Cash Crunch Don't let investors and lenders use that old "it's the economy" line as justification to put the squeeze on your business.

By Jennifer Pellet

Opinions expressed by Entrepreneur contributors are their own.

No question--it's scary out there. The ever-tighteningcapital market has many cash-hungry souls grabbing the first dealdangled before them, and that's a dangerous plan at a time wheninvestors and finance companies are demanding onerous terms.

Sure, you will have to make concessions and consider termsunheard of in those glory days when VCs, banks and other financingsources bid against one another for a chance to supply funding withfavorable terms and few strings attached. But even in a tightmarket, terms are negotiable, and fending off unreasonable demandsnow can help stave off disastrous consequences later. So whenjudging the benefit of potential funding, be on the lookout for thefollowing red flags.

  • A lender undervalues your company--andwon't budge. Always a thorny issue, valuationdebates are more heated than ever in today's post-downturnmarket, says Joe Heller, managing director of Plainview, NewYork-based NextLevel Venture Partners. Heller notes that whileventure capitalists and entrepreneurs rarely see eye to eye on thesubject, there are some gaps too wide to bridge. "If all theVC is interested in is rock-bottom pricing," Heller says,"that should raise a flag that they're trying to takeadvantage of the times."

2.5%
of employee wages are matched by the average401(k) plan (down from 3.3% in 1999).
SOURCE: Profit Sharing/401(k)Council

"What we see today harkens back to the VC market in theearly '90s and the term 'vulture capitalists,'"says 43-year-old John Ticer, president and CEO of Vienna,Virginia-based biometric authentication company BioNetrix SystemsCorp., which has secured three rounds of financing. "We hearabout venture-financed companies liquidated where the valuationwasn't significantly high, and management and the employees getnothing." For example, a venture capitalist that stipulates"three times liquidation preference" would be entitled toreceive three times his or her investment before remaining fundsare disbursed-which could leave company managementempty-handed.

Disagreements can sometimes be resolved by making valuationcontingent on hitting performance targets-but that's anotherdesperation move that could get you in trouble. "The VC cansay, 'This is the valuation I place on the company today, butif you hit certain milestones, the company would be worth moremoney and I would be willing to pay more for it,'"explains Heller, who is quick to add that the difficulties ofdelivering on set targets must be weighed carefully, as direconsequences can ensue if targets are missed. "Depending onhow the contract is worded, either no new money will go into theventure or new money will go in at a significantly lower valuation.So entrepreneurs have to consider whether hitting the targets isreasonable and how much of the company will they give away if theydon't."

  • Lenders demand stifling partnershipcommitments. You might be able to negotiate morefavorable financing terms or even investment capital from yoursupplier as a way to manage cash flow in difficult times. But bewarned: Such agreements can backfire if terms are too stringent."Developing financing relationships with suppliers can bemeaningful in times like these," notes Joel Magerman,president and CEO of New York City-based Bryant Park Capital, aninvestment bank that works with small to midsized companies,"but you don't want to be in a position where you'vemade an exclusivity commitment to a supplier and you have no otheroptions if they're unable to deliver." Instead, Magermanadvises making purchase contracts contingent on delivery within agiven time period, such as 30 days.
  • Hidden fees push cost of capital abovewhat it would cost elsewhere. "Particularly whendealing with factoring companies, which will give you a loanagainst your accounts receivable, people often don't calculatethe fees," notes Magerman, who points out that fees can varywidely by institution. "Origination fees, auditing fees, feeson any unused portion of the loan and other expenses you pay can beprofit centers for the bank--and have you paying over 20 percent.So factor in the fees when evaluating a loan rate."
  • Lenders want ultimate approvalpower. Investors and lenders are no longer shy aboutasking business owners for decision-making power, a prospect thatputs experienced entrepreneurs on edge. "VCs sometimes ask forsupermajority rights, which can effectively prevent you from doingthings that make sense for the business," warns Magerman.Before joining Bryant Park, Magerman found himself hobbled by justsuch a provision while running a golf putter company he and hisbrother started. "We couldn't do anything strategicwithout the fund's approval, and the only thing it wouldapprove was selling the business. So we were forced to sellprematurely."

To gain guidance without sacrificing ultimate authority,Magerman advises negotiating for a provision that additionalfunding or approval of business decisions will not be"unreasonably" withheld. "There are legal standardsof what is considered reasonable," he explains, "sohaving 'reasonable' terms enables you to make sure they actand behave responsibly."

Of course, sometimes you have to accept unwelcome terms--orforsake the cash. "If there are no other options and nothaving money will result in dire consequences, you have to stronglyconsider any option to have the business funded," shrugsMagerman. "At the end of the day, you can't be successfulif you're not around."


Jennifer Pellet is afreelance writer in New York City specializing in business andfinance.

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