The best ways to finance your business.
When the time was right, Reginald Dunham moved into action. Dunham, a computer salesman, knew he could capitalize on the state's recycling mandates for corporations by re-manufacturing used laser-printer toner cartridges. He used $30,000 in savings to attend training workshops before starting Carson, Calif.-based Data-Prompt Inc. in 1989. Within a year, his new company had grown tenfold with 10 employees manufacturing 1,000 toner cartridge replacements a month in Greater Los Angeles. He even landed Atlantic Richfield Co. as a client. But DataPrompt needed expansion capital.
"We tried the bank route," Dunham recalls. "And it was very difficult as a small minority business without a very strong track record behind us. I looked into government and state programs, but negotiating the red tape was so strenuous, I became frustrated." Eventually, Dunham rented a hotel conference room and gave a video presentation on DataPrompt to family and acquaintances--and got commitments for $100,000 in capital. Investors received two-year promissory notes at 12% interest and became company shareholders. Now 4 years old, DataPrompt did more than $500,000 in business in 1992, and Dunham forecasts sales of $1 million this year.
Although financial markets claim the credit crunch is over, small businesses still can't get a break. African-American business owners like Dunham continue to scramble for capital from family and friends.
However, African-American firms can find other sources of funding. Sure, tapping the financial markets is extremely tough, but tenacity, a well-managed company and a great product or service can help open doors. But first you must do your homework. Mining for capital is tricky, especially without a well-thought-out business plan and a clear understanding of how the capital markets really work.
Following are seven sources of financing most often recommended to entrepreneurs. The good news is that most sources are beefing up their financing activities. The bad news is that several of these much-touted sources are only interested in companies with stellar track records in highly specialized industries. They're not interested in start-ups at all.
Pension Funds And Insurance Companies
Almost every book on financing small businesses cites multibillion-dollar pension funds as an important source of capital. But that's misleading; individual entrepreneurs rarely receive money directly from the pension funds. In fact, this type of funding often filters down several investor levels before actually connecting with a small business.
Instead, institutional investors such as pension funds and insurance companies put tens of millions into private placements, which are securities or shares in limited partnerships organized as venture capital funds. In turn, these funds often subsidize even smaller limited or venture partnerships, which provide capital for individual firms or finance-specific deals. Unfortunately, these partnerships rarely invest in minority businesses.
It's the same story at all big pension funds. Teachers Insurance and Annuity Association, the $60 billion private pension/fixed income investment fund for employees in higher education and research, offers some $3 million for business investment. According to TIAA spokesperson Daniela Weiss, "We do private placements [in venture capital funds]. We don't do start-ups."
That's why, says Harold D. Brittain, director of programs for the Washington, D.C.-based National Association of Investment Companies (NAIC), very little of the $30 billion that filtered from pension funds into small businesses between 1980 and 1989 went to minority enterprises.
But since 1989, the $73 billion California Public Employees Retirement System (CALPERS) has approved nearly $1.5 billion for high-risk limited-partnership securities. Of that, $775 million has funded minority-owned businesses. According to Jed Maxwell, CALPERS' principal investment officer, the organization is committed to expanding opportunities for minority- and women-owned businesses. That's all part of its nontraditional, alternative investment policy.
"We have made investment commitments to 19 limited partnerships," Maxwell says. That works out to an average of more than $40 million apiece. The usual minimum investment for CALPERS is $25 million. Recently, CALPERS entrusted the minimum to Fairview Capital, a Farmington, Conn.-based venture fund of $250 million. Fairview, in turn, disburses monies into smaller venture capital funds, including ones that invest specifically in minority firms.
Once you realize the indirect route venture capital travels from pension funds to small firms, you understand why individual business plans don't elicit the desired response. But that doesn't mean you should kiss venture capital good-bye. It just means you need to understand at what level you can link into the investment chain.
Private minority venture funds such as UNC Ventures Inc. in Boston accounted for $20 million worth of investment in 1992. But that doesn't mean black-owned businesses struck gold last year, as anybody who's been turned down by a score or more private venture capital firms can tell you.
