Equity Financing

It is hard for most small businesses to get the financial support that they need because of how low the success rate of small businesses is. Banks want to lend money to people that are lower risk. Only 35% of small business will ever see their tenth year (Birch, 2010). Shaefer (2011) noted the Small Business Administration published statistics showing 51% survive at least five. Small businesses tend to have to rely heavily on the owners initial investment coupled with bank credit.

Lenders aren’t going to want to stick their necks out for a small business if they aren’t sure they will be around 5 years from now. The high risk of start up businesses is what keeps most of them from the financing that they so desperately need. According to research done by the Small Business Administration (2011), 60,837 small businesses went bankrupt in 2009. Banks want to keep themselves as distanced as possible from these situations. The good news is that the Small Business Administration believes that credit conditions for entrepreneurs are improving. “In mid-2010, commercial banks began to ease the tight lending conditions on small businesses that had begun in early 2007” (Small Business Administration, 2011). With all of the issues that arise with lenders today, it is a frequent occurrence small business owner’s look elsewhere for equity financing. Three available sources of equity financing are partnering, corporate ventures, and public stock sale.

Partners

            Deciding to partner with someone who has a large capital base to invest into the company is one of many available forms of equity financing for small business owners. “A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business” (IRS, 2010).  The decision to add a partner to a small business should not be taken lightly because it has a major impact of all aspects of the business.

The advantages of partnering with someone who already has access to the funds needed to grow the small business means that no one would have to worry about paying back the money or the amount of interest accruing each month. You also gain someone with valuable insight into how to run the company. Since the partner would be as equally as invested in the company as you, you gain someone who wants to see the company succeed as much as you do.

The disadvantages to taking on a partner begin with the fact that you are giving up some of the personal control that you had when you started the company on your own. Someone else has a say in how the business is going to be run and if the partners don’t agree, a sticky situation can arise. Going this route runs the risk of losing control over the way you do business. You also have to share the company’s profits with the partner. The more diluted the founders position in the company becomes, the greater the risk there is of losing the control over the decision-making process.

Corporate Venture Capital

            A corporate venture capitalist is an established corporation who is willing to fund the capital needs of small businesses with promising growth potential. They do this in hopes of large financial returns on their investments when the small companies succeed in addition to the ability to influence a company to develop products that would be beneficial to them. “Established corporations seeking growth today face an increasing need to innovate” (MacMillan, Edward, Livada, & Wang, 2008) and funding a small business that has the potential to develop the innovation that they need is a driving force.

Some corporate partners can not only provide the funds that the small business needs, they can provide “technical expertise, distribution channels, marketing know-how, and provide introductions to important customers and suppliers” (Scarborough, Wilson, & Zimmerer, 2009). Most corporate venture capitalists are credible in their claims that they have enough money to fund a small business’s needs.

The disadvantages of accepting equity from corporate venture capitalists are very similar to those associated with starting a partnership. Any time that the founder’s position in the company is diluted, they run the risk of losing control over the company. Surrendering control or interest in the operations of a company can be detrimental for any founder. Unlike partnerships, these venture capitalists usually leave the managing up to the management of the small business however; venture capitalists commonly join the board of directors of the companies they invest in which means they would no longer be playing a passive role in the business.

Public Stock Sale

To initial the public sale of stock, a small business sells an initial public offering of shares to the general public. These initial public offerings are known as IPO’s. It gives millions of people the opportunity to own a small piece of the company. “In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market” (Investopedia, 2011).

The advantages include having the ability to raise larger amounts of capital than they would have been able to through a partnership or corporate venture. There is also a lesser loss in control because a large group of people are buying shares, so their percentage of ownership in the company is rarely enough to give them a say in the way the business operates. Being a publicly traded company reflects positively of businesses because it becomes more visible as well as enhances the businesses competitive position. The process also boosts the net worth of the business and makes it easy if the company decides to seek more funds in the future.

The disadvantages of public stock sales begin with the inordinate amount of red tape and hoops that a small business has to jump through to do so. It is very expensive and can put financial burden on a small business for extended period of time. It is time consuming and changes the way that business is conducted forever. It is also close to impossible for a business worth less than $25 million in annual sales to go public (Scarborough, Wilson, & Zimmerer, 2009). Companies will also lose a significant amount of privacy as being a publicly traded company requires a certain level of transparency in regards to business practices, finances and so on. The businesses also have to worry about the fact that they are becoming accountable for reporting to the SEC and meet all of their requirements on top of the accountability that they have to their shareholders.

Conclusion

Giving everything that is known about these three available equity financing alternatives, I believe that the best of the three is corporate venture capital. It would leave Andy with a modest amount of control in his company. It would also open the doors to the potential for Andy to create innovative products. He would gain knowledge in his industry while growing his own company and could potential make the company much better. Corporate venture capital is the most promising for of equity financing for Andy and Custom Stitches.

References

Birch, D. (2010, October 18). Bahrami Business Solutions. Retrieved October 24, 2011, from Interesting Stats on Small Business Success Rate: http://bahramibiz.com/blog/2010/10/18/interesting-stats-small-business-success-rate

Investopedia. (2011). Investopedia. Retrieved November 2, 2011, from Initial Public Offering- IOP: http://www.investopedia.com/terms/i/ipo.asp#ixzz1cb6VndBu

IRS. (2010, September 30). IRS. Retrieved November 2, 2011, from Partnerships: http://www.irs.gov/businesses/small/article/0,,id=98214,00.html

MacMillan, Edward, Livada, & Wang. (2008, June). National Institute of Standards and Technology- U.S. Department of Commerce. Retrieved November 2, 2011, from Corporate Venture Capital (CVC): http://www.atp.nist.gov/eao/gcr_08_916_nist4_cvc_073108_web.pdf

Scarborough, Wilson, & Zimmerer. (2009). Effective Small Business Management. Pearson Education.

 Shaefer, P. (2011). Business know how. Retrieved October 25, 2011, from The Seven Pitfalls of Business Failure And How to Avoid Them: http://www.businessknowhow.com/startup/business-failure.htm

Small Business Administration. (2011, January 19). SBA Office of Advocacy. Retrieved October 25, 2011, from Frequently Asked Questions: http://www.sba.gov/sites/default/files/sbfaq.pdf