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Financing alternatives for SMBs.

Many companies with revenues from a few million to several hundred million dollars have experienced tough business conditions since early 2008. And though it'll likely be a while before returning to what's considered "normal" market conditions, there are viable financing sources for these small--to mid-sized businesses (SMBs).

In response to the tough environment, SMBs have trimmed costs and become more efficient. They're now trying to grow or hold their own. Their banks have likely tightened the reins on available credit and taken a more conservative posture. Thus, finding the right capital depends on having a solid, well-thought-out strategy and operating plan and a strong management team.

With the fundamentals in place, investors or lenders that align with the type and horizon of funding required for specific businesses can be found. Here are five sources of capital to consider:

1. Asset-Based Lenders (ABLs)

There is a wide range of ABLs--starting with commercial bank-owned lenders that lightly monitor collateral to very aggressive loan-to-own privately held financiers.

Most likely, the bank ABLs are going to be nearly as tight as their corporate finance counterparts, given that they have some of the same regulatory pressures and risk aversion. Nonbank, non-regulated asset-based lenders are a more likely source as they can tolerate higher debt leverage ratios and an inconsistent earnings history.

2. Growth Equity

For initiatives requiring permanent capital, growth equity may be an appropriate alternative. Growth-equity funds make up a minor percentage of the total population of private equity investors. Growth-equity investors can be thought of as being at the intersection of venture capital and noncontrol private equity funds in their appetite for risk balanced with cash flow and control.

These investors are looking for operating companies that have revenues, a proven technology or service and proven market demand. Growth-equity investors will fund operating losses if the company is in a growth or expansion mode and where the losses are an investment in capturing market share or long-term customers.

3. Mezzanine Capital

Mezzanine funds are similar in their positioning in the world of private equity relative to growth equity. However, their investments are primarily in the form of subordinated debt with an equity kicker (warrants to purchase stock) that allows them to participate in the value growth of the business.

Mezzanine is thought of as a hybrid-type of financing, providing a lower cost of capital while having some characteristics of equity, given that it is subordinated to any bank or senior debt and that most banks will exclude subordinated debt in the total debt calculation for testing leverage ratios.

However, mezzanine capital only works if the company is generating positive cash flow, which will likely need to be at least $1 million in EBITDA (earnings before interest, taxes, depreciation and amortization).

4. Key Partners

In almost a counter-intuitive move, strategic supplier and key partner relationships are providing capital as many companies seek to stabilize revenues and earnings. The capital provided is not usually in the form of direct investment (i.e., they write a check), but rather in the form of providing services, resources or new business on increasingly favorable terms to lock-in or secure sales and margins.

Executives are encouraged to look at their company's customer and supplier relationships to determine who has the most to gain by their success. Then seek creative deal or relationship structures that provide value to both parties while not jeopardizing the opportunity for the company.

5. Public Financing Programs

Leveraging public sources of capital under various state, local and federal programs sometimes makes sense for small and mid-sized businesses.

According to Kennedy Advisors' Loren Kennedy, "Government economic development programs are difficult to qualify for and tedious to obtain, but can be worth the effort."

Public programs may be available, continues Kennedy, if your company is seeking project finance, adding a significant number of new jobs, has maximized bank funding, is located in a relatively poor county in your state, is considering opening a significant new operation or is considering buying another business.

There are no silver bullets in fundraising, especially in difficult times. But it helps to understand the overall financing environment, clearly aligning the company's funding needs with the lender or investor and their priorities and seeking out financing before it is actually needed.

Kenneth H. Marks ( is managing partner of High Rock Partners, providing growth-transition leadership, advisory and investment services. He is the lead author of Handbook of Financing Growth, published by John Wiley & Sons
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Title Annotation:private companies
Author:Marks, Kenneth H.
Publication:Financial Executive
Geographic Code:1USA
Date:May 1, 2010
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