Prefer to read? (Transcript)
Speaker 0 00:02 .
Speaker 1 00:14 Hey, good morning everyone. Welcome to business illegal talk with Leroy. Claudine, I hope you’re enjoying your Saturday morning. Uh, guess what? I’m going to fly solo today. Claudine, my gracious cohost, she’s actually out on assignment making things happen so you are stuck with me today. And, um, but anyway, happy Saturday we, we have, um, a lot of really great things are happening and um, I feel that the temperature in the economy and the things that matter for business owners, there’s a good, um, little bit of momentum going on and um, at least that’s what I get on the business side of things. Um, but I realized that as you know, it’s hard to really think one of the things that I talk about. Um, and you know, if you are listening to us for the first time, um, we are here to help businesses be profitable and sustainable.
Speaker 1 01:17 So yeah, this is not like your, you know, gardening show or like in home improvement show. Really what we are here to do, Claudine and I, is to help you be profitable and sustainable. So who is our audience? You know who, who, who benefits the most from listening to this show. If you have a business, if you’re thinking about starting a business and if you know people who are running a business or if you have a management role within a business, it behooves you to listen to this show. And the reason for that is because what we talk about here on a weekly basis with Claudine is a actionable, you know, real life, uh, things that are going on with businesses. And we cover many, many, many, many topics, uh, ranging from pay roll, financing, growth, sales, marketing, insurance, risk mitigation. Um, so, but you’re probably wondering, Hey, so what’s, what’s today it’s show is all about, well, talk about speaking of, you know, real time in real life today we’re going to be talking, it may have to turn into a two part series, uh, on racing capital.
Speaker 1 02:37 One of the primary reasons why I get involved, uh, get started working with companies, particularly in the lower middle market, which is two to $10 million, is because they need to take advantage of an opportunity in the marketplace. And they just don’t know how to about there. Just don’t know how to go about raising the capital needed or how much capital or how the pricing is do I need, um, you know, the, the, the truth is there comes a point in time in the life of a business when decisions need to be made. If you’re a business owner, you’re going to have to make some decisions. Do you stay where you are with the status quo or do you go after that opportunity too? You have before you to grow your business, whatever that is. And it doesn’t matter what business you’re in, you’re going to be faced with that decision. Do I wanna grow my business to a sizable, beyond you when you actually need to get a management team in place or,
Speaker 2 03:49 okay.
Speaker 1 03:49 Do you just keep it as a lifestyle business and you know what, what is a lifestyle business? To me, a lifestyle business is a business that is generating probably from $100,000 a year to, you know, even half $1 million a year in revenue. Very, very profitable. And the owner doesn’t have probably very many employees, maybe a handful of employees is a proven business model. It makes a lot of money. Um, and the owner tick can take off when they want to, um, and be gone when they want to and actually can afford to be gone any length of time in the business. But there’s no intention of growing a past the million Mark. Um, the, if that’s the case, if that’s you, God bless you. That’s awesome. Before the rest of us, you probably gonna have to grow to take advantage of opportunities. So how is everybody doing?
Speaker 1 04:42 How has your week been gets crazy? The amount of, um, earthquakes? Gosh, you know, we are in California, we’re in the central Valley in, you know, you, you be following if you’ve been following the news, there’s been a series of earthquakes, um, rich crest and surrounding areas with thousands and thousands of aftershocks. So, gosh, you know, as a, as a CFO, what I think about, it’s two things I think about risk. And I think about cash. Now if you’re, if you are in an earthquake zone, gosh, you should be thinking about a, do I need the type of insurance, you know, earthquake insurance and you know, you get insurance before you need it because when you need it, this delay is no different than going to a bank to get a loan when you need it because when you need it, it’s too late. So, um, so today’s show back to today’s show, I’m excited because I’m going to share with you some of the things that I’m doing right now with certain clients. Um, and without disclosing the clients, it’s just some of the things what we’re doing, uh, to help them get to the next level and doing so by raising capital.
Speaker 1 05:57 Okay. So, uh, I usually face, we know with this question, so you, so you, you, you are meeting with a business owners and they are figuring out which way to go. And the first question I ask is how much money do you need? And why do you need money?
Speaker 2 06:15
Speaker 1 06:18 do you even in money at all?
