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Fun With Funding

If you left your creativity somewhere with your coloring books, you're not ready to find financing in the post-dotcom era.
September 14, 2001
URL: http://www.entrepreneur.com/article/44428

Could you pick a worse time to search for start-up funding? You wouldn't think so, judging by developments in the economy, financial markets, housing, imports, retail sales, venture capital and by other high-profile influences. There's no doubt it's difficult for new businesses to attract financing today.

Difficult, yes. Impossible, no.

If you need money to launch your business, recognize that the funding honeymoon of the last decade is over. We're beyond the IPO frenzy of the '90s; no one expects the stock market to double this year (maybe not even this decade); and "dotcom millionaire" has become an oxymoron. In other words, things are returning to normal.

However, that doesn't mean things are going back to the good ol' days of 10 years ago. "The market downturn that began last year hit investors and institutions hard, and many are still skittish about taking a risk on new businesses," says consultant Charles Cocotas, the former president and CEO of TCBY who, as president and COO of Boston Chicken, helped transform a single-unit restaurant into a national franchise chain.

So where does that leave you?

First, have you looked for funding in every nook and cranny? If so, that was your first mistake. (When was the last time you stashed any money in a nook, let alone a cranny?) Avoid timeworn clichés, conventional wisdom and traditional routines. Difficult times call for new clichés, unconventional thinking and innovation.

"In this environment, many think there's no money [for] start-ups," says Rich Tambor, senior vice president and general manager of American Express Small Business Services Lending in New York City. "That's not true. There is capital out there. It's harder to get, particularly for dotcoms seeking venture capital, but if you have a good business plan and a clear sense of how your business will make money, you can get financing." Tambor claims lending terms are no less favorable. "You [just] have to search longer and harder. It helps if you're creative."

Think Big

Creativity certainly helped Jeff Kohler, 39, and Chris Hotz, 37. With little more than a business plan and some solid management experience with AT&T, Cell-One and Nippon, they raised $250,000 from friends and family. (Kohler defines them as "people who will still love you if you lose their entire investment.") It was enough money for the partners to launch Reason Inc., which helps companies manage their wireless products and services.

Almost immediately after their 1998 launch, however, Kohler and Hotz needed $1.5 million more to cover 1999 operating expenses. Fortunately, they found additional help in the form of angel funding from two former Pittsburgh Steelers: Carnell Lake, a Pro Bowl safety now with the Jacksonville Jaguars, and Rod Woodson, a defensive back now with the Baltimore Ravens. Such high-profile investors cleared a path for the company to score with other investors.

Like Kohler and Hotz, a determined entrepreneur with a good idea is better off pursuing creative financing. The right business plan is critical. If writing isn't your strong suit, consider engaging an expert to forge a winning proposal aimed at potential investors, even if they're family and friends. Your accountant or attorney could refer you to a specialist, strategist or financial consultant to design a professional plan for you-one that is well-organized, clean and clear. As a bonus, strategists are ideal sources of leads. Just mentioning you have a financial consultant will likely impress potential investors.

Put together the right package and you'll attract the right investors. You may not have to look too far. You're probably already well-connected, directly or indirectly, through:

Knowing your product, your industry and the people in that industry, you no doubt have insight into all kinds of leads and connections.

It's Who You Know

Creative financing, not to be confused with creative accounting, is neither illegal nor immoral. But it is more adventurous. In essence, it's thinking outside the box. It can be an imaginative approach to a proven strategy or a combination of tactics often beyond the confines of traditional financing.

George Dawson, a San Antonio, Texas, small-business consultant and author of Borrowing to Build Your Business (Dearborn Publishing), advises looking for candidates with three characteristics: 1) they want a better return on their investments than they can get elsewhere, 2) they want compensation in addition to the return, and 3) they're extremely familiar with your business. Ideal prospects are suppliers in your industry (wholesalers, distributors, manufacturers, etc.), customers, and other businesses that sell complementary or noncompeting products to similar customer bases.

According to Dawson, there's an advantage to finding such investors and working with them. "They know your business, can accurately evaluate their risk and will share in your success."

Frank Scavone, the 35-year-old CEO of Oakland, California-based Precept Corp., a firm that analyzes, underwrites and auctions commercial mortgage loans online, agrees: "It's important to reach out to people who understand your business and who see the need for solving the problems you address. Finding capital is expensive and time-consuming. A new business is fragile; you're always in a race to get profitable before you run out of resources. You save precious time by aligning yourself with people you don't have to educate."

Beg, Borrow and Deal

Recognizing that buyers of manufactured homes represented a considerable, untapped niche in the Albuquerque, New Mexico, market, Iris Guzman created a proposal to capture those buyers-but it was rejected by her then-employer, a mortgage company. Disappointed, but undaunted, Guzman forged ahead. She prepared a business plan and asked a vendor for guidance.

"He had launched Advantage Printing with the help of an angel who provided financing and expertise in return for 25 percent of the company," Guzman, 29, recalls. "I asked if he would consider a deal like that with me, and he [agreed]."

