In search of money.
But when his banker finally called, it wasn't to firm up the deal: To his dismay, McKinney learned that the bank went under, thus shutting his only source of credit. "From that day, we were unable to buy parts and had to turn down some lucrative opportunities," recalls McKinney, who watched five months slip by without a cash infusion. "We worked hard to conserve our resources to complete the jobs in progress."
Shrewd management, loyal employees and a nontraditional lender helped keep SIMTEC afloat. Still, says McKinney, it cost the company $300,000 to endure the bank going out of business. "Next time," he vows, "we'll spend as much time checking out the bank as they spend investigating us."
Black Business And The Credit Crunch
It's no secret that small business--specially black-owned companies--are starved for cash. Industry observers, however, doubt that access to commercial bank credit--down last year by as much as 43% in some states--will improve anytime soon. And after two years of record bank failures, the Federal Deposit Insurance Corp. (FDIC) is again bracing for more than 200 fold-ups in 1992.
For black-owned businesses in particular, a severed bank relationship spells trouble. A report issued last year by the U.S. Commission on Minority Business Development shows that minority-owned firms typically rely on a single institution and just one type of loan for credit.
"Lack of access to capital is one of the factors that has historically led to the high failure rate of black businesses," says David Swinton, dean of the School of Business at Jackson (Miss.) State University and a member of the BLACK ENTERPRISE Board of Economists. "Any tightening of credit signals a low point for our business community."
However, all is not gloom and doom for business owners needing cash. Even in this troubled capital market, experts agree that capital relief does exist. The current trend has small business owners hunting for as many alternate sources of financing as possible. "It's a matter of Knowing where and how to look," says Bruce Blechman, a San Francisco-based small business finance consultant and coauthor of Guerrilla Financing (Houghton Mifflin Co., New York; $19.95). "And since most businesses can't rely on any single source of cash, it's important to investigate every option."
Perhaps you're not angling for funds today, but what are your balance sheets telling you about the state of your business a year from now? The increased competition for funds demands that you take a long-range approach. Here's brief guide.
When your banker balks at your next request for a business loan, chances are he won't send you away empty-handed. He'll probably slip you the name of a commercial finance company.
Known interchangeably as "factors" or "receivables lenders," these companies pay cash upfront for a company's accounts receivables. So, who are their customers? Companies strapped for funds who simply can't wait 30 days or more for accounts to settle up. Because of their exorbitant fees, factors use to suffer from a serious image problem. In fact, the method they used was often perceived as legalized loan sharking in many entrepreneurial circles. Not so anymore.
"Unregulated sources such as factors are among the most aggressive players in financing today," says A. David Silver, president of ADS Cos. in Santa Fe, N.M., and author of Up Front Financing: The Entrepreneur's Guide.
Indeed, companies such as Allstate Financial Corp. in Arlington, Va., and Commerce Funding in Tysons Corner, Va., say they financed as much as 45% more deals in 1991 than in the previous year.
Here's how factoring works: Say you have receivables worth $100,000. After approving your customer through credit checks, a factor will hand over about 80% ($80,000 in this case) of their face value. Your customers are then notified to pay the factor directly. Once these accounts settle on time, the factor will pay you the difference ($20,000), minus his fee or "discount." Your final check, then, might be for about $15,000, since factors pocket anywhere from 5% and up for their services. That rate shoots up for every day your customers are late paying. If they're seriously delinquent, you may be obligated to buy back the receivables.
Because a factor cares more about your customers' ability to pay up than your own, they are a viable source for companies with spotty credit histories. The hitch? Factors usually will require you to hand over a percentage of your receivables over a yearlong period. That gives them plenty of time to tack up the big fees they crave: Factoring $100,000 worth of receivables each month, for example, could cost $60,000--or triple the amount of interest you'd likely pay for an equal line of credit.
"The general rule is to avoid factoring if your gross profit margin is less than 50%," Silver advises. For companies that fit the bill, the high price of factoring can be a temporary investment worth making. "Many of our clients come to us because they're tired of having to turn down orders," says Lee Fishman, president and CEO of Allstate Financial. "They also appreciate the fact that there's no ceiling in factoring. The more they sell, the more cash they can get."
A similar arrangement, called "receivables lending," uses your business' orders as collateral for a term loan or line of credit. Available through both banks and commercial finance companies, such loans can be taken out against receivables as modest as $10,000.
John R. Kelly, owner of J.R. Kelly & Sons Hardware and Industrial Supply Inc., an Aiken, S.C., distributor of such supplies as power tools and safety equipment, discovered receivables lending after his bank rejected his loan application in early 1990. Frustrated that his anemic cash flow couldn't support customers' rising demands, Kelly, whose 11-year-old business grossed $3 million in 1991, sought and got a revolving $300,000 line of credit.