Speaker 2 06:19
Speaker 1 06:21 because the minute you take a dollar from somebody else, you’re going to have responsibilities, right? If it is a bank, you need to, you’re going to have to be pledging some collateral. You’re going to have to be personally guaranteeing it. And we’ll explore all of that throughout the show, uh, today and the next show. But if you are taking venture capital, which sounds very sexy and attractive and not that people get excited about it, it just sounds very romantic. And, and you know, like you see in the shark tank and some of those other shows, there is a dark side of that and there is a lot of small print that a lot of business owners don’t realize. So we’ll be talking about that, uh, today. So, um, so some of the topics that we’re going to be covering today is the types of investor funding
Speaker 2 07:08
Speaker 1 07:10 and that had three beta, three very basic types of investor funding, equity loans and convertible debt. Now there’s one thing that is not mentioned here that you know that you can always grow your business by generating more sales. So let me play me, put that out there. You don’t always have to go get money from somebody else. Sometimes you may have to. But the number one, the number one source of cash I recommend to business owners is to simply grow your top line and be very shrewd about how you grow the top line to make sure that you have enough gross profit and you have little operating expense and everything falls to the bottom line. And assuming that you are collecting it on a regular basis, you have plenty of, you should have plenty of cash to build your business. So the three basic types of investor funding, we’re gonna be talking about equity loans and convertible debt. Um, what does it mean for, uh, startups raising capital? How long does the funding actually take?
Speaker 2 08:11
Speaker 1 08:13 I get that question a lot. Well, how long will it take, you know, from when we start working together and for me to raise my two, $3 million? The answer is, the quick answer is it depends and we’ll get more into that. Hey, how about how many investors should you talk to in a VC fundraise effort and how do you prioritize? So there is a process that goes to that and you don’t want to, you know, um, you don’t want to go at it half hazardly you have to have somebody in your team. If you are going to go that route to actually understand how to speak the VC language, the venture capitalist language for those up there who are in technology, we’re going to talk about eight ways to increase the value of your software company or your technology business.
Speaker 3 09:11 So, um,
Speaker 1 09:13 so that’s that. So we’re very excited about, you know, there’s, there’s a lot of really good, um, I’m excited just because some of the great things are happening. I haven’t seen this much capital out there available for you. I haven’t seen that. I haven’t seen that much capital available in a long time. What does that tell me? That the appetite for investment is ripe. So if you have a great idea for a product service, the time is now. My father used to say the best time to plant a tree is 20 years ago and the next time today, so if you’re looking at, I was just recently sat down with somebody who told me about GSA contracts, you know, do you know that that’s working with the government and and federal funding in in federal programs and that’s really, really exciting. So those are the kinds of things that we’re going to be talking about today. Stay tuned. This is going to be a great show. There’s a lot to unpack. You are listening to business illegal talk with Leo and Claudine. Stay tuned, we’ll be right back. Hey, welcome back.
Speaker 0 10:41 Yeah,
Speaker 1 10:42 you are at the right place at the right time. Don’t turn that channel. You are listening to business illegal talk with Leo and Claudine, except that is just me today. You’re stuck with Leo. Hey, so if you’re listening to the show for the first time, Hey, what are you actually listening to? Well, we are two professionals. I am the business guy in Claudine is the, the attorney, the very smart attorney who happens to be very business savvy. She’s not here today, but we both are passionate, consummate, passionate about helping you succeed in business. Why? Because we’ve been there, done that. We’ve been there. You know, we’re involved in many businesses collectively, Claudine and I had been involved in over a dozen businesses from real estate software, uh, professional service delivery, uh, restaurants, etc. So we knew a thing or two about what it’s like to build a business. So funding one of the funnest topics.
Speaker 1 11:40 So, Hey, you have built a business and I, and you have put your blood, sweat, and tears on building a business. And you spend the last few years working seven days a trying to carve out a niche for yourself, a name in the marketplace. Isn’t that what the American dream is all about? But now you’ve got a fork in the road. Why do I do I have grown the business as far as I can grow it? And that number may mean any really amount of revenue that you’re comfortable with. You may think that you’re limited. Say I build it to $10 million, I’m very comfortable in doing so, and the average person will say, wow, I would be happy to, if I could get to half of that. I think beauty is in the eyes of the beholder because there’s not really about how big your sales are, how much is your top line as I like to call it, but it real business begins at the gross profit, which means if you have variable costs, you know what we call cost of good souls of cogs, you really begin to make profit at the gross profit level once you pay those variable costs.
Speaker 1 12:51 So if you’re driving to a fro today, you don’t need to listen to this because there has never been so much funding available until now. So there are three basic types of investor funding, equity loans and convertible debt. Each method has its advantages and disadvantages and there are different fits, you know, some are better fit for some situations, some for more. There’s like so much else about the fundraising process, they kind of investor based fundraise. That is right for you. Depends on a number of factors. It could be the stage of your business, the size and the industry of your business. That is important. Your ideal timeframe, the amount you’re looking to raise and how much you planning and how you’re planning to use it, your goals, your company, both short, Tim and long. Essentially you need a plan.