In that Pay It Forward scenario, Guzman and the vendor set up Advantage Lending Solutions in August 2000. As the company's general manager, Guzman gave the Advantage Group LLC, a provider of administrative and financial services, a 25 percent stake. In return, she received $10,000 upfront and had her bookkeeping, payables, legal work, licensing and strategic planning taken care of. Conserving the $10,000 advance, Guzman initially worked out of her home, paying a pittance to two former co-workers who helped lay the groundwork for what has become a multimillion-dollar operation. "[We] begged and borrowed everything we needed: fax machine, printer and telephones from the father of one of the girls; furniture from Beck's Office Supply in exchange for services; computers from the Advantage Group; and cooperation from our vendors, who agreed to wait 90 days or longer for payment," she says. "I begged everyone from the telephone company to appraisers to our credit reporting agency to wait for their money until we were profitable." She even negotiated for free office space at Advantage Group headquarters. Fortunately, no one had to wait too long-within six months, the new firm was in the black.

Such wheeling and dealing is applauded by business strategist Stephen E. Roulac, CEO of the Roulac Group Inc. in San Francisco. "Do what you can to front-load revenues and back-load expenses," says the former Stanford Business School faculty member and distinguished professor of global property strategy at the University of Ulster in Belfast, Ireland.

Roulac further suggests offering customers, or prospective customers, attractive tie-in deals. "If a customer will be spending $10,000 a month with you over the next 12 months, for example, propose an advance payment of $95,000 in return for a year's worth of products or services. The customer saves $25,000, and you get seed capital. Work out deals with vendors to extend payment terms and lower your costs. If supplier costs on that $95,000 contract come to $40,000, go to the supplier. Say, 'I'll guarantee you all that business, but I want it for $30,000.' "

The kicker here is equally clever. Armed with $95,000 on your books and that $120,000 contract, you now go to your bank for a loan. It may be smoke and mirrors, but it's perfectly legal-and you'll likely get the loan.

The Franchise Factor

Richard Weber, 49, used a variation on that theme when he purchased a Batteries Plus franchise in Texarkana, Texas, last year. He was ready to visit as many banks as necessary-until his father-in-law presented him with $100,000. "Excited about the business, he gave us what would have been inheritance money," Weber recalls. "With my business plan reflecting $100,000 in capital, I got a loan from the first bank I visited."

Weber, whose father-in-law is now a partner, believes banks "are more apt to lend money to franchisees rather than independent start-ups, even [those with] a great idea." If you're considering a franchise, "keep in mind that banks like successful franchises rather than new, unproven concepts," says Weber. Veteran franchise magnate George Naddaff concurs. He used his own money to launch the Boston Chicken franchise, among others. "My franchisees could only get money from friends and family," he says. "No big-time lenders offered financing."

Naddaff, chair of Business Expansion Capital Corp. in Newton, Massachusetts, as well as acting CEO of the 60-unit Ranch*1 franchise chain, tells his money-seeking franchisees to run ads in local newspapers to attract angels. "Just say, 'Sophisticated investors wanted. Emerging entrepreneur seeks capital to open restaurant with proven numbers.' "

Jeff Elgin, CEO of FranChoice Inc., an Eden Prairie, Minnesota, company that matches prospective franchisees with franchise opportunities, offers another route to franchise financing: "Ask the franchisor if any existing franchisees want to buy more units without managing those units." Once you identify a willing owner, propose a deal: You'll operate the unit in return for an equity position. You'll improve your chances considerably if you bring some capital and related experience to the deal.

Smaller franchisors sometimes finance part of the franchise fee if they think you'll be successful, reports Elgin, who's also a former vice president of franchising for Great Clips. At least one franchisor also offers franchisees sweat equity, while others carry contracts for a portion of equipment costs. "But such programs are seldom mentioned in disclosure documents," Elgin points out. So ask.

In Arlington, Texas, Comet 1-Hr Cleaners is building stores and leasing them to new franchisees for a charge of 30 percent of gross sales (which covers debt, rent and royalty), according to Michael Seid, founder and managing director of Michael H. Seid & Associates, a West Hartford, Connecticut-based firm that provides franchise advisory services. "Over time, the franchisee assumes total ownership of the business. Comet takes the risk," says Seid, who, with Wendy's founder Dave Thomas, co-authored Franchising for Dummies (Hungry Minds Inc.). "That's what creative financing is about. It's not dumb ideas like using credit cards or risking your family's home by getting a second mortgage to finance a start-up."

Taking A Chance

There are exceptions. That's precisely what Edward Hughes, 43, and Reginald Smith, 43, did to launch Bocaza Mexican Grill in Denver in 1996. "With no experience and less money, we knew we weren't going into a bank to say 'Would you give us $220,000 to open a restaurant?' " Smith recalls. "That wasn't going to happen. So I quit my job at Federal Express, cashed in my 401(k), maxed out 10 credit cards and got a second [mortgage] on my house." Hughes followed suit. Together they raised $190,000-only $30,000 short of the mark.

In retrospect, it was a risk worth taking; their first restaurant was an instant success, and cash flow quickly covered the $30,000 they'd allocated for operating expenses. And their five-unit chain begins franchising this year. "We also were able to pay down our credit cards fairly soon," says Smith. "That was expensive money at 19 percent, but back then we weren't sophisticated about finances."

Should you revert to credit cards and second mortgages to finance your new business? Hughes reflects, "Sometimes if you have something you believe in and others don't believe in you, you must do whatever it takes to make your dream come true."

"If you're not willing to put yourself on the line," adds Smith, "it's hard to ask someone else to."