"It was the only way we could get a short-term loan," says Kelly, who alternately drew on the line and repaid 80% of the balance every 30 days. For access to such cash, he paid interest and fees equal to five points above prime. After successfully financing his company this way for 12 months, Kelly wisely got out of the receivables racket.
Indeed, the high price of factoring and receivables lending is a strong argument against using either as a long-term solution to cash needs. "Most of our arrangements last for about a year," admits Lee Fishman of Allstate Financial. "After getting over a major hump, clients generally replace us with a cheaper source of money."
The very term "venture capital" conjures up images of swashbuckling investors who thrill at the notion of risky business. Lately, however, venture capital hasn't been living up to its name. According to Venture Economics Publishing, a Newark, N.J. company, which tracks the venture capital industry, disbursement in 1990 totaled just $2.16 billion, down almost 35% from the previous year. Tallies for 1991 are expected to be equally dismal. But considering where venture capital comes from--investment dollars from pension funds, corporations and government sources--it's not difficult to understand why these monies have been shrinking.
So why even bother? "The hurdles may be high in obtaining venture capital," acknowledges Bruce Robinson, an associate with UNC Ventures Inc., a Boston-based venture capital firm. "But equity financing lets businesses get through tough times more readily than they would having the fixed obligations that come with debt."
Furthermore, a new limited partnership in Hartford, Conn., promises to soon double the available venture capital dollars spent on minority-owned businesses. JoAnn Price, president of the Washington, D.C.-based National Association of Investment Companies (NAIC) announced last year that the organization will join forces with Bigler Crossroads Investment Management Co. of Farmington, Conn., to raise $250 million to invest in venture partnerships that specialize in financing minority companies. Funded largely by private and public pension fund dollars, the fund, says Price, "will be an important new source of capital for those firms investing in out marketplace."
Venture capital funds are available from both professional firms and government-sponsored sources. Here's where to look:
* Privately Funded Professional Venture Capital Firms are willing to put up cash in exchange for equity in your company. Unfortunately, start-ups rarely qualify here. But if you're in an expansion mode and are looking for a substantial infusion ($250,000 to $1 million and up), you may want to consider a professional venture capital firm. Such outfits, however, seek fat returns--20%-40% annually--and are thus on the lookout for small businesses dealing in hypergrowth fields. Today's hot industries, for instance, include medical and computer technologies. The Commerce Department projects growth in these fields will swell by roughly 15% a year until 1995.
If you're at all squeamish about giving up a chunk of your company, don't waste time courting a professional venture capital firm. They typically demand substantial equity--up to 50% or more--in the form of common or preferred stock, and may want to stay in the deal for as long as 10 years before cashing out. The benefit to you? Aside from blanketing your business with cash, a venture capital firm can often deliver top-fight management advice and valuable credit references.
The best tool to crack the venture capital community is an airtight business plan. Be sure to beef up yours by detailing the strength of your management team. "Since we're basically looking for partners, management is really the key," explains Bruce Robinson of UNC Ventures. Armed with a solid plan, start your search by contacting your banker, lawyer and other business associates who know your business' raison d'etre. To locate prospects in your area, check out Pratt's Guide To Venture Capital Sources (see sidebar "For More Information"). This reference book has entries on more than 800 venture capital and professional services firms.
* Small Business Investment Companies (SBIC): Funded in part by the federal government, the Small Business Administration's (SBA) 34-year-old SBIC program helps small businesses attract venture capital funds. It's easy to be confused by these quasi-government sources. But make no mistake: Though they are licensed and regulated by the SBA, all SBICs are Minority Enterprise Development Companies and are privately owned investment firms. Today, there are more than 360 SBICs, including 130 MESBICs, which specifically provide working and expansion capital to minority-owned businesses. In fiscal year 1991, SBICs made investments totaling an estimated $456 million. MESBICs--ranging from General Motors' Motor Enterprises Inc. to the smaller Minority Equity Capital Co. in New York--invested an estimated $101 million.
SBICs and MESBICs differ from straight venture capital firms in that they provide long-term loans with equity features. Peter Moncrieffe, for instance, found five MESBICs in 1990 who together lent $1.5 million to fund Citywide Broadcasting Corp. of Lafayette, in Baton Rouge, La., in its purchase of local station KFXC. The deal? In exchange for cash, the MESBICs received stock warrants worth 25% of the value of KFXC. When Citywide buys back the warrants in three to five years, it will pay the MESBICs what will be 25% of the station's appraised value at that time, which they're hoping will have grown substantially.
"We get to use their money temporarily," explains Moncrieffe, who says Citywide grosses $3 million annually in advertising revenue. And bolstering Citywide without traditional debt he says, enabled him and his partner to receive 100% owner-financing in their latest station purchase of WXOK-AM in Baton Rouge.
MESBICs are generally more open to start-ups than their traditional venture capital counterparts. Roughly half of all MESBIC investments made last year are with companies a year old or less. For a current listing of SBICs and MESBICs, contact the Small Business Administration of the National Association of Investment Companies. (see "For More Information.")