Speaker 1 13:49 So what we’re exploring here is in this investor based funding in some detail, we’re looking at the way that the option is structured, they situation for you. Then what is the most useful in other stages for you in order for you to be successful? Are you following me? So there are advantages and disadvantages which any of the choices, any of the choices that you have before you some that I’m going to tell you the good, the bad and the ugly. So keep in mind though that for just a quick overview, you will need to do more digging on your own. This is just basically an introductory lesson on this type. I would expect that you, if you have any questions, you come to us. You know there is no charging you. I mean in fact, I don’t expect to work with every person that calls our office. Hey, if you, by the way, if you’re wondering, do you need to call us or need to look us up? Go to Greenland, hq.com dot Greenland, G R E E N L a N D hq.com or call our office (559) 207-3148 anyway, back to this, so equity. What’s the deal? Pursuing equity, what we call an equity fundraise means that in exchange for their money that they investors invest now they will receive a stake in your company
Speaker 2 15:23 .
Speaker 1 15:25 They will be owners in your company
Speaker 1 15:29 and they will be entitled to a portion of the income of the profit, the net profit that you make plus whatever decisions you may make in the future. Equity though is one of the most sought after forms of capitals for entrepreneurs. As I mentioned before, it’s sexy, it’s exciting, it’s at the edge of entrepreneurship and it’s in his part because of it’s an attractive option. Why? Because there is no repayment schedule. Now think of the use for, for those of you who actually have loans and what that means and you have every month money needs to come out of your, your your bank account or you have to write a check to, to pay the, satisfy that principle in that interest. So there’s no, there’s a good thing that there’s no repayment schedule that you got some high power investor partners. It depends who you go with, right? If you have, but, but in general, if you’re lucky enough to be in the realm of the one to 2% of the companies that get funded, you’re going to have some high power people whose sole interest is to help you get to the next level so they can cash in on the success of your business.
Speaker 2 16:39
Speaker 1 16:42 so why is it attractive? There’s no repayment schedule. You’ve got high powered partners with you in this partly because is there a form of capital that requires the most seeking? So how does that work at the outset when you’re looking for this kind of money, you set a specific valuation for your company,
Speaker 1 17:10 which what is evaluation? Well, that is an estimation of what your company’s worth at that point. Now, um, for those of you who are new to this subject, evaluation is nothing more than an appraisal for your business. Now, if you own real estate is easy to figure it out. No. So what is the value of your home? You go to Zillow, you go to realtor.com or you go to the MLS system and then you look for, uh, the address where your house is out in the vicinity, in the value of your home is the composite of all the values of similar properties of look and feel and the same square footage, the half sold in the six months. So you have a pretty good idea what the valuation or the appraisal for your home is. And then you would pay a competent person three, $400 to actually give you a bonafide, uh, a third party. Um, verification of that value. Well, in businesses it’s not that simple.
Speaker 2 18:09
Speaker 1 18:10 if you really want to get a valuation, your company, you’re going to have to pay thousands of dollars. At the very least, a simple valuation by a competent, uh, firm and accounting firm that specializes in valuations can set you back four to $5,000. Now, VCs, those investors who are, will be looking to, uh, do in fiduciary, uh, taking a look at, you know, doing their financial due diligence. They will probably want to have you provide audit of financials if he’d really gets that serious. And how much would that set you back? Gosh, it may set you back 20, $30,000, but let’s not go there now, right? We’re, we’re at the B, so we’re back evaluation. So based on that valuation and the amount of money they invest or gives you, they will own a percentage of stock in your company for which they will receive a proportional compensation once you sell or go public.
Speaker 1 19:06 Now, what that is, what is the Holy grill, those unicorns, those companies who valuations exceed of $1 billion? Think Airbnb, uh, think Dropbox, those, uh, Uber, that one in a hundred or probably one in a thousand companies that get funded that actually make it through the billion dollar plus valuation. So what are, uh, if you’re looking for venture capital, what is it that a VC is looking for? Short answer five X on their investments. So if you are going to be looking for $1 million from a venture capitalist firm, they are going to be looking to make five times their investment within three to five years.
Speaker 2 19:56 Yeah,
Speaker 1 19:56 follow me. So eight is important that you get just enough capital to make it to the next round. You don’t want to get too much capital because the more capital you give, the more your, your equity is diluted. Think about it. You are actually given, you’re given away off your ownership of your own. Do your baby. This is the company that you’ve built. So let me give you an example.
