This is a common scenario for early stage companies. They raised an initial round that got their product to market, got them selling, and now they have the orders, but they can’t deliver because they don’t have the capital to build the widgets or fund the salaries of their workers while the project is being implemented or software installed. They can try to go back out to their existing investors to get more money by selling more equity, or try to attract new investors and sell equity. The problem is that that want to sell it at a higher valuation so they can minimize the dilution of their own shares and their initial investors. Unfortunately without the new revenue and completely proving the business model, they may find it hard to justify a significantly higher valuation and that means more time to raise the capital. Time that they don’t have if they have a customer waiting on the product, service, or application to be delivered. It is the proverbial – Rock and a Hard Place.
What are their other options?
- Offer a Bridge Loan to their private investors — go back to their most ardent investors and ask them to provide a 90 day or 120 day note secured by the order and earn pure interest – reg lender rates + .5%. Roughly pay them 1.5% each 30 days on the loan.
- Seek Alternative Financing – Purchase Order or Contract Financing linked with Accounts Receivable Financing — In this scenario, an alternative lender provides a “letter of credit” for the “Cost” portion of the order. It is is tied to the order and the credit rating of the company issuing the order. The company draws down on that letter of credit to pay the specific things related to the order. When the order is shipped or delivered and billed to the customer, the financier flops the switch on the ‘factoring’ the receivable and pays off the letter of credit and advanced capital to company that is the difference between the letter of credit amount and the amount that equals 85% of the value of the full order. When the customer pays, the remaining 15 % is paid to the company less their financing and processing fees, usually about 10-12% more.
Learn more about how this works from an Angel Investor who is also a source for Alternative Capital from a previously recorded Podcast on the Compassionate Capital Radio Show:
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During the last few years, we have survived one of the worse economic downturns. The new “normal” by many standards is a 10 year set back. Money is like water, it finds a way to flow and come together to multiply. Leading up to the economic crash of 2000, we saw an increase in angel investing triggered by the increase in venture capital investment. As more companies were going public, we saw an increase in day trading as a means to quick wealth. These were enabled because big money from retirement funds, private equity funds and family funds invested in the venture capital funds and took large positions on companies in their initial public offerings.
When it all imploded and the bubble burst, it took a couple of years but angel investing and venture capital investing came back. The intrinsic value of investing in private companies in their early stage was not in doubt, it was the process – how companies were identified and vetted that was in question. Investor groups became more formalized, with better pre-screening, due diligence committees, and terms negotiation. Similar economic conditions exist now. The difference in then and now is that most of the people participating in the growth of angel groups in the mid 2000s were successful high-tech entrepreneurs investing in similar companies to influence a repeat of their prior success without the full cost of time and capital in starting and growing a company.
As an economist, who has worked with angel investors for over a decade, I have identified 6 reasons why private equity investment will be the next “hot” asset class for high net worth men and women that want to create generational wealth.
- Increase in Risk Tolerance: In the last decade, fortunes have been lost in real estate and the stock market. As investors become more sophisticated and become aware of the ability to invest in private companies because of the buzz surrounding “crowd funding”, they are willing to take the risk because the potential for return is greater than with other asset classes.
- Quasi Public Offering: Market Makers are going to be looking for new places to put money and the new rules on general solicitation open up opportunities, awareness, and access to private companies. Private companies raising capital under a 506c will be the next favored market place because it’s easier to directly reach investors to create the market for that stock.
- Return on Investment: Early stage companies that have received private equity investment from angels have found a ripe market to sell their companies to larger corporations even before they need their B & C round of capital. Early investors are not as diluted and the timing for exit is shorter than for companies trying to grow to the point of being able to go public.
- Increased Value: Angel Investors already know the early stage company’s value is at the bottom and will either go up or go out of business, but the investors can impact the company’s value success through their involvement than they can with a public company.
- Safety in Numbers: With the advent of strong collaborative investor groups and investor portals designed specifically for investors to be able to identify, investigate and invest in early stage companies the way eTrade provides that access to public companies, individual investors have an opportunity to collaborate with on early stage companies.
- Efficient Use of Capital: The cost to launch a company is lowest so the investment dollar goes further. Young entrepreneurs can join incubators that are associated with either universities or as part of an economic development initiative in their area.
Watch this space — angel investment will become one of the best asset classes for sophisticated investors to increase their wealth as the economy continues to rebound and early stage companies continue to have ample access capital to grow profitably and create jobs.
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