Funding Your Business
When deciding how to feed your business the capital it will need, you essentially have three options:
- Bootstrap
Try to imagine someone picking himself up by his own boot straps! While it may seem impossible, it really can be done in business if you have enough time, patience and energy.
The idea is simple: you don’t use anyone else’s money. You just work long and hard. You earn, by yourself, what you need to get started. And then you use the profits from your own sales to fund the growth of your operations.
The advantages of bootstrap are pretty obvious. When it’s time to earn dividends, you don’t have to share them. The profits are all yours.
The main disadvantage is, it will probably take you a lot longer to grow your business. Efficient markets are usually pretty good at limiting net profits to around 15 or 20 percent of sales. So even if you plow 100% of your profits back into growing the business, you will still be limited to that same rate of growth. Furthermore, you’re not going to be taking any profits for yourself for quite a long time.
In contrast, a business funded with outside capital can be scaled at a much higher rate. Instead of being constrained by capital, you will only be limited by your ability to sell and then to fulfill those orders efficiently.
The challenge for anyone starting out a new business is to figure out: Can you make more money by giving away some of your profits to a capital partner so you can grow faster? Or is it better to be satisfied with slower growth and keep all those eventual profits for yourself?
The answer will probably be different for different business models. Try to project how your business is going to work and do what is right for you.
- Debt
If you have determined to use other people’s money to grow your business, debt is generally the least expensive option. This idea too is pretty simple: You borrow money at a fixed rate of return. You have to pay it back whether your business is successful or not. But once repaid, the debt goes away and you can again begin to keep the profits for yourself.
The least expensive kind of debt usually comes from a commercial bank. But it can also be pretty difficult to quality for--especially if your business is new and doesn’t have any kind of a track record.
Private debt is considerably more expensive, in comparison to bank debt. But if you structure things correctly, it may not matter as much as you think. The cost of debt is generally measured by an annual interest rate. So a key factor is how long you have to carry the debt.
Clearly if your debt goes on perpetually, it can get pretty expensive and the interest rate will much more critical. But if your business is profitable enough, sometimes you can use debt in the beginning to get things started. This allows you to ramp the business up to a healthy volume much more quickly.
Then, by slowing down your growth to a manageable rate, you can get your debt paid off and then shift back to more of a self-funded model for the longer term. Or, if you want to keep growing, chances are you have a more impressive track record by now and have a better chance to qualify for less expensive bank debt.
The point is, if you only carry the more expensive private debt for a relatively short time, the interest rate may not be as critical since the total cost of the debt can still be relatively small--especially in comparison with the benefit of getting your business launched into a health growth rate!
- Equity
Many people starting out in business instinctively want to seek equity funding. In this model, you give away a portion of the ownership of your company from the very beginning. Your capital partner contributes cash to the deal in exchange for a share of your future profits.
An equity partner is taking a much larger risk by investing in your company because he only expects to get repaid if and when the business is successful. If it fails, he may lose everything.
This is why many entrepreneurs want equity funding--because it shifts a large amount of risk to the investor. If the business fails, you are not left with a debt to repay to your creditors. But if you are lucky enough to find an equity investor during the early phase of your business, chances are, he will take a very large piece of your business, and ultimately for not all that much money. So while equity funding does reduce risk in many instances, it is generally the very most expensive way to fund your business. You often have to give up half or more of the ownership and you may well lose management control as well.
If you are in a very competitive or fast-moving market, you may not be able to wait around for bootstrap growth rates. Then, you will probably need a capital partner.
If you are very confident your business will be a success, debt funding is the way to go. True, you incur a debt you must repay regardless of the success of the business. But if you are really that confident, the rewards later will be worth the increased risk.
If you are not so sure how the business will work out, it would certainly be nice to find a capital partner willing to fund the business in exchange for a large chunk of the future profits. But if you are not so confident of success, it is probably going to be hard to find an investor who is.
The reality is, most businesses that succeed utilize a combination of funding methods. For example, someone has to have enough vision to invest equity in the business. Chances are, this is you--pouring your sweat equity in to get things started by sheer force of will.
Eventually, as your business begins to work on a small scale, others will begin to see your vision. And this will make outside debt and/or equity a stronger possibility. So don’t give up, just because other people might not understand the value of your business model. Keep working your plan. If it is a good one, you will eventually be able to demonstrate that to others.
About Private Funding
Most commercial banks are pretty conservative about what kind of deals they will fund. If you have a good credit history and several years of predictable net income, your chances of securing bank debt are pretty good. But if you are just starting out and don’t really have a good track record yet, bank debt can be very difficult to obtain.
This is where private funding comes in. Private credit is extended by regular business people just like you. The main difference is, you have an idea and not enough money. They have money but may not have your idea or your energy and determination to see it through to success. By making their capital available to you, they hope to earn a market return while you are making your business a success for yourself.