Speaker 2 20:21 .
Speaker 1 20:24 So say you have a bakery and as a successful bakery and you’ve, and you want to turn this into a franchise system, you want to turn it into a national chain of bakeries. Now, no offense to those who are in the bakery business. Um, but this is just an example. So, and they’re looking for hundred thousand dollars equity investment and a company valuation of 2 million venture capital firm, venture capitalists, firm Y XYZ invest 250,000
Speaker 2 20:59
Speaker 1 21:01 how much of the company do they get? Well, there’s the pre money valuation concept and there’s a post-money valuation concept. Pre money is what the company is worth before any money gets out and on. So it’s not really that simple. So you would think if somebody gives you $500,000 and 2 million, is that gonna make him 25% it doesn’t work that way. So in this particular example, you have a, you have a a VC firm that gives you $250,000 because they believe in the promise, they believe that you will become the national franchisee, that you’re gonna become a powerhouse in the bakery business. And you’re going to take a bite out of Walmart. And some of the other big, big, big players that provide bakery goods. The truth is there are 250,000 they are only going to get 11%
Speaker 2 21:55
Speaker 1 21:58 right? Because you take the $250,000 equity injection into the, now the post money valuation. So they, they, the company’s worth 2 million and they injected 250,000 how much is a company worth? 202 million. 250,000 so hang in there with the math. So now it’s worth the 2 million plus the equity injection. So the company is now valued. Do you have a bonafide value third party appraisal of two point $2 million and they injected 250 K that they own 11%
Speaker 2 22:32
Speaker 1 22:34 so very important that you understand how the money works and that’s why you don’t want to go add this without having somebody on your team that really understand all this and not just barely scratching the surface. When do you do it? There are similar situations in which an equity fund rate makes most sense or is the only real option for our company. The number one reason why companies need to raise VC money is because you need a loan runway. Not every business will start generating income as soon as it launches, specially those who have a very bold idea. Those market disruptors, those very savvy visionary type thinker founders who think that they can disrupt an industry, but they may take them a while, you know to perfect this model. Think of it, what happened when the whole idea of
Speaker 2 23:31
Speaker 1 23:33 Netflix came about? Think about it at the time. How many times do the founding team of NetPlus went out meet with telling them this idea of, Hey, you know what, there’s blockbuster and this is, they’re doing a such a great fine job, but we think we can do it better, cheaper, faster,
Speaker 1 23:54 and we have a model that we think is going to revolutionize the industry and we’re going to do that by sending people a movie and they’re going to keep, they can keep it for however they want and they can just pay us late fees and they can, you know, return the movie whenever they want. Then we just did to have enough. I’m in circulation. I can imagine how many VCs were like, Whoa, that is crazy. Whoa. Who pays the shipping fees? Right. Well, how do you ensure that those, uh, movies come back to you and how much are you going to spend in marketing? What is the cost to acquire a customer? What is the lifetime value of the customer? Things that were not known at the time, but there were few. Obviously there were more than a handful of VC firms that actually understood and were able to catch the vision of what Netflix could become and became that eventually took down blockbuster. So it is important that, but they needed per a lot of cash to perfect their model and that’s why the number one reason is if you’re going to need a lot of money, pre-revenue, you’re going to need a loan runway, you’re going to need venture capitals. So right now we’re talking about raising capital for your business. You are listening to business illegal talk with Leah and Claudine. Stay tuned, we’ll be right back.
Speaker 0 25:04
Speaker 1 25:29 Hey, welcome back. Are you still awake? Are you still interested in I you still looking for capital? Well this is Leo land diverted, founder and CEO of Greenland advisors green and hq.com if you are looking for capital financing or getting your books in order or really wanting to scale to grow, you need to talk to us, we will help you with that. That is our specialty. We love helping businesses grow and take taken, take them to the next level. And we’d done it with many industries. And we’re currently raising capital for multiple companies in multiple industries. So we know this stuff. So anyway, where were we? We were talking about when to get, when you need private equity in the form of venture capital.
Speaker 3 26:18 So
Speaker 1 26:20 not every business will start generating income as soon as it launches. But spending a few years in the red doesn’t mean your company is a viable business preposition. Think Amazon, right? Remember Amazon and even as a publicly traded company, lost billions of dollars because they were still perfecting their model. Now, who would argue it? Now it’s said and done. They are the 800 pound gorilla in the marketplace. But it took him a while to perfect their model in. Jeff Bezos had a vision for it and he had, he had enough capital behind him to pursue that. So internet companies, for example, are notorious for going years in operation without even attempting to charge their customers. Think of it, the Facebook model, the freemium model that I call is free to access. But who’s paying for the services? How do you generate revenue?