Which private venture capital firms are looking for a company like yours? There's no surefire way of knowing. That's just part of the arduous research an entrepreneur must undertake, says JoAnn H. Price, NAIC president and general partner of Fairview Capital. "It's important for entrepreneurs to do their homework," she says. "They must understand how venture capital works and be clear about what kind of money they're looking for."
Knowing which industries are suited to venture capital is also important. "Every deal is not a venture capital deal," Price explains. "Venture capitalists don't take on many real estate deals. They like technologies--low, medium and high--and niches in the marketplace that have a lot of upside potential. They're not as interested in retail services."
Private venture capitalists are extremely aggressive investors, often seeking fat returns of 20% to 40% annually. That's why most firms specialize in hyper-growth fields such as health care products and new technologies. But beware. For their hefty infusion of cash (which can range from $250,000 to over $1 million), these venture capitalists may demand a big chunk of the equity in your firm--up to 50% or more. In return, you may be the beneficiary of top-flight management advice and valuable credit references, along with the funding.
Specialized Small Business Investment Companies
The best source of minority-venture funding is a Specialized Small Business Investment Company (SSBIC). This is a private investment firm licensed and regulated by the Small Business Administration (SBA) under Section 301(d) of the Small Business Investment Act. About 130 active SSBICs (formerly known as Minority Enterprise SBICs, or MESBICs) across the country provide venture capital to small minority-owned firms, both new and established. Last year, SSBICs put $88.5 million into minority businesses, down from $136 million in 1988, according to NAIC's Brittain. The decline, he claims, was due to the economic slowdown.
NAIC is the umbrella organization for SSBICs, which are financed through private sources, corporations, insurance companies, banks and individuals. Such companies as General Motors Corp., Motor Enterprises Inc. in Detroit and Amoco Venture Capital Co. in Chicago put their money to use in SSBICs.
Although SSBICs are regulated, their investment policies, funding structures and evaluation criteria vary greatly. "The amount of financing with one company can go from $75,000 to more than $1 million," Brittain explains. "It depends on the type of business and the funding vehicle."
At Opportunity Capital Corp., an SSBIC in Fremont, Calif., the minimum investment is typically $100,000; the maximum, about $300,000. "We prefer to do acquisitions and expansions with businesses 2 to 5 years old," says company President Peter Thompson, "but we provide start-up financing in selected instances. We typically don't do retail at all; we prefer manufacturing and communications concerns. If a franchising entrepreneur had the opportunity to acquire or expand into multiple sites, that could be attractive. A start-up franchise would be a tough sell to us."
"In the late 1970s, we were a start-up," recalls John Douglas, president of Douglas Broadcasting Inc. in Palo Alto, Calif. Trying to build a television station in San Jose, Douglas and his partners sought construction capital and a year's worth of working capital. What he brought was experience as a securities analyst and a team with broadcasting know-how. But he had no business track record because, at that time, says Douglas, "very few African-Americans owned any TV stations."
As a securities analyst, Douglas understood financial markets. Still, it took six years to close the deal. Opportunity Capital (along with other SSBICs) committed $4 million only when he got a pay-TV subscription contract guaranteeing him a monthly revenue stream of $100,000. "An entrepreneur is basically a salesperson who believes in a concept and can market it to venture capitalists," Douglas explains.
The station went on the air in 1981 and was sold in 1987 for $17 million. Both investors and Douglas profited.
Now Douglas boasted a track record. Seeking to finance three radio stations in 1989, he had to wait only four months--not six years--from business plan to $25 million in venture capital. Today, Douglas Broadcasting owns 10 radio stations in New York, Chicago, Los Angeles and San Francisco. It is also the largest broadcaster of Asian programming.
Small Business Innovation And Research Awards
Small Business Innovation & Research (SBIR) awards, the equivalent of federal government contracts, are specifically targeted for innovative projects. Established by the Small Business Innovation Development Act of 1982, the SBIR program awarded $486 million in fiscal year 1992, according to SBA spokesman Michael Stamler.
