Business Organization & Transactions Newsletter

Venture Capital

The most frequent source of capital for small companies is owner capital investment and cash generated from operations. Often, however, these sources are insufficient to finance equipment purchases or business growth. Small businesses must then consider seeking venture capital from a commercial bank.

When deciding whether a start-up business should rely on a commercial bank for financing, business owners should be cautious. Often, the only type of bank loan offered to a fledging company is a demand note secured by a lien on all of the assets of the enterprise. This permits the bank to demand repayment at any time.

Although the lending officers of commercial banks normally have extensive experience with business in general, they often do not have extensive experience with the start-up borrower or the particular vagaries of the industry within which the borrower operates. Some relief from these problems can be obtained by negotiating with the bank for additional compensation to the bank, in the form of an equity interest in the enterprise, for the bank’s willingness to incur added risk. The advice of an attorney experienced in commercial lending practices can be invaluable to persons considering venture capital financing for their business.

Another common method of raising capital for new business ventures is through federal Small Business Administration (SBA) loans. Although the SBA participates in direct lending to small business enterprises, a more common arrangement is a bank loan guaranteed by the SBA. The primary advantage of an SBA-guaranteed loan is that the bank is likely to permit a longer maturity period and a higher loan-to-value ratio on tangible assets.

There are several thresholds for SBA loan qualification. The applicant must have attempted to obtain financing from other nonfederal sources, including the owner’s resources and private lenders. The maturity of the SBA loan obtained is required to be the shortest feasible repayment period consistent with the borrower’s ability to pay, with a maximum maturity period of ten years (25 years for real property loans). Often, the SBA requires the owner of the venture to personally guarantee the loan, and the SBA can collect from the owner in the event the SBA is called upon to pay on its guarantee. Finally, there are limits on the amount that can be loaned or guaranteed. For instance, the SBA is authorized to guarantee only 85% of loans of $150,000 or less and 75% of loans over $150,000.

An alternative to an SBA loan is a loan from a privately owned Small Business Investment Company (SBIC) that uses funds obtained from the federal government and administered by the SBA. SBICs are, for the most part, profit-motivated firms that are licensed and regulated by the SBA. In general, SBICs are privately owned and operated investment firms that use their own capital and funds borrowed at a favorable rate with a guarantee from the SBA, to make venture capital investments in small businesses. In addition to charging interest on their loans, SBICs commonly participate through equity options such as subordinated convertible debt. Many banks and bank holding companies have organized SBICs to participate legally in a non-bank equity investment activity.

If you have questions about business finance, contact an experienced business law attorney in Maryland.

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DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent counsel for advice on any legal matter.

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