Speaker 1 27:13 You know, here’s the, here’s the interesting thing. I don’t think you’ve, I don’t know if you’ve, a lot of people know that most companies that start one way, I think Twitter, the way we know it now, isn’t that initially how they started, they started up maybe as a different type of business model that wasn’t making any sense and the founders, the owners, the management team was like, Oh, this is not working. We need to do something. We’re going to run out of money. And then basically landed on the type of business model that they have now. But there’s the tweets. But that’s not how it was envisioned. Facebook was not meant to be what it is today. What Mark Zuckerberg wanted wanted a platform to Trey pictures in college dorms. That was the lofty aspiration, but he changed over time. And while perfecting the model, you need cash so that an inter companies, technology companies are notorious for that.
Speaker 1 28:09 So if you need a sizeable infusion of operating Cassius within your business before he starts turning a profit, equity investments are the only form of capital that makes sense. Right now we’re talking about venture capital. We’ll get to the other types in a little bit. So when, when you have zero collateral, so, alright, in order to take our loans, you need to have something to offer. Hello in case those things don’t work out as planned. And I always say this, if you’ve known me for any length of time, I say this, don’t go to a bank when you need money. Because when you need money, it’s too late. Banks are in the business of making money. And if they see you as a money losing business that is losing cash every month, how are they going to ensure that they get repaid? Their interest? Plus their principal bag doesn’t want to lose money. So if you don’t have anything of value to give to, to collateralize you loan that provides the security, then you only real option is funding for finding equity investors who are willing to take a chance on your idea with nothing to sell. If the business goes South. Did you know that only a very small percentage of funded companies actually make it and produced a five X returns that the VC firms want? It’s true. So they’re betting on very few investments to actually make it. That’s why they won the aggressive returns that they want.
Speaker 1 29:54 So here’s another, so when, okay, we’re talking about when to do it. Number one, when you need a loan, runway number two, where you have zero collateral, which means you have zero offer nothing but a great idea. And number three is when you can’t possibly bootstrap, what does that mean? So while holding, growing your company from the kitchen or spare bedroom, which is the American dream by bit by bit, may not sound as glamorous as hitting the ground with investors are really lining up. Most investors will expect you to start there before they invest. But some businesses, a private jet, a service, for example, require massive amounts of capital just to get off the ground.
Speaker 1 30:39 In those cases, you have little choice but go directly to equity. So what is the American dream, right? You start with nothing. You know, many businesses were started under a thousand dollars you can actually start a business today for less than a thousand dollars it is just the type of business that determines the amount of capital that you need to fund it. Now, if you get into the restaurant business that has a notoriously high failure rate, you need a lot of capital to make a go of it. That’s why the franchise model with McDonald’s and those top franchises to make sense, because they have a proven annuity model. So if you put in $1 million, it’s almost guarantee that you’re going to get 7% on your return cash on cash return of 7% why and why are some people willing to live that low with that kind of investment? Aside from the 80 hours you’re going to work with while developing your franchisee because what are the options for returns elsewhere? If you put the money on a money market account and you’re going to get, you’d be lucky to get one, two and a half percent.
Speaker 1 31:45 So, but the idea is I highly encourage you to get us much done, perfect your model, do whatever you can to be profitable and have a proven business model before you go see capital because you, the more successful your idea, the more attractive you are to investors and chances are they gonna fight over for you if you have a profitable business idea that is making sense. And it’s almost like you don’t need the money and you’re going to then to vet your idea. And usually what happens and explosion of capital and some companies actually take too much, which is a subject for another discussion. So,
Speaker 3 32:26 okay,
Speaker 1 32:27 so number four, when you are positioned for astronomical growth, equity capital tends to follow businesses and industries that have potential for massive growth and exponential paydays. Hello, right. Your local coffee shop concept may do really well and may be very profitable, but doesn’t have the potential to become the next Google. So if you’re not likely to attract many equity investors, right? Because of that, that’s just, that’s just what is. On the other hand, if you’re looking to build the next Starbucks chain and you have a vision and a plan to support that kind of growth, chances are investors will be interested in jumping into your bandwagon on the road to an IPO. Think Lyft. Think Uber things to keep in mind. Equity narrows your options.
