Ownership Structure and Capitalization
Once the legal structure is decided upon, issues of distribution of ownership,
and distribution of risks and benefits may be addressed. The primary decision
to be made is whether the entrepreneur will finance the venture or whether
there is a need for other stakeholders, and whether these stakeholders
will be investors or lenders or some combination thereof.
Financing our venture by borrowing adds to our fixed costs, but makes
no claim beyond the amount of the debt no matter how great our success.
Standards for debt financing are generally very difficult for startups
to meet; lenders are not generally willing to share the risk with you.
If a lender turns you down, ask them for specific reasons. If the reasons
cannot be countered with this lender, the insight gained can be used to
strengthen the presentation to the next.
The advantage of selling shares of ownership to raise capital, referred
to as equity financing, is that the investor is sharing the risks of the
venture; this lowers expenses since there is no debt service to be paid.
The investor also shares the rewards, however, and the entrepreneur must
be careful not to sell the equity too cheaply.
What do we have to offer prospective investors? For most, their primary
interest is in a high return on their investment, through dividends and
appreciation. There is little appeal to most investors in being a long-term
minority owner in a closely-held business, so some way of "cashing out,"
must be offered, such as a provision for company buy-back or a public
offering.
Venture capitalists look for generally larger deals and impressive returns.
Many fund projects only in specific industries; some work only from referrals
from within their "network." Carol Steinberg, in "Success Selling," puts
the odds of receiving venture capital funding in perspective: "Each year
a venture capitalist fields 400 to 500 deals, seriously reviews 40 or
50, and funds only 4 or 5."
Less visible as a source of startup capital are individual investors,
known as "angels," who typically invest $50,000 to $250,000 in private
companies. While we must generally "recruit" such investors ourselves,
angels are thought to represent a significant pool of risk capital.
While stakeholders are hard to find at startup, sources of assistance
are available. A good starting point is the U.S. Small Business Administration
(SBA). Their Small Business Investment Company (SBIC) program allows private
investment partnerships, or SBICs, to leverage their own capital using
SBA guarantees.
