The State of Small-Business Funding

From banks to VCs, there's plenty of cash out there for entrepreneurs. But that doesn't mean the road to finding financing has gotten any shorter or smoother.

Bige Doruk founded Gaia Power Technologies Inc. at a doubly good time. Interest in energy storage and management products has soared in step with record-high oil prices. And opportunities to finance the growth of her New York City company, which manufactures devices to help businesses attain reliable backup power and reduce overall energy costs, have rarely been better. At 4 years old, the company has secured a total of $4 million from three separate financings involving a combination of angel and VC equity investments, a bank loan, and a grant from a state-government-backed research fund.

Gaia's financing run began in 2003 with a $1.5 million product-development grant from the New York State Energy Research and Development Authority. The next year, a $250,000 loan from a consortium of large banks called the New York Community Investment Co. helped complete the product development effort. Last summer, a group of VCs and angels made a $2.25 million equity investment in the $3 million firm to expand operations and marketing. "It's been great for us," Gaia's 38-year-old CEO says. "We didn't have to tap into the capital market and give up equity without having a product and a market."

Cash Craze
From banks to VCs, financiers brim with funds, and investors are just short of frantic to put their money to work. "It's amazing the amount of cash that's out there," says Jim Ellis, a management lecturer at Stanford University's graduate business school who says lenders are willing to fork over "imprudent amounts" of capital. "We're looking in the rearview mirror and can't remember a debt market like this."

The view looks the same in the equity markets. "There's a massive need to deploy capital in a way that's productive," echoes Mike Simon, 41, CEO of LogMeIn Inc., an 80-person Woburn, Massachusetts, remote control software company that has raised $20 million in three years, including a $10-million VC round last November. "If you have a good business, you can get venture financing very easily."

Commercial banks, the largest source of financing for entrepreneurial businesses, remain less than universally welcoming, however. Charles Ou, an economist in the Office of Advocacy at the SBA, describes the bank climate as only "adequate" for most loans. Ou sees one bright spot in the growing number of credit lines and business credit cards from major banks. "Just think of [all] the ads you see on TV," he says.

When Linda Pinson thinks of those ads, her tone turns wry. "There's so much hype," says Pinson, owner of Out of Your Mind . . . and Into the Marketplace, a Tustin, California, publisher of business-planning books and software. "[Entrepreneurs] get mistaken ideas about what it takes to get money," says Pinson, who serves on lending committees and boards.

Borrowers still need about as much collateral, dollar for dollar, as they hope to borrow from a bank, Pinson says. They must provide historical and projected financial statements showing the company can repay the loan with internally generated funds. Banks usually require personal guarantees, and even those may not help if your credit score falls below 700. "If you're in the habit of getting behind on other things, they figure you're going to get behind on paying your loan," Pinson explains.

Local and regional banks are most likely to cut entrepreneurs some slack, says Larry Bennett, director of the Center for Entrepreneurship at Johnson & Wales University in Providence, Rhode Island. "There is still a huge difference in banks' receptivity to lending to entrepreneurs," says Bennett. The major difference is that local and regional banks will customize loans to fit entrepreneurs' needs.

Benjamin Richter won't argue with that. The 40-year-old CEO of Bradford Airport Logistics Ltd., a Houston material management and distribution services company founded in 2001, was dealt a blow last year when a major bank postponed a commitment for $250,000 the day Bradford was to receive the funds to buy equipment for a new installation. "The [banker] said he was working on $100 million deals and took us off the table because we weren't big enough to push on," says Richter, who has 75 employees. It boiled down to a likely delay of a week. Unwilling to renege on his own commitment that the installation would occur as scheduled, Richter got on the phone to search for a solution.

He quickly found the local Bank of Houston, which funded the loan in three days and kept Bradford on schedule. Richter now has a new appreciation for smaller lenders. He plans to arrange backup commitments for future loans. And long term, he aims to develop significant relationships with at least two or three banks rather than relying on one. "As much as banks sometimes publicize how sensitive they are to [their] customers, the proof of the pudding is in working with them," he says.

Banks of all sizes look more favorably at loans that are backed by government guarantees. Andrew Salamone bootstrapped, a Milwaukee maker of inventory management systems for auto dealers, from its 1995 founding until 2001. Since then, three bank loans guaranteed by the SBA have provided a total of $560,000 and helped the company double sales--2006 sales are projected at $1.5 million. "Without [the SBA's] program, it may have been far more difficult," says the 32-year-old, who employs 20.

The SBA reports nearly 96,000 small firms received 7(a) loan funds in fiscal year 2005, compared to 81,000 in 2004. Still, some say the program is rapidly declining. Rep. Nydia Velázquez from New York, ranking Democrat on the House Small Business Committee, says nearly 13 percent, or 3,000, fewer loans closed in fiscal 2006's first quarter compared to 2005. She blames the drop on higher fees.

Following sharp increases in the past year or so, borrowers now pay SBA guarantee fees ranging from 2 percent on amounts under $150,000 to 3.5 percent on loans over $700,000, with another 0.25 percent tacked on for anything over $1 million. That's fine with Salamone, who surrendered a $500 loan origination fee and a $4,500 SBA guarantee fee for a $200,000 loan in March 2005. "For us," he says, "getting the financing was the important thing."

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This article was originally published in the July 2006 print edition of Entrepreneur with the headline: The Money Market.

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