Speaker 1 33:16 Choosing the equity route significantly narrows your options when it comes to the future of your company. What is, what does that mean? Equity investors are interested in only one thing. Liquidity. They part $1 million in your company. They want to get 5 million hours in three to five years and they’re going to make sure that that happens. once you’re accepted, so liquidity, right? That means that they won’t be satisfied with just a cut of the profits every year. That’s not what they’re about. Once you’re, you accepted their money, they will expect that end game for your business is either a sale or an IPO. Let me repeat it again. Once you accepted the money
Speaker 3 34:02 from
Speaker 1 34:04 of venture capital, they will expect their angle M game to be for you to either sell or an IPO before they invest in the first place. They’re going to look for assurances that your idea can sell or be big, go big or go home right and end if that is your plan. Great. So before you pursue the equity funding you know, a fundraising route, you should be, you should make sure that your vision is aligning with big promises, big returns, a bold idea. You know, you want to, um, create something that is not there, that is not in the current marketplace, that is such a novel idea doesn’t exist. Like, um, breeding, um, gosh, walking on air or tele teleprompting yourself somewhere else. I mean, just really crazy ideas. Those are the ones that get funded because investors are interested in ways to really disrupt markets.
Speaker 3 35:06 Okay.
Speaker 1 35:08 Equity investors expect big rewards in exchange for the big risks that they take when they give money to any company.
Speaker 3 35:19 Let me put it to you this way.
Speaker 1 35:22 . If every entrepreneur could walk into a bank and get a loan to finance the idea, many probably would. Unfortunately banks are incredibly risk averse. They are on the other side of this spectrum and the only one that provide loans that they’re sure with the payback and they will make sure by running an infinite amount of ratios to make sure that their risk is minimize so they stand diametrically opposed to the VCs and the private equity people. It’s two different crowds and you pitch to them differently. that’s where equity investors come in. They’re willing to take risks when lenders aren’t, but there are two sides of the coin and equity investor isn’t looking for an interest payment on the money they’re giving you, so they don’t really care about the payback in terms of interest. They’re exchange there. One that really big payout, they’re exchanging more risks for more reward. That makes sense, right? A lot more and they’re to want to see results and they’re gonna want to have oversight. Next competition for equity investments is very high. There are far more people looking for equity investors. They are checks being written so there is an overwhelming demand for money, but very few suitors are found. Most equity investors will see hundreds if not thousands of deals in a given year before they found even one. I’m just giving you a dose of reality.
Speaker 1 36:56 Getting an equity investors is like getting the perfect score and you’re getting, it feels like getting a 1600 and a sat. You have to be on the top percentile. You have to be bright, articulate, and you have to be able to lead your team. You have to be prepared, motivated entrepreneur who is willing to risk it all
Speaker 2 37:20
Speaker 1 37:21 and if they perceive that they may walk away with a chicken hand next racing equity capital, it takes time. It’s not going to happen overnight and be prepared no matter how prepared you are, it can easily take three to six months to find the right investor and that’s not counting the times. The completes that take the final legal documents because there will be legal documents that make the money available. You will be signing legal documents to ensure that you understand what you’re getting into. So if you and your business out in a time crunch equity fundraising may not be the best way to go. You might have to look for other alternatives. Next, giving up equity is a one way street. Once you’ve given up equity, you’re not likely to ever get it back. It is very rare for an entrepreneur to buy back the equity. They’re given away early in the creation of their company.
Speaker 2 38:14 Oh,
Speaker 1 38:14 once you sold a certain percentage of your equity, let’s say 45% of your business, you can’t sell that 45% again, you have 55% left once he sold equity to an investment that investors part of your world, whether you like it or not. So tempting. Okay, well stay tuned. I’m being told I need to go to break. Stay to them. Business legal talk with your accordion. We’ll be right back.
Speaker 0 38:37
Speaker 1 39:03 yeah, yeah, yeah. Having some fun talking about money. Funny thing is I’m most always get involved. My firm almost always gets involved when it comes to raising capital because it’s fun, but it’s also very technical and you have to know what you’re getting yourself into. So, Hey, so if you’re just tuning into the show, uh, you are listening to business and legal talk with Lee and Claudine, we’d be having some fun talking about racing capital, which is the thing that I’m doing the most my firm has engaged in most across the state of California is looking for capital for companies for different, whether it is private equity, VC angel investors, or just financing deals, destructuring debt, et cetera. So that’s what we do. We help businesses grow and be profitable and sustainable. Claudine is not here today, but she will be talking about all the legal implications or keeping your business sustainable.
Speaker 1 39:54 No chance of making, no, there’s no fun in making all that kind of money if you have to pay it through a lawsuit. So heck, anyway, back to this. So we need to wrap this up. So we’ve been talking about the types of investor funding so far. We talked about equity, now we’re going to talk about loans and convertible debt and the time we have, and we only have about eight minutes. So there’s a lot to pack, so hang tight. So loans, loan or debt based fundraising is the easiest of the three varieties to understand and basics, you borrow money now and you pay it back later when it’s where did established rate of interest payback. That is also the most common form of outside capital for new businesses. And here is where I very, I’m very happy of our association with the spa in score.
