Alternative Venture Finance: Shell Corporations & Federal Grants and Loans

A shell corporation is a company that is incorporated but has no significant assets or operations. These corporations may be formed as an alternative venture financing mechanism.

Shell company financing works in two ways. In many cases, the shell corporation is created from scratch. The purpose of these shells is to raise money and to get a number of shares outstanding into the public’s hands. In most cases, the shares are sold in units. That is, the shares are sold as one share of common stuck plus warrants at the current offering price.

The “empty” shell is then merged with the operating company. The merged companies begin to report operating results and when the results are good, existing stockholders exercise their warrants and provide needed capital into the company.

A second type of shell corporation is formed when the company seeking capital identifies an existing shell or inactive public company (IPC) as a candidate for a reverse acquisition. This typically occurs after a public company emerges from bankruptcy. At this time it may be void of assets other than cash. In fact, the principal asset of the IPC is it’s often its public registration and a roster of shareholders from which new capital may be raised.

Shell corporations are a quick and cost effective way of taking a company public and raising public capital. However, typically bridge capital is required to finance the process and take the company to a point where investors are interested in exercising their options.

While most companies seeking venture capital initially think about angel investors and venture capitalists, a large alternative source of financing is federal grants and loans. The two largest federal grant programs are run by the Small Business Administration (SBA), and by Small Business Investment Companies (SBICs).

An SBA loan, regardless of whether it is a direct loan from the SBA, or, as is more common, a bank loan guaranteed by the SBA, is essentially a bank loan. The benefit of it versus a traditional bank loan is the rate. SBA rates are typically much less than traditional business loan rates.

In most cases, in a guaranteed SBA bank loan, the SBA guarantees 90 percent of the loan will be repaid to the bank. As such, banks are at much less risk than in most other loans, and are a bit more flexible with regards to who they offer these loans. However, the SBA usually requires the founders of the company to personally guarantee the loans, which makes them risky should the venture collapse.

Alternatively, Small Business Investment Companies (SBICs) are privately organized corporations that are licensed and regulated by the SBA. Small or emerging businesses which qualify for assistance from the SBIC program can receive equity capital and/or long-term loans from these companies. Essentially, these companies provide their own capital, which is supplemented by federal funds, to the companies they fund.

Interestingly, U.S. taxpayer’s benefits from the SBIC program as tax revenues generated from successful SBIC investments have more than covered the cost of the program. Likewise the program has created hundreds of thousands of jobs.

In summary, SBA and SBIC financing are viable alternatives to financing from angel investors and venture capitalists and should be considered in the capital raising process. Similarly to angel and VC financing, companies seeking SBA and SBIC financing need a strong management team and value proposition, and a highly professional and compelling business plan in order to raise the capital they need.