Raising Money For Your Business Alternative For Raising Money For Your Business • 1. Fund through your savings. • 2. Home equity loan • 3. Factor financing of accounts receivable • 4. Bank loan • 5. Bringing in another managing member/general partner/co-owner. • 6. Raising funds from investors through a private offering of securities. Pros of Funding Through Savings • Pros • You do not incur additional debt. • No lender security interest on your business assets. • No lender second deed of trust on your house. • No factor lender getting 15% to 30% accounts receivable. • No messy co-owner of the business relationship (80% of business co- owner relationships break up. Business break up litigation is expensive). • You do not have to incur the expenses of doing a private offering of securities. Cons of Funding Your Business Through Personal Saving • There are other things that you could be doing with your money. Home Equity Loan Pros • You already have the equity in your house. • You do not the expense of going out and raising money from investors. • No business co-owner relationship problems. • No factor taking 15% to 30% of your accounts receivable. Home Equity Loan Cons • You are taking out more debt. Will you be able to pay the debt back if there is a recession, and your income from the business falls by 30%. Factor Financing Pros • No home equity loan debt or business debt to repay. • Your business gets cash from the factor lender. • The only security interest is the business’ accounts receivable. • No messy co-owner business relationship. • No expenses for offering securities. Factor Financing Cons • You lose 15% to 30% of your businesses accounts receivable revenue every month until the loan is repaid. Bank Loan Pros • No factor getting 15% to 30% of your business’ accounts receivable. • No messy co-owner business relationship. • No expenses for doing a securities offering. Bank Loan Cons • You have to pledge the entire assets of the business as security for the loan. • You probably will have to give the bank a second deed of trust on your principle residence as well. • Your business must have enough hard assets, or fixed assets for the bank to claim as collateral for the loan. • You still need sufficient equity in the business, or you do not meet the bank’s lending standards. • Will you be able to repay the loan, if there is a recession and your businesses sales drop by 30%. Bringing In Another Co-Owner Pros • No loan repayments, unless the co-owners decide to borrow money. • No expenses of doing a securities offering. • No losing 15% to 30% of your accounts receivable revenues to a factor lender. • No lender liens on the business or your home, unless of course the co-owners decide to borrow money. Bring In Another Co-Owner Cons • You need to give the person actual control over the business, or it will become a securities offering. • You will lose some or most control over how the business operates. • 80% of all co-owner business relationship do not work. • Business break up litigation is very expensive. • You may need to form your business entity in Delaware instead of Maryland for various reasons in a co-owner business relationship. • You will need to purchase life and disability insurance for all co- owners to fund a buy in the event of death or disability. Raising Money From Investors Thorough A Private Offering Of Securities Pros • No repayment of debt, unless you are raising money thorough a debt offering. • You can keep control of the day to day affairs of the business. • Your investors can be, and usually are largely passively involved in the business. • Can help a business without sufficient hard or fixed assets, or accounts receivable get capital. • Gives investors a way to earn money at a rate of return exceed bank savings accounts, US treasury bills, or money market funds. • Enables you to come up with a down payment to acquire a larger business or property that you would otherwise be able to do so on your own. Raising Money From Investors Through A Private Offering Of Securities Cons • You have to give all unaccredited investors, and you should give all accredited investors a private placement memorandum prior to receiving any money from investors. This document can range between 50 and 120 pages. • This is expensive for many of you (legal and accounting fees). What Is A Security? (The Howey Test) • An investment of money • In a common enterprise • With the expectation of a profit. • To be derived in whole or substantial part from the efforts of others. (The control test). Note giving somebody a vote, does not give them control actually. That investor/investors could be outvoted. Note, many angel investments and nearly all venture capital investments are not securities offerings, because of the amount of control the angel investor/venture capitalist has over the business. Definition Of A Security Under Maryland Law • Promissory note • Stock • Bond or debenture • Certificate of participation in any profit sharing arrangement. • Voting trust. How Do I Raise Money From Investors Through A Private Offering Of Securities • Rule 504 • Rule 506 (b) • Rule 506(c) • Crowdfunding Rule 504 • Total offering cannot exceed $5,000,000 • You must register the offering with at least 1 state securities agency, or be exempt from registration under the laws of that state, or the offering must be made to accredited investors only. • Investors must receive a private placement memorandum, unless otherwise provided by state law or regulation. Problems With Rule 504 • The applicable exemption from state registration in a Rule 504 offering vary from state to state. Possibly more blue sky law compliance costs in terms of attorney time. • The disclosure in a private placement memorandum could vary from state to state in a 504 offering. Rule 506 (b) • Offering to 35 or fewer unaccredited investors. • Unlimited number of accredited investors. • All unaccredited investors must receive a private placement memorandum. • I strongly recommend that all accredited investors get a private placement memorandum. • No advertising. • You can raise an unlimited amount of money. Rule 506(b) Problems • Limited to 35 or fewer unaccredited investors. • No advertising. Rule 506(c) • You can raise an unlimited amount of money. • Offers must be made to accredited investors only. • You can advertise. • I strongly recommend that all investors, even though they all are accredited get a private placement memorandum. Problems With Rule 506(c) • The offering is limited to accredited investors only. No friends and family. Who Is An Accredited Investor? • An individual who earns more than $200,000 per year adjusted for inflation, and there is ever expectation that level of salary will continue. • A husband and wife who earn more than $300,000 per year adjusted for inflation, and there is every expectation that will continue. • An individual whose net worth exceeds $1,000,000 adjusted for inflation, excluding the home equity, cars, and life insurance. • An officer or director of that business. • A corporation, business, or trust fund with a net worth of $5,000,000 or more, adjusted for inflation. • Banks, broker-dealers, investment companies, insurance companies, and small business development companies. What Goes Into A Private Placement Memorandum • A description of the business, its primary suppliers, its primary distributors/reseller, and its primary customers. • The condition of its properties and facilities. This includes intellectual property. • A description of the business’ directors and officers. • A description of the securities offered, such as price per security, voting rights, and rights to share in profits/losses. This include dilution. • Risk factors (these can be extensive). • Audited financial statements. • A description of any Company indebtedness. • Transactions between the business, and its directors, officers, as well as 10% or more owners, etc. This includes director and officer salaries. • Any litigation or bankruptcy filings. • What are you going to do with the money? Form D • In rule 504, 506(b), and 506(c) offerings you need to File Form D with the Securities and Exchange Commission. • You also need to file Form D with the state securities agency in every state in which you have investors. Crowdfunding Alternative Pros • You can have up to 500 investors to taking advantage of crowdfunding . • You can have up to $25,000,000 in assets and still do a crowdfunding offering. • You are not limited to 35 unaccredited investors only. • Very limited advertising is permitted. Crowdfunding Cons • You cannot raise more than a $1,000,000 over a 12 month period. You can raise more money doing a Rule 504, Rule 506(b), or Rule 506(c) offering. • Individual investors are limited to the greater of $2,000 or 5% of the individual’s income, if that individual’s income or net worth is less than $100,000. • If the individual investor’s net worth or income is equal to or greater than $100,000, that investor is limited to investing no more than 10% of their income or net worth. • More filings with the SEC. • You need to use a broker-dealer or funding portal. What Must You Disclose To Investors In A Crowdfunding Offering? • Basic business information. • The names and employment history of the directors and officers. • The names of all 20% owners. • The business plan, including major customers, suppliers, and distributors. The number of employees. • Risk factors. • What are you going to do with the money? • The target offering amount, and the deadline to reach that amount. • The price and type of securities offered. This includes dilution. • A description of the business’s financial condition, including liquidity and capital resources. • Transaction with directors, officers and 20% owners.