of losing money if the investment does not produce expected results.

Some firms choose to issue stock in an organized transaction. In this case, the issuing company issues stock directly to all shareholders in a transaction, usually through a broker. If the company makes a profit, all shareholders receive dividends to boot. However, if the investment does not produce expected results, some of the issuing stock may be forced out, resulting in additional share losses for investors.

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