If hooking up with a corporate partner brings the game "Pac-Man" to mind, think again. Forming a strategic alliance or partnership with the right corporation doesn't mean your company is a prime target for a takeover, but it can help you muscle into your market of choice.
Author Bruce Blechman estimates that 60% of all Fortune 500 companies have paired up with small firms and that such deals will mushroom over the next decade. The reason? Partnering allows corporations to tiptoe into promising niche areas that wouldn't be cost-effective to explore on their own. "It's a way for them to increase productivity without increasing their existing resources," Blechman says. One recently publicized deal for instance, joined a small San Francisco-based company with drug giant American Home Products Corp. (AHP). In exchange for funding research for an Alzheimer's disease treatment, AHP will share its forthcoming profits.
The most practical form of pairing is a strategic alliance, which does not require the formation of a new, separate company. In exchange for financing--either upfront or future--your company might perform research for a joint project then hand over the rights to license or sell, or manufacture the product.
It was precisely such an arrangement that helped Ron Walker launch his black hair care products business in 1988. At the time, large pharmaceutical companies were moving into cosmetic sales. Realizing that "specialty markets need specialists," the Atlanta entrepreneur signed on with Schering-Plough Corp., a Madison, N.J.-based pharmaceutical and consumer-products company, to research and develop his Kink Wave Memory System, a professional line of hair products. "We had the expertise and they had the resources and technology," Walker says. Under three one-year contracts, R.M. Walker HealthCare Products Co. received $3 million from Schering-Plough, which made the product in exchange for an undisclosed profit stake. "It was more than mutually beneficial," says Walker, whose company grossed $18 million during the three years.
Since partnerships are highly individualized arrangements, their duration will depend on each party's motivations. That could mean a decade or more for a miracle drug seller, or, as in Walker's case, just three short years. That's all it took before Schering-Plough decided to leave the cosmetics field and concentrate on pharmaceuticals. In 1991, Walker took his product solo and grossed $2 million.
Of course, not all corporate pairings go so sweetly. A big company share seeking more than shared profits or equity could gobble up its partner in a buyout. To avoid any unwanted takeovers, make sure the terms of any alliance--including exit provisions--are stated in a contractual agreement.
Experts recommend approaching potential partners through their corporate planning offices, where decisions on joint ventures and product development are typically made. Start by pitching any big customers who may have complex distribution networks in your industry nailed down. Another route is hiring a strategic partnering firm such as TMF Inc. in Princeton, N.J., which helps to arrange alliances and limited partnerships for small firms. The price? Roughly a 20% equity stake in your business. But, says TMF Vice President William Bridgers, "we only take the equity after clients are happily matched." Contact your local trade associations and your chamber of commerce for a similar matchmaking referral.
State and Local Programs
Would you be surprised to learn that 23 states offer venture capital funds, and that 31 provide loan guarantees? Once, states turned a blind eye to small business; today, they are concerned with boosting their economies--and that means helping to fuel more entrepreneurial efforts.
"Of course, they have ulterior motives," says Joshua I. Smith, chairman of the U.S. Commission on Minority Business Development and CEO of The Maxima Corp., No. 14 on the BE 100s list. "The states don't want to lose jobs." States with the most active programs, adds Smith, "tend to have much lower business failure rates."
Though the bulk of such programs offer assistance on a small scale--financing a handful of deals a year--they can add up to make a real impact on the business communities they serve.
A call to your local economic development agency should turn up some good leads. Navigating your way through the maze of regional funding programs can be dizzying. And unfortunately, there is probably no single source to guide you. The best bet is to start inquiries at your chamber of commerce and state office of economic development. Also check out the States and Small Business Guide published by the SBA.
Additional SBA Loan Programs
The SBA's Loan Guarantee Program is known mainly for backing bank loans for small businesses. But there are other ways of using the agency's muscle to secure credit. Specifically, more nonbank sources--or more specifically, Small Business Lending Companies (SBLCs)--are participating in SBA loan guarantees. (SBLCs are private-sector, nonbank lenders licensed and regulated by the SBA to issue SBA-guaranteed loans to small businesses.) In 1991, according to the SBA, 12 such lenders made loans totaling $335 million. These types of loans can be used to purchase a franchise, real estate, equipment, inventory or an existing business.
One of the newest SBLCs is AT&T Small Business Lending Corp., a subsidiary of AT&T Capital Corp., a Morristown, N.J., financing and leasing company. AT&T recently announced that it was approved as an SBLC and will provide up to $20 million in SBA-sanctioned loans.
The SBA also has launched special loan programs for small service businesses in need of $50,000 or less and for low-income entrepreneurs who need start-up capital under $15,000. To get the lowdown on those programs, contact your local SBA office or call, 800-827-5722.
Remember, the key to finding cash in this credit-crunch era is to research and explore all finance alternatives.
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|Title Annotation:||business capital|
|Date:||Apr 1, 1992|
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