In The Rough Studies show fast-growing companies across the nation face a crippling capital shortfall. Here's what these firms can do to find the cash they need.

We can't believe this is happening," say CharlieNickell and Anthony Candell, two of the five co-founders ofScimitar Golf USA, which manufactures customized golf clubs. Thepartners are mystified by the quick growth of their company:Scimitar, which opened its doors for business last December, nowbooks at least $1.7 million per month in sales.

In just nine months, Scimitar's owners have cobbled togethera far-flung empire. First, there's the manufacturing facilityin Garden Grove, California, where 150 employees manufacture customgolf clubs to individual specifications with a proprietary processknown as tri-matching. Then there are the two California telesalesoperations (in Carlsbad and Irvine), which employ more than 50telemarketers. Scimitar also produces a catalog that features afull line of apparel and accessories, and is launching anindependent dealer network to sell clubs directly to golfers andgolf pros. Nickell, an avid golfer with significant industryexperience, says of the company's growth, "We don'tsee any end in sight."

Candell acknowledges the potential but expresses concern overthe prohibitive cost of growth. "Every month, we hire newpeople in sales, marketing and manufacturing; we purchaseincreasing amounts of raw materials; and we stock moreinventory," he says. That doesn't even include the sidedeals Scimitar has made to accommodate expansion, such as buyingout the leases of and relocating its neighbors in the industrialpark that houses the manufacturing facility. Although thecompany's cash flow is strong, with expansion at this pace,Candell and Nickell need a layer of capital so the company cancatch its breath.

David R. Evanson's newest book about raising capital iscalled Where to Go When the Bank Says No: Alternatives forFinancing Your Business (Bloomberg Press). Call (800) 233-4830for ordering information. Art Beroff, a principal of BeroffAssociates in Howard Beach, New York, helps companies raise capitaland go public.

Growing Pains

Remarkable as the Scimitar story is, it represents a nationwidetrend that's particularly strong, according to studies, in LosAngeles and Orange Counties, California. That's becausegazelles, defined as extremely fast-growing companies, often face apotentially crippling shortfall of expansion capital.

According to a study recently released by the CaliforniaResearch Bureau, the 35,000 gazelles in Orange County face acapital shortfall of close to $5.4 billion. Nationally, theshortfall is even more staggering and potentially morecrippling--since gazelles are credited with, well, the lion'sshare of job creation.

Despite this capital shortage, there has been relatively littleinformation available on how to overcome it. Following are severalfinancing techniques that gazelles such as Scimitar, as well asother up-and-comers, might do well to consider:

• Sell the revenue stream. Many entrepreneurs fixate onselling equity in their companies to raise capital. Break out ofthe box. Why not sell investors what they really want: a slice ofthe revenue stream? That's right--ask investors to advancecapital in the form of a loan, which gets repaid as a percentage ofproduct or service sales.

What do you get? Three of the most important benefits includepreservation of equity, a larger pool of potential investors whoare attracted by the prospect of an immediate cash return, andlikely circumvention of all state and federal securities laws,since the advance on a royalty deal is a loan, not a sale ofsecurities. On the flip side, however, royalty financing works onlyfor companies with high margins and strong product or service sales(or the prospect thereof shortly after financing).

• Tap ACE-Net. ACE-Net--the Angel Capital ElectronicNetwork--is an investor-matching service affiliated with the SBA.ACE-Net was developed after years of public policy debate about howto link the country's estimated 250,000 angel investors withthe growing legions of companies looking for growth capital.ACE-Net was launched in late 1996 and today, though still in itsinfancy, boasts 18 offices nationwide that help entrepreneurs liston the electronic service.

The mechanics of ACE-Net are simple. Accredited (read: wealthy)investors registered with the service gain access to a list ofbusinesses seeking capital. Entrepreneurs pay a small fee to listtheir companies on the system. Similar to a stock market, theuniformity of information and ease of access generate a greaterflow of funds between capital seekers and capital providers.

