The Other Colors of Money If banks and VCs are out of your financial picture, don't despair. These 3 alternative sources of capital could provide the funding you're looking for.
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Even with all the venture capital choices we've presented in"SeeingGreen," you may need some alternatives to banks and VCs.Alternative financing sources abound-if you look in the rightplaces.
Start close to home, and consider these three options: hiddenpersonal wealth, angel investors and commercial financecompanies.
Hidden Gold
It may sound clichéd, but no one believes in your dreamsquite as much as you do. So it's natural that you should try tobankroll yourself. Doing so will impress partners, investors andcustomers. After all, nothing says "I'm serious" likeinvesting your life savings in your business.
Before you apply for a second mortgage or a wallet full of newcredit cards, however, you might want to dig a little deeper foryour own "hidden" wealth. You may be surprised to findmore capital than you imagined.
These hidden sources of personal wealth can include nearly anycurrent financial asset. Life insurance policies, 401(k) plans,IRAs and stock portfolios are among the most commonly overlookedsources of business capital.
"Borrowing against life insurance can actually be verybeneficial," says Russ Grzywinski, a registered investmentadvisor and president of Oak BrookFinancial Group in Charlotte, North Carolina. "You cantake a loan against the cash value of a policy, then pay it back ata flexible rate that suits your business cash flow."
You may think his approach is counter-intuitive, but Grzywinskisuggests borrowing from yourself at a high interest rate:"When you borrow against a life insurance policy, the interestis a deductible expense for the business [as well as] tax-deferredincome for the individual. It's a very powerful concept."Not only are you repaying your loan, but you are also effectivelycreating a higher cash balance for the next time you need it. SaysGrzywinski, "You're taking the finance company out of theloop and becoming your own bank."
With a whole life policy, Grzywinski adds, you may have theoption of not paying back the loan at all. Any shortage will simplybe deducted from the death benefit when you die. If you can'ttake it with you, use it to grow your business.
Your retirement savings is the next logical place to look forhidden personal wealth. That 401(k) from your previous employer maybe the best place to start. Grzywinski advises entrepreneurs tokeep retirement savings in a 401(k) account, since it's easierto borrow against than, say, an IRA.
IRA accounts, including SEP and SIMPLE retirement plans,typically have stricter limitations on borrowing or investing.Generally, you can invest your IRA money in a private company (withsome restrictions), but there are only a handful of custodians thatwould allow that to be done, says Grzywinski. "The problem isvaluation," he explains. "The account custodian can'tget a handle on what that investment is worth each year."
Finally, Grzywinski says, don't forget your public stockinvestments. But before you ask your broker for a traditionalmargin account, check with your local banks. "The interestrates are probably better at a lender than in a margin loan at yourbrokerage firm. Plus, a local bank may be more sensitive to anentrepreneur's needs," he says. Check around for the bestrates.
Silver Wings
There are many benefits to using personal assets first. But ifyou're tapped out, don't despair. The next best source forsmall-business capital may be right around the corner.
According to the Center for Venture Research at the Universityof New Hampshire, there are some 400,000 active individual or"angel" investors who invest in more than 50,000businesses each year. Compare that to the country'sapproximately 450 venture funds, which, according to the NationalVenture Capital Association, invested in just 2,715 companiesduring 2003. Clearly, individuals-not VCs-are much more likely toprovide the capital your company needs.
Where to find angels has always been a problem, but that may bechanging. "More and more angels are joining clubs ornetworks," says Marianne Hudson, director of Angel Initiativesat the Ewing MarionKauffman Foundation in Kansas City, Missouri. "There werefewer than 10 of these groups in 1996. Now there are about 200 ofthem, and we hear from more all the time.
"The good news for entrepreneurs is that these groups haveWeb sites, and they're looking for quality deal flow,"says Hudson. That's a welcome change from the past, whenfinding an angel investor usually meant months of carefulnetworking.
One new angel investment group, the Blue Ridge Angel InvestorNetwork (BRAIN), is an excellent example. Based in Asheville,North Carolina, the group hired executive director Jim Roberts toreach out to both new and growing companies throughout theSoutheast in an effort to expand the economic region of Ashevilleand western North Carolina. "Our members are often semiretiredor retired," says Roberts. "They want to get involved ingrowing something."