Speaker 1 40:40 The SBA makes it incredibly easy for our new budding entrepreneur to raise the capital they need when otherwise you will be unbankable. So if you’re looking for funding for your business, the easiest, and you’re a fairly new business, you need to go to the SBA. So a hit us, you know, go to our [email protected] if you want to learn more. But yeah, so back to launch. So while angel investors and venture capitalists get all the big headlines for funding existing companies, it’s the debt providers, the banks that are behind most of the investment dollars that go into the 99% you hear that 99% of companies that are dysplastic cross magazine covers a business websites. And that is true for every company you see the news or hear on the radio or read in newspapers and magazines, there is 99 that are not even talked about.
Speaker 1 41:40 And their successful businesses that didn’t get funded by VCs got funded by a bank, by the local bank and they’re very, very profitable and no wonder banks invest in them. So how does that work when you decide to pursue debt based fundraising for your business? You S you specify in your racing fundraising terms that industry, you will come with a repayment of the loans you receive. You may also provide an expected timeframe. So whether it’s three, five, seven years that there are more decision of your loan, whatever is necessary. So you’re comfortable making that payment and the bank will assist you with that. Your banker will determine your debt service coverage ratio based on the, based on your net income, how much debt can you afford to pay in any given year. The important piece here is that the loan puzzle is collateral. Remember what I said?
Speaker 1 42:31 If you have no collateral, chances are you’re going to need to raise capital and if your idea is sexy enough, you have to go to VC as well. Here, when it comes to loans, you do have to have some collateral, some concrete sellable thing your lenders can take from in the event that your business goes under and you can repay your loans. Think of it, what can they have when you’re no longer around? Now the number one thing the banks hold onto is you receivables. So if you produce receivables, if you are in the service business and you produce invoices and to be paid on a later date, the bank will want to make sure that their debt is secured against those. So if you go under, they’ll have receivables and they have what is called the current ratio and that’s going to be a very powerful thing for make.
Speaker 1 43:17 Speaking of the ratios, the ratios that are very important to banks or your debt service coverage ratio we just talked about, which is your net profit or your cashflow divided into the actual debt service. And they liked that to be at least 1.2 or 20% in excess of the the debt service we, that means principal and interest or whatever other fees. The next one is the current ratio, which is your current assets over your current liabilities. Does that make sense? So that means if something bad happened and you had to close, for instance, we had this whole thing that happened with the earthquakes, right? And say you, gosh, knock on wood, right? Something bad was to happen to your business and you’re in the line of fire and the fault, a fault zone of the, of the earthquake, and then you no longer have the liquor store or the seven 11 then and then the bank has a loan against your business.
Speaker 1 44:23 What are they going to do? They’re going to take all the receivables and they’re going to liquidate them and they’re going to pay back their loan. And all the people that there’s a, they basically are going to be ahead of everybody else, but they basically are going to liquidate all of your liquid assets, you know, anything that can be liquidated within a year and they’re gonna get themselves paid back. That’s where the curtain ratio is very important. And if third ratio that is not often talked about is the debt to equity ratio is how much debt for every dollar of equity they’re willing to give you usually is about two and a half to $3 for every dollar of equity you have.
Speaker 1 45:06 So, um, bottom line is the more collateral you have, the better your chances see here in large amounts of financing. Example. So let me give you an example here. So let’s say in order to start his new luxury car dealership, rusty, you know, or, or let’s call it, uh, Bob’s, uh, auto parts of seeking $2 million in loans, which he will use to pay his first run of cars to sell. And his fundraising terms, Bob establishes the loans will be repaired with an interest of 10%, which I think is pretty high. You know, but let’s go with 10% any collateral or for these lows. Rusty offers the cars themselves as well as a mortgage on the property for the dealership, which already he already owns, probably free and clear and he’s going to personally guarantee the loan. So what is the downside on the bank that he actually doesn’t make a go of his business and the bank has to liquidate his cars, probably pick up his home and whatever else. So what does the rest of the bank, little to none when to do it. As with equity, there are a handful of scenarios where there is the most useful options for financing your company. Okay, here they go. Here we are number one, when you need less than 50,000.
Speaker 1 46:29 Number two, when you need capital quickly.