Streamlined forms and a short application make the use ofACE-Net a no-brainer for a gazelle or any other company looking forgrowth capital. You can take the first step by visiting ACE-Net onthe Web at http://www.sba.gov/ADVO At this site,you can also find links to ACE-Net feeder offices near you.

• Get a loan guarantee. When you consider that banksactually lend other people's money, which they must pay backupon demand, it's no surprise that they're so conservative.In fact, commercial banking and small businesses are a lousy matchto begin with: Banks need predictable cash flow above and beyondwhat it costs to service a loan plus good collateral toliquidate, while small businesses have unpredictable cash flow andgenerally little in the way of collateral. You can satisfy thebank's need for safety and still preserve the equity of yourcompany with a loan guarantee from a third party, such as an angelinvestor.

The benefits of such a loan guarantee are manifold. First,unless the guarantor is an extremely hard bargainer, a loanguarantee will not cost you any equity. Second, there is a largerpool of investors that will guarantee a loan for, say, $1 million,than will cut a check for $1 million. Of course, if the deal goessouth, then the investor will have to cut the check. Butwhen you're romancing investors, this is secondary in theirminds because they believe they can pick the winners and avoid thelosers.

• Consider a direct public offering. Customers, vendors,employees and the people who live in the surrounding community arepotential sources of capital. If your company has a strongrelationship with them, and they believe in your company,capitalize on it by selling stock through a direct publicoffering.

Consider the case of Michael Quinn of Hahnemann LaboratoriesInc. in San Rafael, California. Quinn needed additional capital toupgrade his manufacturing facility so he could distribute hishomeopathic medicines nationally.

"Banks said no, and investment bankers and venturecapitalists weren't offering much hope either," Quinnsays. But Quinn had an epiphany when he realized that if just 200of his more than 28,000 customers invested $2,000 each, he'dhave all the capital Quinn Labs needed.

"My feeling was that people who use homeopathic medicinesand believe in alternative medicines might also be attracted to analternative investment," says Quinn. He was right:Approximately 240 investors collectively forked over more than$477,000, and Quinn, now with a new manufacturing facility and 1998sales projected at $920,000, has never looked back.

Direct public offerings are a viable option for any company thathas a lot of external constituents, can easily identify andcommunicate with these constituents, and does not need all thebells and whistles that come with a conventional initial publicoffering--namely the aftermarket trading and close relationshipwith an investment banking firm.

• Tap your 401(k). If you've been cut loose fromcorporate America with a 401(k) plan, it may hold the key tofinancing your new business. While popular myth suggests that401(k) plans can only make investments in large public companies,mutual funds and government securities, it's not so, says GregBrown of the Chicago law firm Seyfarth, Shaw, Fairweather &Geraldson. And if you tap into the money in your own 401(k) plan,it postpones the day when you'll have to get outside investorsinvolved in your company.

Brown says one strategy involves setting up an Employee StockOwnership Plan (ESOP) to purchase equity in the company, which isthen distributed to the 401(k) plan. With this technique, he says,if over time the company grows and takes on a lot of employees,they can participate in the plan as well.

"Allowing employees to invest in their company offers anumber of management, tax and estate planning benefits," saysBrown. Perhaps one of the most compelling, he says, is that an ESOPprovides the founders with an exit strategy, so when they'reready to retire, it can purchase their interest in the company.

Back at Scimitar, Nickell and Candell are keeping their optionsopen. "It's a great time to be an entrepreneur," saysNickell. "There's been a tremendous amount of wealthcreated over the past 15 years and, as a result, lots of investorsout there are looking to recycle their wealth. If we can keep ourgrowth on track, we can help them accomplish theirobjective."

Contact Sources

Hahnemann Laboratories Inc., 1940 Fourth St., San Rafael,CA 94901, (888) 427-6422

Scimitar Golf USA, (714) 379-6699

Seyfarth, Shaw, Fairweather & Geraldson, browngr@seyfarth.com