From the June 2002 issue of Entrepreneur

When Kevin Nikkhoo took the entrepreneurial plunge in 1992, it was with a modest amount of start-up capital--his own--that he co-founded Los Angeles-based Vertex Systems Inc. The technology consulting firm thrived without so much as a loan, providing technology solutions to the entertainment, manufacturing and financial services industries.

In 1999, however, Nikkhoo found himself in an unfamiliar situation. Eager to position his company for significant growth and to capitalize on the booming IPO market of the late 1990s, he needed a loan. He was also seeking a commercial lending relationship that extended beyond just borrowing.


28%
of venture-backed start-ups have received follow-ups financing since January 2001.
SOURCE: PriceWaterHouseCooper

"We talked to many organizations," recalls Nikkhoo, 41, the firm's chairman and CEO. "We found that although they were very interested in providing a credit facility, they did not have the ability to scale up with us as we grew. If we needed to strategically look at the different areas we were going to go into, we [needed] to feel comfortable that [the organization] could provide those kinds of services."

Nikkhoo found credit in his stockbroker's office, of all places. While meeting with a Morgan Stanley Dean Witter & Co. broker to discuss his personal assets, he learned the firm offered credit and advisory services to established businesses like his.

In January 2001, Vertex Systems finally had its financing: a long-term loan and credit facility from Morgan Stanley. While the company didn't go public, Nikkhoo felt Morgan Stanley's expertise with IPOs and acquisitions made it the ideal long-term financial partner for his $10 million company.

Brokering a Deal

While Morgan Stanley is a relative newcomer to the small-business financial services industry, its commercial lending practice is hardly unique. Merrill Lynch & Co. Inc. introduced the first central asset account to consolidate checking, investing and borrowing for small businesses in 1986. Morgan Stanley and Salomon Smith Barney Inc. are now mining their own customer bases for potential small-business clients. Their often friendlier lending procedures, account consolidation and other services intended to cut the clutter of running a business are effective marketing pitches small businesses are embracing. At the same time, bank consolidation has left some disgruntled entrepreneurs seeking a personal relationship with a financial advisor, which has also fueled the financing trend.

This credit option isn't for the fledgling business, though. Minimum deposit requirements, typically $20,000, as well as lending restrictions on some industries-Morgan Stanley, for example, won't lend to restaurants, gas stations, hotels and construction firms unless they pledge securities as collateral-favor a more select group of high-end small businesses than typically found on a bank's loan roster. Morgan Stanley's standard client has been in business for five years and has sales of more than $10 million. As a minimum, businesses must be at least two years old and have sales greater than $1 million. Merrill Lynch, meanwhile, generally focuses on companies at least three to five years old with revenues of at least $5 million.

Merrill Lynch, which has tripled financing commitments to small and midsized businesses to more than $6 billion over the past five years, now ranks among the top 10 small-business financial services providers, according to market research firm NFO Financial Services.

Banks Still Have Clout

While brokerages are attracting small and midsized businesses with convenient offerings, they haven't displaced banks. NFO Financial Services research suggests entrepreneurs are still more likely to go to brokerages for investment and cash management products than for financing; the vast majority of brokerage customers still use a bank for some of their needs.

The brokerages have had success with larger small businesses and those less dependent on a bank's branch-based service, says Charles Wendel, president of New York City-based Financial Institutions Consulting. And while brokerage customers may find account officers more sophisticated than the typical banker, "the best banks have closed a lot of the gaps," Wendel says, citing Citigroup, Wells Fargo & Co. and National City Corp. as examples. "Because of the drop in interest rates, and because banks are better at marketing to small businesses, I don't think there's a great advantage anymore."

Another potential drawback is the lack of local credit decision-making, even for a "story loan," Wendel maintains. "If the loan is complex, you're better off dealing with your bank. They have more of a local presence, and can deal with some of these issues more easily than a Merrill Lynch can."

Access to credit wasn't an issue for Vertex Systems. Rather, finding a commercial lender that would advise the company on economic and growth issues was Nikkhoo's greatest challenge. He also feared volatility in the tech sector might wield too much pressure on a bank's lending decisions. "Everybody is willing to give you money in an up market," Nikkhoo says. "The challenge is when the markets get tough, how are banks going to react to the companies?"


Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.

Contact Sources

  • Financial Institutions Consulting Inc.
    (212) 252-6700
  • Merrill Lynch Business Financial Services
    (800) MERRILL
  • Morgan Stanley Commercial Financial Services
    (212) 310-6258
  • NFO Financial Services
    (813) 637-0087
  • Vertex Systems Inc.
    (310) 571-2222, ext. 222