With the Clinton Administration's emphasis on technology, the SBIR program could be enlarged for the future.
Every quarter, SBA publishes a catalog of presolicitation announcements, or PSAs, describing the types of research projects that federal agencies want to review.
Successful proposals are funded in three phases. Phase 1 awards as much as $100,000 to test the project's scientific and technical feasibility. This phase usually takes six months. If a Phase 1 feasibility study passes muster, you are then eligible to apply for Phase 2 financing. Phase 2 maxes out at $750,000, and has a life span of up to two years, during which time you refine your research project or develop the prototypes or products.
Stamler explains that by this stage your product or new technology should be ready for manufacturing or implementation. If your product was developed exclusively for the government, then it will finance the actual Phase 3 production or implementation process through your client agency. If you want to expand into the private sector, you must seek financing elsewhere. About 20% of all SBIR awards actually reach the marketplace, Stamler says.
Important as SBIRs have been to small firm development since 1982, they are not miracle cures. "This isn't a grab bag grant program for every crackpot idea," Stamler cautions. "The strong emphasis in this program is on delivery." Retail or franchise concepts are unlikely SBIR candidates," he adds.
According to Stamler, "Typical technical awards in the past include a multifunction device that helps the hearing- or visually impaired use telephone lines in the Department of Education, and a rocket-engine leak-detection system for NASA."
A black-owned start-up that focuses on an industrial, manufacturing, or technical product or process probably has a better shot at an SBIR award than at private sector venture capital. Black-owned firms have also expanded on the strength of SBIR awards. MANDEX Inc., a Springfield, Va., training and technical-research company with 150 employees, has made the transition from conducting all its business with contracts protected by 8(a) minority set-asides to bidding on unrestricted open-competition contracts.
Thomas Anderson, director of programs for the $10.8 million private company, credits SBIR with helping in that transition. "One of our first awards was for a program to help medical professionals deal with teenage alcoholism," says Anderson. "This interactive training course is still available through the National Institutes of Health in various hospitals." Today, MANDEX is the U.S. Army's omnibus contractor for 35 training programs and has developed classified and unclassified weapons applications for the Department of Defense.
MANDEX now has 15 SBIR awards in Phase 1 or Phase 2 of operation, a phenomenal success rate when you consider that the government reviews up to 12,000 proposals at any one time. Like SBA's Stamler, Anderson emphasizes the importance of delivery. That's why MANDEX specializes in projects that have a solution they can technically demonstrate; or a tangible product they can deliver.
Small Business Administrations Bonds
Suppose the city of Madison, Wis., needs new repair facilities for city vehicles. In order to make a successful bid for the work, the contractor must be insured with a performance bond. (These bonds pay the city back if the contractor fails to finish the project.) The trouble is that small companies often can't buy performance bonds on the open market. That's where the SBA steps in, providing a surety bond guarantee, which covers up to 70% of losses, to a maximum of $1.25 million.
"Surety bonds are a form of insurance that guarantees that contractors will comply with terms and conditions of a written contract," says Stamler, "and they are necessary for all sizable public construction projects, some service contracts and many private sector projects. SBA's guarantee improves the small contractor's ability to compete."
If you're a contractor who needs to put up a bond and can't get one through the usual channels, contact the SBA office nearest you. Or get in touch with a branch office of one of the preferred sureties: SAFECO Insurance Co. of America, First National Insurance Co. of America, Continental Casualty Co., US Fidelity & Guaranty Corp., Fidelity & Deposit Co. of Maryland and Standard Fire Insurance Co. If you qualify, these bonding companies have the authority to put an SBA surety on the contract.
SBA Loans 7(a) Program
When people talk about getting an SBA loan, they are referring to the 7(a) program. You could say it's SBA's "core" program. However, the word "loan" in the 7(a) title is really a misnomer. The truth is that 7(a) "loans" are really SBA guarantees of bank loans. That means if the small business borrower defaults, the SBA pays the bank up to 90% of the loan's face value.
