Brass Tacks

Q. My company is two years old and growing fast. I’m soon going to need more cash. I’ve been advised to try and sell some stock to friends and family, since such funding involves no interest cost or principal repayments. What do you think?

A. There is a significant downside to an early issuance of equity interests to people who are not directly involved with you in running the business. Once the stock is owned by third parties, you acquire significant new responsibilities as the shepherd of the enterprise. Other shareholders’ interests must be considered when it comes to determining the corporate tactics and strategies that will determine the success – or failure – of your firm. This can constrain or confuse operations at critical points in your firm’s development when quick, confident, “entrepreneurial” direction is essential.

In the start-up or rapid growth phases of a business the single-minded determination of a person willing to take risks is often required to exploit important opportunities or kill off threatening challenges. However, when there are outside shareholders, your judgment and risk-taking tolerance is open to scrutiny. But you are the CEO and are empowered to do what must be done in your judgment to succeed.

The law says that their basic entitlement is a vote when it comes time to elect a board of directors (another problematical issue entirely). But that doesn’t mean that you are immune from second-guessing and litigation. The degree of your exposure to shareholder legal action – or even personal harassment – is going to be determined by how well they were informed about your intended strategies when you sold them the stock, how well you communicated the essentials of your operations to them in your periodic reporting and how carefully and thoughtfully you applied your skills to the operations as it progressed.

Working with a bank

There’s another important negative impact of an early stock offering that will hit you, the owner, in your personal pocketbook.

Assuming your company goes on to enjoy a pattern of growth and success, each share of stock in your company will become more valuable with every year that passes. One hundred shares of stock issued five years from now will very probably fetch a much higher price than the same number sold today. In other words, your firm will realize a greater capital infusion, with less of an equity give-up on your part, if you defer any sale of equity until further down the line. Why sell a piece of something that is growing in value, if you can wait and get more for it later?

Here are a few Brass Tacks Tips for borrowing from a bank:

• Apply for a loan before you really need it. Let the bank get to know you when you are not desperate. Your goal should be to build a long-term relationship with an institution that really gets to know you, your firm and it strengths and vulnerabilities.

• Have good financial statements – especially cash flow projections — prepared by a reputable accountant. Make sure you know these statements inside and out.

• Get a current appraisal of your hard assets at work, including raw materials and inventory.

• There’s quite a bit of turnover in lending departments, so get known by more than one officer.

• Try to get the bank to structure a package of loan vehicles that is custom-tailored to your needs. To start, a modest term loan coupled with inventory and receivable financing should be designed to meet your immediate and intermediate cash flow needs.

• While the bank will surely want your personal guarantee, try to avoid having your spouse co-sign. If she is not required to sign, make sure that your home is jointly owned by both of you.

• Make sure that the bank attains a defensible credit interest in your business assets. If the “worst” happens, and the bank is forced to move on your business assets, you want them to be able to get them without interference from other unsecured creditors. If the bank has to get in line with other business creditors, it will be more inclined to act on your signature, thus putting your personal assets in jeopardy.

• Most importantly, all assurances, promises and commitments should be in writing and checked by your attorney before any agreement is executed. nhbr

Paul Willax is a professor of entrepreneurship and chairman of the Center for Business Ownership Inc., Amherst, N.Y. He also is the author of the book, “Brass Tacks Tips for Business Owners,” available at barnesandnoble.com. If you have a question or suggestion for his column, or to receive a free, weekly e-mail newsletter, “Brass Tacks BrainFood,” write to Willax@TheBrassTacks.com.