Financing Options for Your Company
Financing Options for Your Company. As new funding options emerge, small business owners have more diverse options for financing growth
Introduction: The Financing Challenge
Economic conditions, legislation, and technology have sparked a sea of change in small business owners’ options for securing funding. Traditional bank lending and venture or angel investment still figure prominently in today’s financing landscape. But today’s alternative sources of funding range from emerging online lenders to crowdfunding and do-it-yourself initiatives. Financing Options for Your Company
These changes have been developing for years. Bob Seiwert, senior vice president of the American Bankers Association, notes that during the housing boom, some business owners relied heavily on home equity lines of credit and credit cards to fund their businesses. “As values of real estate have dropped, so have those lines of credit,” he says. “There’s no substitute for equity in the business. And banks don’t make equity investments into small businesses. They make loans. We don’t get paid to take equity risks. We get paid to take loan risks.” Financing Options for Your Company
That also creates a challenge for business owners who saw their equity disappear during an extended period of losses and negative cash flow and who now need permanent working capital. “Bankers are not going to provide 100 percent financing,” says Seiwert. That leaves those business owners in need of funding alternatives, whether that means personal resources, assistance from relatives, or funding from suppliers or major customers “who are willing to make equity investments in the business because they know that business well, have confidence in it, and need that product.”
2. Capital Sources
“We’ve been in a prime-plus world lending to people who really weren’t prime-plus borrowers,” says Charles H. Green, executive director of the Small Business Finance Institute and author of The SBA Loan Book: The Complete Guide to Getting Financial Help Through the Small Business Administration.
DIYtoBank_PQ.jpgAs bank financing availability tightened for companies facing an equity crunch, new funding options emerged to fill the void. But some are high-interest options that won’t work for every small business owner. “There’s going to be a price adjustment for small business credit,” Green cautions. “These new capital sources online, and there are several of them, are charging from 16-36 percent.” That’s a dizzyingly high rate, but the terms can be viable for a company whose margins are high enough and who need the money fast, he adds. “They need to evaluate what their profitability is, and that will tell them if they can afford it. They need to ask, ‘will this be a net profit to us overall, and will it last?’”
Joining the crowd
Crowdfunding— the collective effort of individuals who network and pool their resources, usually via the Internet, to support efforts initiated by other people or organizations—is another emerging alternative for business owners who need to get creative about financing their growth—but here, again, there are caveats. Kickstarter reports that of 32,311 successfully funded projects, 25,695 raised $10,000 or less—and of those, 3,800 raised less than $1,000.
That’s not to say that crowdfunding is off-limits to companies with higher funding aspirations: the total includes 326 projects that gained $100,000-999,999 in financing, and 15 projects have raised more than $1 million. Financing Options for Your Company
But the odds are daunting. Those 32,311 funded projects represent just 43.8 percent of 77,072 projects that were launched on Kickstarter. The remainder failed to gain full financing—12 percent received no financing at all—and projects that fall short of full financing get no financing, in keeping with the company’s all-or-nothing policy.
Moreover, the site reports that crowdfunding works best for companies that have already established a following among likely supporters. “In most cases, the majority of funding initially comes from the fans and friends of each project,” Kickstarter reports in its FAQ. It adds that social media and press are “big sources of traffic and pledges”—which means this approach to financing is best suited to companies that already have a strong social media platform.
The angel alternative
Angel, or venture investors aren’t likely to come from your circle of friends, but those that agree to invest in your company will expect to join your circle of advisors. That distinguishes them from the business banker who issues a loan and simply wants it repaid.
A venture investor is essentially taking a stake in the company. Susan Preston, general partner at CalCEF Clean Energy Angel Fund, notes the attributes she seeks in a business that’s seeking funding: “Having validation in the market that there are customers who are willing to pay for the product is certainly an excellent attribute, and it is a plus for the company. But for me it is more about: Who are the customers? What is the market potential? Can the company scale? And can it give me a return that is high margin for the money I would be putting in?” Financing Options for Your Company
That doesn’t mean, however, that you have to accept loss of authority and venture capital as a package deal when working with angel investors. “With some exceptions, investors don’t come in and try to run the daily show. They’re there to help the entrepreneur grow,” Preston says. “I always advise entrepreneurs that you need three things from your investors. The third most important is the money. The first is their sage advice, because 90 percent of the time, angel investors and venture investors are prior successful entrepreneurs themselves.” Their experience leads to the number two item on the list: their connections. “They know people. They know prospective customers, experts in the field, and can bring those in to the company’s advantage.”
With that in mind, business owners should consider prospective angel investors’ personalities and professional fit, not just their ability to provide funding. Good entrepreneurs understand their limitations and recognize the value of advisors who can provide greater strength in those areas, Preston says. “It really is a lot of honesty with yourself: where do I need help, and where can I most benefit from support from my investors and advisors?” Financing Options for Your Company
Taking it to the bank
While angel investors and bankers differ in what they expect of business owners who seek funding, they share one critical trait. Success in either type of financing depends in part on personal relationships. That element is often lost on a new generation of small business entrepreneurs who are accustomed to conducting business, and particularly financial transactions, electronically and virtually.
“But there is one thing that you can’t do online, and that’s build a relationship with a banker,” says the ABA’s Seiwert. “At the end of the day, the credit decision that a banker makes is based on their knowledge of your business; it’s based on a degree of trust that that banker has built up over time with you. And that trust can only start via a personal relationship. The people who get the money or who have the best chance of getting money in an economic downturn, when times are tough, are those who have relationships with bankers.”
Relationships help business owners to understand what bankers need to make a favorable credit decision. Of even greater value, he says, is the opportunity for business owners to get feedback on how bankers view their companies. “Bankers have the benefit of seeing lots of business owners, and they have a feel for what works, what doesn’t work, what are best practices, and what are not best practices.”
Interaction with business bankers also keeps the company’s track record on their radar. “By building a relationship, you have the loan officers watching what you do,” says Mitchell Petersen, professor of finance and director of the Heizer Center for Private Equity & Venture Capital at Northwestern University’s Kellogg School of Management. “They see this track record of when you’ve taken out, borrowed from suppliers, and repaid, or when you’ve borrowed a small amount from me, you’ve repaid. So there’s a paper trail that shows you are able to take out credit and repay it.” Financing Options for Your Company
3. Enlisting Bankers as Advocates
Beyond that trail of hard data are softer indicators of the company’s merits as a borrower, he adds. “If you’re a loan officer, and you saw a firm operate very well under very unfavorable conditions the last three years, you’re much more comfortable with that person. That loan officer can go up to the credit committee and say, ‘I’ve seen what happens when they’ve lost a major customer, and here’s how he responded. I’ve seen when he took money out and there was opportunity not to repay it, and here’s how he responded.’ He’s essentially vouching for you, and they’re more likely to do that if they know you well.” Financing Options for Your Company