The State of Small-Business Funding

Factoring and Corporate Venture Capital

Factoring is an old financing tool, and corporate venture capital is a new one, but both are currently popular and potentially powerful ways to finance growth in entrepreneurial companies. Dennis Hauser Jr. needed working capital to help meet payroll and other short-term cash-flow needs for Tampa, Florida-based DCH Roofing Inc., the 70-person company he founded in 2001. "The banks didn't want to talk to us," says Hauser, 42. His accountant suggested factoring.

Factoring firms buy a company's accounts receivable and then collect on the invoices themselves. Factors typically charge a fee of 2 percent to 4 percent for each 30 days it takes to collect, says Hauser's factor, David Wolf, president of Hennessey Capital Southeast in Tampa. Factoring doesn't work for companies with low profit margins or those that need and can get long-term financing. "If you qualify for a bank loan," Wolf says, "then factoring is probably not the right solution for you."

Hauser says factoring is fast--funds are available hours after submitting his receivables to Hennessey--and affordable. DCH Roofing started factoring in 2004 and grew annual sales from $3.5 million to nearly $5 million in a year. Sales are expected to reach almost $6 million in 2006. "And I don't have near the amount of stress as far as making sure I have money in the bank every week to make payroll," Hauser adds.

In the 1990s, many big corporations set up VC investment arms only to suspend or close the operations post-bust. Lately, corporate venture is enjoying a resurgence. "You have Amgen and other big companies actually starting new corporate venture efforts," says Gary Dushnitsky, assistant professor of management at the University of Pennsylvania's Wharton business school. Corporate venture concentrates on life sciences and IT, but is also in some other fields, Dushnitsky says.

Corporate venture offers advantages over institutional VCs. Big firms have seasoned executives to mentor entrepreneurs, can provide introductions to customers and suppliers, and may even let entrepreneurs peek into R&D labs. On the downside, big companies sometimes have uneasy relationships with small firms they invest in. "A small company with an idea is a wonderful opportunity for a large corporation, but it's also a threat," Dushnitsky says. "In some cases, a small company's idea has found its way into a large company, and lo and behold, the bigger company has come out with a competing product."

Before you look into corporate venture, get your intellectual property protections in place, and consider the potential effects of allying with a major player. "If you are willing to accept investment from Microsoft, for example," Dushnitsky says, "how likely are you to sell to Oracle?"

Growing Fast? No Questions Asked
When CEOs of the fast-growing companies surveyed for Entrepreneur magazine and PricewaterhouseCoopers' 2006 "Entrepreneurial Challenges Survey" sought financing recently, they found the environment welcoming. Patty Brown was financing her 12-person San Diego information management software company internally and with a bank line of credit. But that's likely to change. "Venture capitalists are talking to us right now," says the 46-year-old founder and COO of BlackBall Corp. "I can see the light at the end of the tunnel." With money raised from selling equity in the $1.5 million company, Brown intends to roll out a new wave of products this year.

Evan Giniger avoided using debt financing to grow Dynamic Resources Inc., his 15-person New York City retail project management company. But when a client hired the $10 million company last year for a $1.2 million job, he had to ask his bank for help with managing cash flow. "I was thrilled, really surprised and happy," Giniger, 40, says of his bank's response. A $1 million line of credit at the prime interest rate allowed him to take on the job and, hopefully, future jobs like it. "When you have a purchase order from a Fortune 1000 company in hand," Giniger reports, "people are tripping over themselves to lend you money."

Mike Manners lines up multimillion-dollar loans as often as monthly to fund the activities of Elan Development LP, his Houston land development company. "We're having no problems getting financing," reports Manners, 50. The five-person company has 2006 projected sales of $27.5 million and last borrowed $13 million from a group of banks. If anything, Manners feels banks have been too ready to lend. "They are becoming a little more selective," he says, "but it's actually going to help my company because we're a strong company, and we'll continue to get financing."

Money Hunt
In a recent survey of fast-growth companies, PricewaterhouseCoopers' "Trendsetter Barometer" found that net profits, increased bank credit and new loans were the three sources used most often for financing growth.

The top 5 nontraditional financing sources that companies plan to consider over the next 12 months are:

1. Debt restructuring
2. Private placement
3. Angel investors
4. Venture capital
5. IPOs

Don't Bank on It?
Businesses appear to be going beyond banks in their search for growth capital these days, according to Pricewaterhouse-Coopers' "Trendsetter Barometer" survey. The percentage of Trendsetter companies completing new bank loans in the first quarter of each year has gradually declined over the past decade.

don't bank on it

Mark Henricks is Entrepreneur's "Staff Smarts" columnist.
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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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