Choosing the Right Venture Capital Alternative

Venture capital financing sounds sexy for a reason. It’s where some of the largest institutional cash gets siphoned and where some of the biggest capital raising deals occur …

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Venture capital financing sounds sexy for a reason. It’s where some of the largest institutional cash gets siphoned and where some of the biggest capital raising deals occur before companies eventually go public. It’s also where equity shareholders get squeezed the most. The idea of a “vulture capitalist” exists for good reason. Here are some motivating factors that should steer you far away from the VC den:

  1. Venture capitalist terms are heavily weighted toward the capital providers and not the company toilers.
  2. Venture capitalists almost always require equity as consideration for capital placement. Equity is the most expensive form of business finance.
  3. In worse case scenarios, VCs look for equity control and multiple seats on the board.

Luckily the number of alternative business financing options available to entrepreneurs has skyrocketed in recent years. Finding the best venture capital alternatives typically requires a keen understanding of the options, both new and traditional, on the market and the relative cost and benefit of each. Generally, financing outside the realms of venture capital can be thrown into either the debt or equity bucket.

Debt Options

While the types of available debt range across the board, debt can be one of the least expensive options for financing a business–especially one with the cash flows to be able to handle the debt load. Here are some options available on the debt side to facilitate working capital needs for nascent, growing and established firms alike:

  • Asset-backed senior debt
  • Senior subordinated debt
  • Convertible subordinated debt
  • Redeemable preferred stock

The bottom three fall into the bridge or mezzanine financing category–meaning they fill the gap between the more stringent asset-back, senior debt required by most traditional banks and lending institutions and the equity squeezed out by most venture capital firms. It’s important to note that this form of financing is best used with companies that have existing cash flows that can cover the cost of the debt. Startups are often not as equipped for complex financing commitments. This is most often true because they lack the funding required for legal preparation or the ongoing cash flows to facilitate the debt burden. Established firms and, in particular, those looking to perform leveraged or management buyouts will some of the aforementioned options the financing of choice for facilitating merger and acquisition deals.

Equity Options

In the scheme of financing, equity falls into the most expensive bucket of all. Equity ownership in any entity is costly because the typical ROE has an unlimited upside, particular for companies with high growth or potentially high growth many years into the future. Selling equity means sacrificing potentially unlimited returns. Debt, on the other hand, has a finite and definitive rate of return. Debtholders certainly are first in line at the trough in the event of bankruptcy, but they’re not even in line at all in the event that the company has a common stock liquidity event. Since such events are where all the upside remains, debtholders come away empty handed (unless the debtholders include convertible mezz lenders).

Today’s business owner now has more available options on the equity side than ever before. With new promotion options, including general solicitation and crowdfunding options for private placements, the ability to raise money in the private markets is now easier than ever. And, for the truly brave, options for alternative and direct public offerings can provide equity financing to a far more broad group of retail shareholders.

Deciding how to avoid venture capital for financing growth and working capital needs is no easy task. In reality it’s a roulette game where the player typically ends up picking his/her own poison. Each options should be carefully weighed against the short and long term costs, the relative benefits and the expected outcome of the business potentially far into the future.

 

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