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Inventors Handbook

II. Sources of Financing – Debts and Equity

The most commonly used sources of financing are debts and equity. Most businesses need both and must use each in the right way at the right time. Normally, debt follows equity. Equity is best used in the initial stages for research and development, product development, and later for sales and marketing initiatives. Debt is ideally used for meeting working capital needs and building infrastructure.

Equity Financing

Equity Financing is the grant of financial funding in exchange of a proportional allocation ownership in the business. Equity financing is considered risky for both the investor and the owner of the business. An equity investor, unlike a debt financer is totally at risk and has no absolute guarantee of returns. It may prove equally costly for the owner of the business as depending on the size of investment and level of risk, they may seek a control position and seats on the company's board of directors.

Major sources of equity financing often include
Friends and Relatives: A source of additional equity from non professional investors such as friends, relatives, employees, customers or industry colleagues.

Venture Capitalists: Institutional risk takers are one of the most common equity finance providers. They may be groups of wealthy individuals, government assisted sources or major financial institutions who normally specialize in one or a few closely related sectors. They will support any venture which they feel is worth the risk, be it start-up businesses, a company that is expanding or acquiring another firm. The characteristics in your business that may attract the interest of a venture capitalist include:

a. A Strong Management Team – with finance, sales and technology expertise and business acumen
b. Return on Investment – a ROI of 25% or more
c. Unique Product - a different, innovative, better and useful product or service mix
d. Patent – the product should be patented or patent pending.
e. Ownership – proportionate allocation of shares as well as membership in the board of directors
f. Agreement on Exit Strategy – Normal investment term may be 5-10 years and the preferred exit options include an Initial Public Offering (IPO) or strategic purchase of the company by a third party.

More information is available at the U.S. Small Business Administration, and The National Venture Capital Association (NVCA).
“Angels”: This term refers to high net worth individuals who are prepared to take substantial risks by investing in business ventures that may interest or inspire them. Investment decisions are typically based on a number of parameters that may include:

a. A strong management team with finance, sales and technology expertise and business acumen
b. A high return on investment
c. Documents reflecting the existing investment in the business
d. The support of a lead investor, an expert evaluation of your product and market, and expert due diligence.
e. Exit options, including sell out provisions.

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