The dollar volume of SBA loan guarantees, which average $240,000 in size, shot up 37% in fiscal 1992, to $5.62 billion. This year, the rate of loan guarantees is running 30% above that.
The first step on the road to securing an SBA loan guarantee, therefore, is a bank. "We advise going to the bank where you usually do business because that's where the banker knows you," says Stamler. Another option: Seek out so-called preferred lenders, or banks that can authorize loan guarantees on SBA's behalf. The preferred lender list is available from your local SBA office.
Like any government-sponsored program, getting an SBA means lots of paperwork. But keep in mind that 7(a) institutions are banks first and SBA affiliates second. Therefore, loan approvals, with or without SBA, involve collateral, such as real estate or capital equipment, as well as financial statements and credit checks.
"Many people refuse to recognize errors they make in applications," Stamler warns. Many entrepreneurs also resent having to fill out all of the required SBA paperwork. However, "the bank is going to ask for all the same things whether or not the SBA is involved," Stamler says, "and for all the same reasons."
The friendly neighborhood bank is often the first of many disappointing stops for capital-hungry entrepreneurs. But some minority-owned banks have begun the creative financing of black-owned enterprises. James M. Shirley, president and chief operating officer of Drexel National Bank in Chicago, calls this partnering.
In the last 25 years, corporations determined to boost black economic development in urban areas have banked with African-American financial institutions for payroll taxes, lines of credits and other services.
Last year, Drexel made a $30 million line-of-credit commitment to Colgate-Palmolive by partnering with other minority banks in syndication. As agent for such lines of credit, Drexel makes money in service fees, thereby strengthening its own financial position.
This infusion of capital empowers Drexel to develop its lending capacity. "What a bank tries to do," says Shirley, "is take its deposit base and reinvest it in the form of loans to improve the standard of living in the surrounding community. That includes lending money to businesses for working capital so they can purchase equipment."
Drexel works with partners at this level, too, such as the U.S. Department of Transportation (DOT) Short-Term Loan Program. Lorette Yamini and Tremont Jones administer the program at Drexel, one of three minority banks that helps disadvantaged business owners complete contracts they have with DOT.
"The DOT, in effect, funds 75% of the deal and the bank funds 25%," says Shirley. "You recognize that emerging minority- or women-owned businesses are often a higher risk regarding capital structure, but because we know they are able to perform work on the contract, we will help them get the necessary financing."
The obvious question is: How can a small firm get its foot in the door? Make no mistake, commercial banks--including those owned by African-Americans--require proof that the business is a good risk. As Shirley puts it, "In its early years, a small business generally has a capital structure problem and not enough evidence to get loan approval. Bankers by nature are conservative because of their fiduciary relationship with depositors."
He advises emerging companies to find a partner, such as DOT, SBA or other investors, to guarantee your loans. Otherwise you may need to put up your personal assets as collateral (i.e., home, stocks, and bonds; items of value that can be easily liquidated).
The bank president also respects companies with good business management practices. "When we look at the administrative side and the financial records," says Shirley, "that is the area where start-ups and young businesses come up short."
He adds that a small firm's relationship with a commercial bank can develop and improve when the business is well managed. "The evidence of the financial statement may be either profit or loss," Shirley says, "but the important thing is tracking your business through the early years. Keep those records in such a way that someone could review them and feel comfortable with what they are reviewing. You can then show the evidence of what you have done."
|Printer friendly Cite/link Email Feedback|
|Date:||Jun 1, 1993|
|Previous Article:||Getting an edge on selling your services: here's what it really takes to snag a lucrative corporate contract.|
|Next Article:||Tech stocks get hot.|
|Financing available in cautious 90's.|
|Sheldon Good addresses UN group on housing.|
|GCP Capital Group LLC.|
|GCP Capital Group L.L.C.|
|Public Goods, Tax Policies, and Unemployment in LDCs.|
|GCP Capital Group LLC.|