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Out on a Limb

Finding capital in today's battered market means taking risks.
August 1, 2001
URL: http://www.entrepreneur.com/article/42400

Fred Marinari, 36, and his two partners at The Aventine Group LLC see real opportunity in the $300 million market for oncology data management. By centralizing information about patients' diagnoses and treatments in the Cancer Registry, and making it accessible via the Internet, "the quality of care and the ability of the patient to manage the process goes way up," he says.

But the trio (which includes Ed Krasovec, 40, and Michael Gallagher, 54) won't get much further without an infusion of expansion capital. Life would have been a lot easier if they'd started searching for capital for their Doylestown, Pennsylvania, business a couple of years ago. The fact is, capital is much, much harder to come by now. Marinari and his partners, who are looking for $125,000 as a prelude to a $1.5 million deal, may have to put up some of their own cash before getting any help from the outside. For the partners at Aventine, as with so many entrepreneurs these days, it's time to consider guerrilla financing tactics that just weren't necessary in the late '90s. Here are some options to consider:

1. Take out a margin loan against securities you own. Brokerage firms will lend you up to 50 percent of the value of most securities, with no muss or fuss. It's fast cash with a reasonable interest rate. Of course, if the value of the underlying securities drops to less than 50 percent of the loan, you'll get a call from the brokerage firm asking you to put up cash or face immediate liquidation of the shares you pledged. So how strongly do you believe in your idea?

2. Sell the revenue stream. The problem with raising money in early-stage offerings is that it's hard for investors to get a payday unless the company goes public or gets acquired. If you experience immediate and explosive sales within the first 180 days, don't sell equity. Instead, get a loan in return for a monthly portion of your sales, say 2 to 3 percent, until the investor gets two to three times his or her money back. And guess what? Because this kind of deal is a loan and not an offering, you may circumvent all those sticky securities laws and legal fees.

3. Direct your 401(k) plan to buy shares in your company. Of course, you must have a 401(k) for this to work. But let's assume you do. Contrary to conventional wisdom, 401(k) plans can make investments in public as well as private companies. This kind of transaction, though seemingly easy, is not for the faint of heart. You could lose your retirement savings. Nonetheless, what better way to invest than in a company whose destiny you control?

4. Take out a home equity loan. The equity you've built in your home can support a loan, often referred to as a second mortgage. So, if you have a $150,000 home and owe $50,000 on the mortgage, a bank or finance company will lend you between $60,000 and $80,000. Down the road, you can generate a lot of juice with investors by saying you put your house on the line to get your company off the ground. Technically, however-and this is the part you can use to get your spouse to sign the loan documents-your home is not at risk unless you default on your first and second mortgages.

5. Liquidate or roll over your IRA. You can withdraw funds from your IRA, do whatever you want with them for 60 days, then roll them over into another IRA without creating a taxable event. Such capital might help you finance the sale of a product that you expect to be paid for in full in 60 days. But (brace yourselves, financial planners and advisors) because that covers a relatively narrow scope of events, consider liquidating your IRA altogether. The downside is you'll pay a 10 percent penalty and the amount of cash you take will be added to your taxable income. In addition, if everything goes south, you will lose not just the cash, but all the future earning power of that cash.

So why consider such an ill-advised strategy? Even though $25,000 earning 8 percent for the next 25 years will turn into $171,000, starting your own business, if it's the right time for that business, might yield much, much more in the end.

All the above suggestions are presented with a specific premise in mind, which is a financing environment where cautious investors are folding their arms and saying "If you're not willing to take a big risk, why should I?" Maybe there's some real wisdom behind the Dutch Uncle ring to those words. After all, if you evaluate the risks, and they're too high, you might be better off in the long run not taking them.

NextStep
Calculate your net worth. Then think long and hard about what percentage you're not only willing to put on the line, but also willing to lose. Could this amount of capital get you to some milestone for your business from which you could then raise additional capital? If not, your long-term prospects are dim.

David R. Evanson is a principal at Gregory FCA , an investor relations firm.