Finding the right financing for your business

Laura Lindsey, an associate professor of finance at the W. P. Carey School, is an expert on venture capital and private equity, governance and financial contracting. In this column Lindsey touches on finding the right balance when making the decision to finance a business, particularly a small one.

By Laura Lindsey  |  Associate Professor of Finance

The costs of starting a business — particularly in technology-related areas — have declined, but finding the appropriate type of finance has grown more complex as the range of options expands to adapt to new laws and modes of communication. Yet, the old joke about getting a bank loan only if it isn't needed still rings true. Young businesses usually get traditional loans only if they have assets that can be used as collateral or with a personal guarantee. And access to public markets is not generally available to small businesses.

That leaves alternatives under the private equity umbrella such as venture capital and angels, though nontraditional debt finance is also expanding. (The "equity" part means they take a percentage of ownership.) In addition, there have been innovations in crowdfunding, though equity crowdfunding is not yet allowed at a national level. Last, for more established businesses, there are new rules governing mini-offerings. We'll take each in turn. VC firms are intermediaries investing on behalf of large institutions such as endowments and pension funds.

Because of the large amounts involved, VCs need to put a lot of money to work and require highly scalable businesses. If your business can't use several million dollars and return eight to 10 times that amount to an investor if all goes well, traditional venture capital isn't for you. Angel is the term used for individuals investing their own money. Angels don't have to return money to an end investor after taking a cut of fees like traditional VCs, so they can tolerate lower returns. And, since there are as many different types of angels as there are people with investable funds, good opportunities can usually find a match.

Angels are a common source of funding for very early stage companies and businesses less scalable than what a VC requires. Finding angel investors is easier since the Jumpstart Our Business Startups Act allows companies to announce that they are seeking funds publicly, enabling the growth of online portals like AngelList and EquityNet, which match companies and accredited investors. Before the JOBS Act, a company could target only accredited investors who met specified wealth or income threshold levels. The JOBS Act also allows equity crowdfunding from non-accredited investors, but the U.S. Securities and Exchange Commission is still working out the details.

Importantly, companies currently using portals such as Kickstarter to raise money cannot offer shares in the company. This route is therefore best suited to companies with a product awaiting manufacture or for creative endeavors that will spark widespread interest. For businesses with almost all operations within Arizona seeking Arizona investors, however, only state laws apply. Companies can now raise up to $2.5 million with a $10,000 limit for any unaccredited investor, either face-to-face or online.

For more established firms, The JOBS Act raised the limit of a "mini" registration with the SEC from $5 to $50 million per year, and SEC rules for this provision become effective Friday. There are different requirements for firms raising amounts above $20 million, including ongoing audited financial disclosures. This increased disclosure allows companies to bypass the morass of individual state regulations widely believed to have limited use of the "mini" in the first place, although smaller offerings still will need to conform to applicable state rules in what is supposed to be a more coordinated process.

Also, don't overlook "strategic" investors, such as a corporate investor that may have an interest in your business's success. And, there may be niche opportunities such as accelerator programs, government grants and community funds. The key for any entrepreneur is to match the type of funding to the stage and growth prospects of the business. Otherwise, you'll spend a lot of time pitching the wrong source and most likely being told "no," even if it is still a good opportunity — for someone.

"Getting Started" is an entrepreneurship column by the faculty of the W.P. Carey School of Business at Arizona State University. Laura Lindsey, an associate professor of finance at the W. P. Carey School, is an expert on venture capital and private equity, governance and financial contracting.

First published in The Arizona Republic, June 15, 2015.