Be Careful What You Wish For
Many startups and small business are always on the hunt for outside capital in order to boost growth, take themselves to the next level, or just relieve the pressure of the every day grind and anxiety of worrying about meeting their obligations, particularly in the short-term. Additionally, when an investor or a lender agrees to provide a business with capital, it instills a sense of confidence in the owner or management team — a confidence that someone else agrees with their vision and sees the potential for success.
While in many ways, obtaining capital can be a savior, it is important to realize that it comes with strings, and it introduces other entities into the business — other entities with varying perspectives, experiences, goals, and interests. In a variety of ways and to varying degrees, these new entities will leave their mark on a business and will shape its direction.
Therefore, it is extremely important to not only understand what type of capital to take on, equity, debt, or a combination of both, but also, who that capital comes from, and what strings are attached to it. The wrong decision can have catastrophic effects, even to very profitable businesses.
What Fits my business
Not all capital is equal. There are different types of debt and different types of investment. In fact, the very same loan with identical terms can differ significantly simply based on the business model or “personality” of the lender.
It is important to truly set and understand the goals — short and long term — in order to decide what type of capital is best for the business. If the issue is having cash for short-term operational needs, a line of credit may be appropriate. Depending on the type of business and its ability or appeal to traditional lenders, it may be better to consider some form of factoring.
However, if the purpose is a new business venture, or a new product line, capital investment will likely be more appropriate. Lines of credit, while good for short term operational needs, will likely not have the flexibility needed for the risks associated with new ventures. The same is true with most term loans. This is not even considering the fact that loans come with some form of regular interest payments.
What Strings Are Attached
It is always important to remember that all things come with strings attached to them. Too often, entrepreneurs see dollar signs, and immediately drift into what they can do with those dollars, boosted by the knowledge that some other person (the capital source) sees the potential in their vision. They pay little attention to the strings that are attached to those dollars.
As long as things are going well, many of the strings will not come into play — although plenty do. In fact, it is not uncommon during the initial “honeymoon” period for busines owners to view their capital sources more as partners in the business. And during good times, it may well feel that way. It is usually when things do not go as expected that the strings come into play.
Over the years, capital sources have availed themselves of significant contractual advantages which find their way into their increasingly voluminous contracts which can take up hundreds and even thousands of pages, even when they involve small businesses. These provisions allow them to use various self-help — or extrajudicial — remedies as well as obtain immense advantages if the legal process is invoked. In many cases, if a dispute arises, businesses will be at significant disadvantage to assert their rights, and in some cases, may be stripped of them altogether.
Therefore, it is extremely important, if not vital, to the survival of the business to assure that the documents are reviewed by an expert, and all of the “fine print” is considered carefully.
Who Is the Source
Perhaps as important as the type of capital involved is the entity or person who supplies that capital. These sources have their own business models, protocols, and outside pressures that significantly drive their approach to capital and those to whom they provide it.
Even traditional banks can have completely different approaches and programs depending on whether they are federally regulated, or a small state bank. Private equity firms approach capital in significantly different ways, though they may be more flexible in many respects. And all of these entities react differently to economic pressures, regulatory issues, and investor relations.
Again, this makes it important to approach an expert when dealing with a capital source in order to properly navigate through the maze of sources and select the appropriate one.
Capital is vital to the survival of any business. At the same time, even when one is successful at obtaining capital, the wrong choices can be fatal. That same vital capital can easily spell doom.
