The Maryland Entrepreneur's Guide/Private Financing Programs
Chapter 1 Private Financing
Financing a new or emerging business through private means occurs in a variety of ways. Examples include equity financing and loans from sources other than a government agency or program, advance payments from customers, factoring receivables, and gifts from family members. As used in this Guide, “equity financing” means the sale of an ownership interest in the business to an individual or entity in exchange for cash or other property that the business can use to fund its operations.
Private Equity and Loans
In addition to personal and family-member contributions or loans, angel investors and venture capital are popular methods of financing a business in its early stages of development. Choice of entity (see Chapter 9) will have an impact; independent investors and lenders will generally require an entity form that, among other things, protects interest holders from personal liability and has structured management.
Angels are wealthy individuals who invest in the early-stage of start-up companies. The benefit of using angels for early-stage financing is that it is less complicated and generally requires less expense than venture capital financing. However, there are downsides to using angels. Often these individuals can only provide a one-time investment, which may require a greater number of investors to provide all of the needed financing and create an administrative burden. Also, many times angels are not sophisticated investors and may have unrealistic expectations regarding the return on the investment. When financing is obtained from angels it is important for the entrepreneur to ensure that the angel is an “accredited investor” under securities laws.
Venture capital is a fund of pooled investments that is managed by a venture capitalist. It generally becomes involved in the early stage of a company with the intent of growing the business, where a return on its investment will be realized through an eventual IPO or trade sale. The benefits of venture capital are that the funds generally have enough resources to provide much of the company’s needed financing, and many venture capitalists can also provide assistance with general business issues, including formulating a business strategy, recruiting, and providing introductions into the business community. However, the downside of using venture capital is that it requires shared equity, and many venture capitalists insist on also sharing control of the company (usually through representation on the board of directors). This financing is generally not available to smaller start-up companies, as the venture capital funds generally desire to make investments upwards of $500,000 to $1,000,000.
Crowd funding, also known as crowd financing, describes the collective effort of individuals who network and pool their resources, usually via the internet, to support efforts initiated by other people or organizations. In the context of start-up businesses, crowd funding involves selling small amounts of equity to many investors. This form of funding has recently received attention from policymakers in the United States with direct mention in the JOBS Act; legislation that allows for a wider pool of small investors with fewer restrictions. The JOBS Act was signed into law by President Obama on April 5, 2012. The U.S. Securities and Exchange Commission has been given approximately 270 days to set forth specific rules and guidelines that enact this legislation, while also ensuring the protection of investors. Some rules have already been proposed by the SEC.
Accessing Private Equity and Loans
Active Angel Groups
An active angel group consists of high net-worth individuals who join together to invest collectively in entrepreneurial firms. The active angel group meets regularly (often monthly) to review business proposals. Often entrepreneurs are asked to make presentations to the membership of the group. If the active angel group decides to make an investment in a start-up business, the angels work together to conduct "due diligence" to validate the business plan, statements and history of the entrepreneurial team.
The members of active angel groups tend to be former entrepreneurs themselves and are attempting to make a return on their investment, but often are also trying to “give back” to their communities by spurring economic growth, which leads active angel groups to want to invest locally as opposed to nationally.
Some active angel groups are more likely to invest in firms that are recommended by people they trust; therefore, it is important for entrepreneurs to network in the local community to gain a referral. Examples of people to contact include: entrepreneurs who are backed by angels, attorneys who specialize in equity investments in start-up businesses, accountants and business counselors.
Process: Active angel groups typically conduct several stages of review before making funding decisions. While no two groups of active angels are alike, below is a general list of stages of review:
1.Application/Business Plan Angel group websites will contain information regarding the process to complete their application, which often requires submission the entrepreneur’s business plan.
2.Pre-Screening Once an application has been completed or a business plan has been submitted, the angel group will review it to determine if the potential investment opportunity meets the angel group’s general requirements and investment preferences.
3.Screening If an application is accepted for further review, the entrepreneur will often be asked to meet with a subset of the active angel group to allow the group to further understand the nature of the potential investment, receive more information regarding the business plan, and answer the angels' questions.
4.Investment Meeting If the angels in attendance at the Screening stage show interest in the entrepreneur's business, the entrepreneur will be invited to present in front of a meeting the entire active angel group. The presentation will be followed by a question and answer session. These types of investment meetings are usually held on a monthly basis.
5.Due Diligence If the entire angel group shows interest in the business, a period of due diligence will begin. This due diligence will be conducted by those angels and specialists with knowledge of the specific industry under consideration. The due diligence will be a thorough review of the entrepreneur’s business plan and business including the management team, marketing opportunities, a site visit, customer calls, and financially analysis. This process can take anywhere from a few weeks to a few months.
6.Term Sheet If the angel group decides to invest in the entrepreneur, a term sheet for the investment will be negotiated. This term sheet will guide the lawyers in preparing investment agreements and will determine the relationship between the angel group and the entrepreneur.
Examples of Active Angel Groups:
Angel Capital Association: Association of angel groups that provides information and education for entrepreneurs on angel investing.
New Vantage Group: Angel group focusing on Mid-Atlantic region.
Kaufmann Foundation: Provides advocacy and education for entrepreneurs.
Dingman Center for Entrepreneurship: Focusing on student entrepreneurs.
Venture capital firms are usually organized as a partnership where the firm acts as an investment advisor and the general partners are professional investors who manage funds looking to make investments that may be high risk but yield above-average returns. The firms vary their investment strategies -- some being industry specific, some operating only locally or nationally, and some preferring to invest in only businesses at certain stages of growth. Oftentimes the goal of a venture capital firms is to develop an emerging company to the point it can "go public."
Process: Venture capital firms go through several steps of research and planning before making funding decisions Their vetting process is similar to active angel groups, but they are typically more involved in the development and growth of the business once invested.
Examples of Venture Capital Firms:
National Venture Capital Association: Venture capital firm offering investments to a full range of professional services.
Gabriel Venture Partners: Early-stage venture capital investors.
Highland Capital Partners: Venture capital for early-stage and growth-stage companies. Emphasize information and communication technology, healthcare, and internet and digital media companies.
Valhalla Partners: Venture capital firm that invests in early-stage companies primarily in the technology industry.
Signature Capital LLC: Invests in early-stage growth companies that have received no prior significant funding in a variety of industries.
Propel Baltimore Fund: Angel fund managed by the Maryland Technology Development Corporation (TEDCO) focused on early-stage companies located in, or moving to, Baltimore City. The fund invests in companies with compelling new technology ideas or innovation-based business plans.
Springboard Enterprises is an organization designed to foster women business entrepreneurs by supporting emerging companies led by women. It describes itself as a "go-to organization" to obtain information and support for women-led emerging companies. This support is intended to accelerate access to equity markets for women-led companies by offering workshops and seminars, membership programs, education, coaching, connections with investors, forums, and a web-based learning center.
1. Venture Forums are designed to feature women-led emerging businesses in front of venture capitalists.
2. Educational programs are offered to provide information regarding the equity markets and building a new company.
3. The Learning Center is an online site designed to provide women entrepreneurs with a "virtual boot camp" regarding the equity raising process. The site contains resources designed to help women better understand the process of obtaining financing for emerging companies. The site contains tutorials on fundamentals of the equity market, creating a pitch, preparing a business plan, and other tools, resources and videos.