Microlending - The Global Distribution of Capital

The distribution of capital, along with other fundamental resource allocations, is central in the evolution of economic interactions from the ubiquitus power centric model of today to a network methodology that meets emerging requirements of the Global village.

Large credit markets, on which so many of our economic interactions rely, demand critical mass of information and duplicate transactions to support profitable arrangements (http://ideas.repec.org/p/sef/csefwp/36.html ) (Jappelli and Pagano 2000). These credit markets, however, do not address the real needs of the majority of the world's economy. The markets serve, in many respects, the economies of the past. Thus, as we depart from old way and head toward solutions that will support the new , the creation of solutions that arrange resources appropriately in light of Global economic realities is essential. There is evidence of a revolution in credit markets that reinforces this thinking. As the poorest among us gain access to resources, they will further push the rate of change and thus available capital in the emerging third world is a good sign for continued upheaval ahead.

Such is the power of microlending, a form of finance that is helping to eradicate poverty in countries all over the world. In rural India, for example, a loan of $50 can spell the difference between poverty and economic self-sufficiency for an entire family. Vinod Khosla, founding CEO of Sun Microsystems and a partner at the venture capital firm Kleiner Perkins, calls it "one of the most important economic phenomena since the advent of capitalism and Adam Smith."

Speaking at the Global Business and Global Poverty conference at Stanford Graduate School of Business, Khosla used the Indian organization SHARE Micro Finance Limited to illustrate microfinance. SHARE targets rural women in India whose per capita income is less than $8 a month—well below the World Bank poverty line of $30 a month. The organization lends each woman $50 to $100 to fund entrepreneurial projects proposed by the recipients. For example, a woman might open a market tea stall or small grocery or buy a rickshaw or bicycle to transport the wheat grown by her family to market. The rickshaw would allow her family to retain 50 percent of the profits from the wheat that would have gone to pay another transporter. On the high-tech end, some women have opened Internet kiosks that have become profitable within the first three months and have provided a livable wage within six months. "There are hundreds of examples like this," Khosla said.

In what Khosla calls a "virtuous pyramid scheme," SHARE lends money to eight-member women's groups. Because they are all part of the same community, the group members are under strong social pressure not to default. "It's embarrassing to default, and if one person does, the others have to make up for it," he said.

Critics argue that lending money in $50 increments is uneconomical and will lead to even greater burdens for the poor. The success of the more than 6,000 institutions doing some form of microfinance today has proven this wrong, said Khosla. "The phenomenon can draw economic resources on a worldwide and competitive basis," he said. Khosla urged listeners to join in the movement to remove regulations currently prohibiting microfinance organizations from obtaining necessary credit. Addressing the question of whether interest rates of 20 to 30 percent are usurious, he said: "Would you rather have no loan, or an interest rate of 25 percent? The alternative is a local money lender who charges 5 to 10 percent per day. So let's be pragmatic, let's get beyond superficial, ethical dilemmas."

Capital Formation - The Private Placement

Obtaining capital for a business is a complex process that requires knowledge and experience in a variety of disciplines including business planning and analysis, an understanding of the industry and the opportunity proposition, team and resource recruitment, finance and accounting, information systems, marketing, concept and product development, the preparation of contracts and an understanding of both federal and state securities laws. Performed properly, the process takes into consideration innumerable issues including those of shareholders, investors, lenders, managers and the requirements of the company itself. Each contributor to a business must be clear in what they intend to receive as a result of their relative commitments, be it capital or otherwise. Defining, managing and balancing the expectations of all stakeholders is the key to successfully obtaining and structuring necessary capital that fits all of the stakeholders needs.

I have advised many clients in the area of capital formation and concluded many financial transactions. During the past seventeen years I have successfully directed ten private debt or equity placements for companies with net capital raises of between $300K to $3 Million each. Sources of capital included venture capital firms, high net worth individuals, commercial lenders and others. In addition to securing over $40 Million in debt refinancing and financings, I was involved as a key player in a significant hostile acquisition, where our team secured $249 million in senior debt from a group led by Canadian Imperial Bank of Canada, a $149 million bridge loan from Merrill Lynch and the issuance of PIK notes on the public market.

