Friday, January 30, 2009

Are there alternatives to VC/Angel Financing?

In a recent blog post, I discussed some questions that an entrepreneur should ask himself to determine whether his company is more suited to venture capital financing or angel financing. However, in doing so, I did not mean to draw a false dichotomy between the two or to imply that these were the exclusive ways to capitalize successfully an emerging growth business.

In fact, in some sectors (such as medical devices and biotech) many early stage businesses have at least as good, if not better, luck obtaining financing from strategic investors (such as big pharma or the large medical device firms) than they do with financial investors (such as VCs or Angels). Moreover, the strategic investors can provide more than just financial resources. For example, they can provide distribution support, OEM or manufacturing services and perhaps they may be willing to partner up/joint venture with the entrepreneur to pursue a particular technology.

Another possibility for an entrepreneur is to forego third party financing entirely and fund growth internally (with possible friends and family support). This "bootstrap" approach, although not always possible, may well be the best financing approach of all for an entrepreneur, since he will retain the vast majority of the equity in the business.

A third possibility, is venture debt. These sort of debt is available from a group of lenders that focus on growth stage companies which likely could also obtain venture financing. By taking an equity kicker in addition to their loan (often in the form of a warrant), these lenders are able to "juice" their potential returns and take a relatively lower return on their investment than a VC fund would expect. For a broader description of the typical emerging growth company financing stages and their relative target returns, check out my blog post here.

A final financing possibility for an entrepreneur is straight debt. This could be A/R or inventory based financing or it could be a bank line secured by the entrepreneur's personal assets (sometimes through a guaranty). Or it could be an SBA backed loan. In addition, the start-up field is filled with companies that finance their early growth using their founder's credit cards. Either way, when available to an entrepreneur, debt can be a much less expensive form of financing than any type of equity. Plus, by using debt instead of equity the entrepreneur maintains control.

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.