In finance, debt solutions are ones in which money is borrowed in exchange for interest. In practice, large companies sell bonds. With small business, this typically comes in the form of borrowing from a bank or other financial lending institution.
It should be noted that Businesses that are Limited Liability Corporations, S-Corporations, or C-Corporations offer financial liability protection. This is unlike a sole-proprietorship or non-llc partnership. This means business owners are not personally liable for the debts or liabilities of the company. However, if the business does not have enough credit, then a co-signer may be required. This is typically the business owner. The issue here is that even if the business defaults, the business owner may be still liable for paying back the loan regardless of if the business is in operation. Be aware that each loan’s terms and financial liabilities are different. Contact an attorney and/or a CPA for understanding the particular details of a specific loan.
Barriers to entry
A business having credit is one of the most difficult parts of borrowing money. Typically, the solution is to back the debt with your own personal assets and earnings. This means, regardless of if the business is in operation, the loan is payable by the person who backed the loan. SBA loans can help reduce this barrier to entry.
Categories of Loans
The longer the duration of the loan, the lower the annual interest rate.
Small Business Administration Loans
SBA Loans are typically administered through a Banking Institution. A business can use the banking institution of its choice, even the primary business account is not held there. According to the SBA “The SBA reduces risk for lenders and makes it easier for them to access capital. That makes it easier for small businesses to get loans. “(sba.gov/funding-programs/loans)
Alternative Lenders can be more flexible than commercial banks, as they have less regulation on the types of loans they can make.
Financing a business through equity involves selling a percentage of the business in exchange for capital, typically in the form of cash. How the portion of the business that is sold and the mechanisms in which it can be sold depend on the legal structure of the business. In a C-Corp or S-Corp, shares of the business are sold. In a large C-Corp, this is known as selling stock. In an LLC, it would be selling a percentage of the business. It should be noted each different legal structure has its own limitations on the sale of equity, and there are also company specific limitations based upon the By-Laws or Operating Agreement of the individual business.
Additional Perspective on an Equity Sale for Cash
For a good perspective from the restaurant industry as to who to bring-on as a partner, read Life, on the Line: A Chef's Story of Chasing Greatness, Facing Death, and Redefining the Way We Eat by Grant Achatz and Nick Kokonas of Alinea. Kokonas has a background in finance and is a former Derivatives Trader at the Chicago Board of Options. What Kokonas boils his advice down to is: Find partners that can give your business more support than just money. Find someone who also has skills to contribute like an accountant, a financial advisor, or an attorney. This is because, as a co-owner, they ultimately benefit from helping the business succeed.
Valuation of the Business
When the decision to sell equity is made, the first question to ask is: “How much much is the company worth?” This will help determine if a $50,000 investment is worth 5% of the company or 20% of the company.
Valuation of a company is as much of an art as it is a science. The reality is, a company's value is only what both parties agree for it to be worth. The best way to settle upon a mutually agreed upon valuation is to have a numbers based discussion.
There are main approaches to Valuation:
There are entire professions based upon figuring out the value of a business, including investment analysts, underwriters and investment bankers. For small businesses, looking for valuation help:
To execute an equity sale, a business will need to create a contract with all the terms of the equity sale. An attorney specializing in corporate law would best be able to help steer a business through this process and define the terms of the agreement as they apply to a particular entity.
Catherine Taschner, a Partner at of McCorriston, Miller, Mukai, MacKinnon LLP provided the following perspective:
Finding an Attorney
If you are planning for an equity sale, make sure you ask for a corporate attorney, because they will have the specialized knowledge to guide you through the process.
The best way to find an attorney is by word of mouth. Reach out to your friends and family, and see if they have any recommendations for attorneys that they’ve worked with.
Another option is the Lawyer Referral & Information Service (LRIS), offered by the Hawaii State Bar Association (HSBA). All Attorneys licensed in the State of Hawaii are members of the HSBA. The referrals are free and clients are encouraged to contact the attorneys referred to find out whether they are able to assist with the legal issue, and the terms and costs for doing so. For more information on LRIS, contact the office at (808) 537-9140 or by email at LRIS@hsba.org.
If you can’t afford an attorney, a good resource is the Business Law Corps (BLC). The BLC is a nonprofit organization that provides free legal advice to small businesses and entrepreneurs on corporate and other transactional matters. The BLC offers free thirty-minute consultations every Wednesday from 11:00 -1:00 pm at either the Patsy Mink Center for Business & Leadership at the Richards YWCA or at the Entrepreneur’s Sandbox in Kakaako. The BLC also offers free assistance to businesses that qualify. For more information the BLC, please visit: http://businesslawcorps.org/.
The process of working with an attorney:
Once you find an attorney, you should schedule a time to sit down and talk with them about your company’s goals and strategic plan.
Your attorney should be able to guide you through the type of equity you want to issue (restricted stock, stock options, etc.), and they should be able to spot some of the potential accounting and tax issues that may come up. If your company is not already in the position to issue that type of equity, your attorney can help with repositioning the company to meet your goals.
Your attorney will assist with the documentation of the issuance, which can include several agreements and securities filings at both the State and Federal level.
Depending on the attorney, fees range from:
Most attorneys bill by the hour, so make sure you ask your attorney for their hourly rate. Rates range from $175 for the newest associates to $600 for seasoned specialists. Many attorneys accept payment plans, so be sure to ask your attorney if this is an option at the beginning of the engagement. "
When To Close (Shut Down Point)
When to Close
There may be circumstances when temporary or permanent closure may be a better option. To understand when temporary closure may be the best recourse, one will need to remain vigilant of profit and loss statements to understand if fixed costs are greater than variable costs. Essentially, if variable costs cannot pay for themselves, then a company is considered to have reached a shutdown point.
Fixed Cost vs Variable Cost
Fixed Costs are those that remain the same regardless of how much or little business you do. Examples include, rent, internet, and phone. Variable Costs are costs that increase in proportion to how much of them you use. These include ingredients, and depending on your lease, electricity and water. The biggest and most difficult variable cost is labor.
Typically, the largest variable cost is labor, therefore figuring out how to minimize labor is key, as well as utilizing the Payroll Protection Loan as best as possible. To do this, the ownership group should start by providing as much labor as possible. This is because the ownership group is essentially free labor, as they are ultimately fiscally responsible for the success of the business. One suggestion for small business owners is to ASK YOUR FAMILY AND FRIENDS FOR HELP. In this scenario, help equals free labor. As repayment, you can buy them dinner or a beer (or both), and it will still be cheaper than employing someone. Even if a family member is not trained or in the industry, they can still take a phone order, or give the proper order to a take-out customer. These are desperate times, and they call for desperate measures and an all-hands-on-deck approach.
Tap into your free labor sources first, then add paid employees. The key here is to maximize your output with the addition of an employee. Given the buffer of the payroll protection program, if that means someone can help with delivery or catch up on cleaning and maintenance, any labor that can be used is helpful.
Other Financial Solutions
Non-profit Organizations Assistance