The environement today is replete with available capital given the right proposition that includes the proper balance of management first, and specific market opportunity second.  My experiences have provided in-depth knowledge of the complex issues and challenges facing the successful close of these transactions. In speaking with potential clients, I am often asked many questions regarding the process of raising capital. Since many of the firms I have advised are not fully aware of the issues that must be managed in the process, I have prepared some basic information for potential clients to review in evaluating the acquisition of capital for their businesses.

Frequently Asked Questions

1. What is a private placement?

A private placement is a capital formation transaction, privately negotiated with individual or institutional sources, which provides funding to support a company's financing requirements or shareholders' liquidity needs. Typically, capital is being sought by a company and given the phase of the business, going public or obtaining capital via other means is impractical. Thus, private placements become a rational means of securing the required funding.

Strict legal rules govern private placements. These transactions are typically completed under registration exemptions from Section 5 of the Securities Act of 1933. Private placements fall within alternative Regulation D rules and requirements, depending upon the size of funding and the nature and number of investors. Transactions less than $1 million are frequently structured for and directed toward individual investors while larger transactions generally target private equity funds and institutions. However, this is not always the case, as many Small Business Investment Companies fund smaller amounts. While disclosure requirements differ, depending upon deal size and investor attributes, the general preparation and process for completing a successful private placement transcend specific transaction categories.

Private placements may take the form of senior debt, subordinated debt, convertible debt, preferred stock, common stock and hybrid or combined forms of these instruments. Key structural determinants include development phase, historical and projected operating performance, current capital structure, designated use of proceeds, future funding expectations, time horizon for return realization and desired exit strategy.

2. Why would a company consider a private placement?

The private placement market is accessed by a diverse group of companies for a wide variety of purposes. Some of the more common transaction contexts are described in the following:

Secured credit sources may not be available to support an internal expansion initiative, given the company's relatively leveraged capital structure, lack of collateral or early phase of development;

Shareholders may wish to execute a liquidity strategy (such as a recapitalization or management buyout) which does not involve the public capital markets or sale of the company to a strategic buyer;

The public capital market may not be a viable long-term source of funds given the company's size, development stage, management organization or industry dynamics;

A significant strategic opportunity, such as an acquisition, may unexpectedly present the company with a consequential financing issue. A private placement can be tailored to the project's specific capital requirements and completed relatively quickly;

While shareholders may ultimately desire to take their company public, the firm's current market capitalization may prevent it from securing a quality underwriter. Alternatively, the timing of the company's funding may not coincide with favorable public capital market conditions. A private placement can bridge this gap, providing interim funds in anticipation of a subsequent public offering, and

A private placement transaction can help secure outside investors for the business to assist with business strategy formation, future financial support and financial strategy execution.

3. Who invests in private placements?

The ultimate source of financing for a given private placement transaction primarily depends upon deal size, phase of company and investment structure. For new and early stage companies, individual investors and venture capital firms are more likely to provide equity financing. Private equity partnerships, Small Business Investment Companies and mezzanine funds serve as the principal sources for equity and hybrid transaction structures involving expansion phase to mature companies. For larger transactions, institutional credit sources (insurance companies, pension funds, banks and other credit institutions) usually consider direct purchases of relatively large debt instruments.

4. What are the key success factors in closing a private placement transaction?

Capital formation transactions pose important implications for any company. Additionally, while significant capital is available within the private placement market, creditors and investors remain very discriminating with respect to their choices. As a result, management should invest the necessary resources and thoroughly prepare in identifying appropriate long term funding solutions and attracting suitable financing sources. In differentiating their company as a high-quality credit or investment opportunity, management should:

Structure the financing to accomplish achievable organizational goals. Identify logical and specific uses for the requested funds;

Develop realistic expectations with respect to prospective operating performance, entry and exit valuations and ownership dilution;

Prepare a descriptive but concise financing memorandum to professionally present the industry, company, management team, business strategy and return prospects to investors;

Target the solicitation effort. Approach investors that clearly understand issues confronting companies within your development phase. In addition, select creditors or investors with favorable experiences and continuing, expressed interest in your industry;

Ensure that current shareholders' time horizon for creating and realizing value is consistent with the investor's desired time horizon;

Approach credit institutions or investors that are comfortable with the size of the proposed transaction and capable of providing follow-on financial support to the business, and

Present reasonable financial strategy scenarios to investors with respect to return generation.