Private investors have a variety of things they could put their money into. Most notably, they might instead just buy one or more commercial properties and rent them out to existing, successful businesses.
This kind of investment may only yield 7 to 10 percent each year. But once in place, it can provide a reliable return for 5 to 10 years, or longer without a lot of maintenance or fuss. It is also pretty low risk.
If you hope to direct this kind of investment capital into your own business, you will have to provide a better return. And if your venture involves a lot of risk to the investor, the return you offer may have to be much much higher.
As a rule of thumb, you should expect to offer a return in the range of 12 to 24 percent to a private capital partner lending money to your business. You should also be prepared to convincingly guarantee that debt. Chances are, this will include providing some asset as collateral to secure the loan.
At a rate of return in this range, your capital partner does not want to take much risk on your business. He is counting on you to bear that risk. After all, he is only earning a fixed interest rate. You are the one who will enjoy all the profits when your business eventually becomes wildly successful.
If you can’t guarantee a private loan, you may have to resort to equity funding. But you should probably plan on eventually giving up at least half of the business ownership. You may have to raise multiple rounds of funding, so try to start out slow if you can. Sell as small a part of your ownership as possible for as much money as you can get. Because each time you issue more stock to sell, you may potentially face additional dilution of your own retained ownership.
Ridgeline Capital’s Role
Ridgeline wants to be your resource for all your funding needs. How do we do this?
First, we want to be a helpful resource to help your business become as successful as possible. If we can help you avoid the need for much outside funding, that can be a great service just by itself. If you do end up needing some outside funding, and can do it with debt instead of with equity, that can help you greatly maximize your own profits in the future.
So first, we are here to offer what advice we can. Then, if your business can benefit from some kind of private debt funding, we would like a chance to provide that for you.
If you choose the equity funding route, we don’t usually provide that directly. But we do have a variety of associates who do. And we may be able to find just the right partner for you.
So give us a try and see if we can find the right solution to best fit your needs.
Is it Really Hard Money?
A loan from Ridgeline Capital can fairly be called a “hard money loan.” We might also call it an “asset loan” or a “private loan.”All this means is:
- You will be borrowing from other private business people--not a bank.
- You should be prepared to pay market rates for private money--not necessarily the lower rate you might expect from a regulated bank.
- You are assuming the risk for the success of your business. Don’t expect your creditor to share in that risk.
- You will need to provide one or more assets as collateral to secure the loan. If you don’t have any such asset, maybe one of your existing equity partners does.
- We are not in this to take your collateral. We would much rather just get paid our principal and interest, within terms so we can cycle it back into the next deal.
- And if you do fail to repay the loan within the agreed upon terms, we want to take reasonable steps to help you work it out, if possible.
- But if you can’t or won’t work it out, you can lose your collateral.
When you apply for a loan with Ridgeline, we will evaluate all the parameters of your project. This typically focuses on the value and quality of the proposed collateral, and the requested term of the loan. Once we have completed this review, we will respond--hopefully with a proposal.
If your project meets our internal parameters, we will provide a proposal to fund it directly through Ridgeline. Otherwise, we may attempt to place the deal with one of our associated groups who are a better fit for your project metrics.
Smaller loans can be managed using Ridgeline’s internal funding pool. For larger loans, we will bring together a group of ad-hoc private participants who will each contribute a portion of the capital needed for your loan. Up until this point, you will not be expected to pay any fees or incur any costs.
If you find the Ridgeline proposal acceptable, you will next be expected to sign a term sheet outlining the general parameters for the proposed loan. This will include the term, the loan amount, the interest rate, and the proposed collateral.
Once you accept the term sheet, we expect you to follow through and close on the loan as agreed in the term sheet. If you do not, you are still expected to pay the costs incurred by Ridgeline in connection with preparing your loan package. This may include due diligence costs, attorney fees, title costs, and the like.
In order to secure your obligation to cover these costs, you will likely be asked to post a deposit, or to authorize a lien on the collateral property, where applicable. Any portion of your deposit that has not been expended on costs or earned fees is fully refundable.
OK, How do I Get Started?
Click through to our Application page and select the type of project that best describes what you are working on. Fill out the selected form, being as descriptive as you can on each item. Submitting this form will start the process.We will then attempt to line you up with the best capital partner for your needs. That might be a loan from Ridgeline Capital. Or, it might be with one of our associated lenders. If you are seeking equity funding, we may refer you to one of our associates who can evaluate your business further.
If you don’t yet have enough critical mass to support outside funding, maybe we can help out with some pointers and advice, including the information on this site. Hopefully, you can keep working your project, and eventually build the capital base you need to make your business a success. If we can, we would like to help you get there!