Speaker 1 46:33 If you have a time sensitive opportunity and you don’t have three to six months to look for investors, we’re probably not gonna even be interested in talking to you for, for a fee for 50,000 or even a hundred thousand dollars. You look, go back, maybe willing to give you a line of credit if your numbers make sense, but don’t go to the bank unless you have your financials done. And you know what your, you know that you make sure that you are having profitable and you have a history of growth. Uh, otherwise, you know, you get one chance to impress a bank and I may be it. One is another reason when to get alone was when you need the money for a very concrete, tangible reason. Think of it as, um, S real estate, for instance, computers, equipment. So you need to buy a building or because you’re sick and tired of paying rent for you on and you are, you feel like you’re, uh, you want to stop paying rent and you want to own the building. Well, that’s a tangible way. The other one is, you know, you, you want to, um, get equipment for your business or you, you know, if you’re in the, in the, um, transportation business you need, um, trucks, etc. Also, when, when do get loans, it’s when equity isn’t available.
Speaker 1 47:42 If you aren’t ready to start offering equity or just, just don’t want to.
Speaker 1 47:47 And so people don’t want to and that’s okay. A debt, a racing death through alone is the right course of action. Many entrepreneurs are understandably reluctant to give up equity in their company in a straight forward. Um, loan is, it has an attractive benefit because really what a bank bank doesn’t want any ownership or your company, they just want to get paid back. So keep in mind, these are the things to keep in mind. Collateral is the name of the game when it comes to loans, despite what you may think. Banks and other lenders don’t really make that much profit in a single loan specially if they go bad because some do go bad for that reason. They only say yes to deals where they can actually be 100% if there is such thing, 100% sure that they won’t lose out. Lack of collateral is not the end of the world. Lack of Colorado doesn’t completely rule out the possibility of taking a loan, but if you don’t have any collateral and you don’t plan on signing for the loan personally, which is what I talked about personally, guarantee in the loan, your options are mostly limited to smaller loans, usually less than $50,000 a loan. And again, I’ll tell you what, you not gonna like those terms in this case
Speaker 2 48:56
Speaker 1 48:59 you know, you have other options. Now here’s another thing that plays a role when you actually look in for loans, debt versus equity. When you’re looking for that, um, your credit is a big thing. It’s a, it’s a big key. You can achieve a lot if you have great credit. So you know, I, I’ve heard of business owners that I can actually get lines of credit with American express.
Speaker 1 49:32 Tremendously powerful lines of credit if you have great credit to prove it. To back it up. One thing that we have not talked about and I’ll quickly go over it is convertible debt. Convertible debt is essentially a mashup of debt inequity. You borrow money from investors with the understanding that the loan will either be re-paid or turned into a share of the company at some later point in time after an additional run of fundraising. So it’s kind of a, a way for the VC to hedge their bets once the business reaches a certain valuation. So if the valuation and the next round makes sense, they’re going to convert to a debt to equity. If not, they’re going to keep the debt. The specifics of how the debt will convert it into equity, I’d establish at the time of the initial loan. Usually that involves some kind of incentive for investors to convert a deck into equity such as the discount or Warren to the next of fundraising. So if your offer, if you offer investors a discount, the most common is 20 to 25% it means that they can convert their loan into equity at a discounted rate. For example,
Speaker 1 50:40 for example, if an investor loans you $1 million with a 25% discount on the first round, they can get 1.2 5 million worth of equity in the next round.
Speaker 1 50:56 So if you’re offering investors a discount, so let me say that again, an example. So if your investor loans you $1 million with a 25% discount on the first round, they will get 1.2 5 million worth of equity. A warrant is also expressed in percentages. For example, 20% warrant coverage if we take are the same million dollars with a 25 20% warrant coverage. The investor gets an additional $200,000 on two or 20% and 1 million and securities at the next round. You would also need to set the interest rate as you will be for a spread that raise in order to repay the investors until they convert. There’s typically a valuation cap for four convertibles. So when to do it, convertible debt fundraise makes the most sense for stars that are not ready yet for the valuation of the company. So you’re not ready to cuff up the $4,000 or the three 30, 20, $30,000 worth of um, uh, audit, you know, financial audit.
Speaker 1 51:54 If I audited financials he did because it’s too early or for whatever reason, if you, if you believe that your company’s valuation is likely to skyrocket soon, but not soon enough, you might want to consider, um, convertible debt. These to keep in mind for investors coverable that offerings a an option. So, Hey, gosh, we were coming up out of time, so I hope this was helpful. I know I packed a lot of information. If you have any questions, reach out to us at www dot Greenland, G R E E N L a N D H q.com or call us at (559) 207-3148 it’s been a pleasure. Have a great Saturday everybody. We’ll talk next week.
Speaker 2 52:34 .