The Tech Wreck of 2000 seems as if it's old news, but it has left capital markets with a wicked hangover. High-risk capital has been wiped out, and those who didn't lose money are so paranoid that they won't take risks. That makes raising new money pretty tough.

The reality is that there are billions and billions of capital dollars out there just looking for investment. This huge supply is often referred to as capital overhang (think large beer belly). The problem is that many business owners don't know how to tap that keg.

Banking rates have never been better, but with financial institutions suffering big losses, bank loans are difficult to obtain. "We have all this money and low-cost debt available, but investors are too nervous to employ it," says Jeff Klank, director of mergers and acquisitions for Leading Edge accounting firm Brady Ware in Dayton, Ohio.

When most people talk about capital, they are referring to equity or selling stock, which is the most expensive kind of capital. The cheapest form of capital to raise is debt—short- and long-term loans and mezzanine debt.

"Debt is cheaper than equity. You pay it back and it goes away. Equity is forever," says Paul McAllister, director of Witan Securities LLC, the investment banking division of the Leading Edge accounting firm KGN Financial Group in Chicago.

"It's never more important than now to have financial advisers," says Klank. "You can spend a lot of wasted time unless you understand what you need, why you need it and who you're asking for it, because you really only get one shot," he says.

Conventional lenders

Term loans are the cheapest source of capital. Banks will look at your company's historical profits, ability to repay and collateral. If you need to raise $1 million to pursue a new product offering, you probably can borrow from a bank if you have a good track record. If you're a smaller firm, you have limited options, says Klank.

"Banks were lending money based on the inflated expectations of their customers and they lost big. It's difficult to raise capital," adds McAllister. "In the hangover of the tech days, banks are skittish. Raising capital through banks for all but the cleanest companies is impossible," he says.

"Larger banks are driving down cost structure and trying to do more with less. They can't afford to make the smaller deals," says Klank.

Although large national banks are harder for the middle-market company to approach for financing, a number of regional banks appear to have stepped in to fill the niche of financing smaller investments.

All lenders understand that the past 12 to 24 months have been particularly difficult for businesses to meet profit goals and achieve bank covenant requirements. Management must be prepared to articulate the causes of any downturn in profitability. Perhaps most importantly, though, management needs to present an achievable business plan designed to demonstrate adjustments made to return to profitability and stabilize the company.

Angel investors

We've heard a lot about angel investors recently and Klank explains why. "If you took the aggregate of all angel capital and all venture capital, there is four times as much angel capital as there is professional venture capital."

The problem is that these investors don't advertise. "These are cash-out entrepreneurs who recently sold their business for a nice return and may want to invest in, but not start, their own business. Or they are high-net-worth retired executives with great retirement packages and management skills that they'd like to use. Or they are simply high-net-worth individuals with inherited money who would like to take a stab at a business. Angels are successful businesspeople, not necessarily experienced investors," says Klank.

The best way to reach them is through your financial or legal adviser.

Individual angel investors can set their own investment threshold, pricing an investment any way they choose. But in return, they may want a say in the business. Institutional investors have to raise the bar to meet what the investors in the fund expect.

Next Page: Venture capital  //  1  2