BRAIN, a group of individual investors that meets quarterly,brings several entrepreneurs to present their business plans ateach meeting. According to Roberts, the forums facilitate theintroductions that will be critical for Asheville's continuedeconomic growth.
A quick Web search will help you find a local angel group nearyou. Or just ask around-most CPAs and business lawyers will knowsomebody who's involved in your area.
So what's his answer? "Get customers to fund yourgrowth by targeting early adopters-those people who have more moneythan time," he says. As an example, Birol points out that thePalm Pilot was once priced at more than $1,000, yet early adoptershappily paid the price. Those early sales helped Palm get the cashin and the price down.
When cash is tight, young companies need to focus more onselling and less on fund-raising. An overemphasis on fund-raisingis one sign that a business suffers from the "if we build it,they will come" approach to sales. Instead, Birol suggests anew tactic. "I believe organizations have to focus on theirbest and highest use-what they do well, what they enjoy doing, andwhat customers have valued in the past."
"Focus, accomplish and grow" are the three tenets ofbusiness success, according to Birol. For more on the subject,check out his book Focus. Accomplish. Grow. The BusinessOwner's Guide to Growth, available on Amazon.com or atAndyBirol.com.
Blue Suits
When your growing company is facing a cash emergency, it helpsto go to someone who understands the dynamics of growth.Traditional bankers, who are generally looking for something"slow and steady," are probably not your best resource inthis case. That's where a commercial finance company can stepin.
"In general, commercial lenders will look at tougher loans,because they are not subject to the same regulations as abank," says Douglas Mitman, managing director of investmentbank GraceMatthews in Milwaukee. The more critical your need, the lessuseful banks become. "The commercial finance guys can be moreaggressive with a struggling company," says Mitman. "Butthey're typically going to look for asset coverage."
"Asset coverage" is essentially another way to say"loan collateral" and can include accounts receivable,inventory and factory equipment.
While finance companies may have less stringent rules thanbanks, they still look for one of two things: either hard assets touse as collateral or enough cash flow to comfortably make debtpayments. If you have the collateral, look for "senior"or "asset-based" loans. If you can afford to pay back theloan from cash flow but don't have hard assets, ask aboutunsecured, mezzanine or subordinated loans. Rates these days areroughly equivalent to those of a credit card.
Subordinated and unsecured credit are now widely available tobusinesses that have solid operating profits-sometimes to the tuneof two or three times the business's annual cash flow.
CITSmall Business Lending Corp. (a subsidiary of CIT Group Inc.),for one, provides SBA-guaranteed loans of up to $2 million basednot just on assets, but also on the company's operating historyand the strength of the business plan. "We're looking atthe projected cash flow-the ability of the business to repay us.And we put a lot of weight on what the business has done in thepast couple of years. But it's not uncommon for us to lendbased on projections, too," says Chris Lehnes, vice presidentof business development for CIT Small Business Lending Corp., basedin Livingston, New Jersey. Franchises, professional offices andothers with proven business models are most likely to qualify forcredit based on projections.
For lending companies like CIT Small Business Lending Corp.,seeing businesses with a substantial amount of debt is notuncommon. In fact, according to Lehnes, private businessesfrequently have leverage ratios as high as 10-to-1-meaning theyhave 10 times as much debt as equity. "That would beoutrageous for a public company," he says, "but for asmall [or midsize] business, that's very common."
While the biggest commercial finance lenders include CIT Group,GE Commercial Finance and Textron, there are also hundreds ofsmaller shops. Some of these lend SBA money through what'scalled a Small Business Investment Corporation.
Mitman sums it up: "There are a million options for you ifyou have an up-and-running company that's either making moneyor has assets. And if you're large enough, with a healthybalance sheet, you'll find capital even if you're notmaking money."
Your options will be dictated by several considerations,including how much money you need, how long you'll need it,what you'll need it for, and how much control you'rewilling to relinquish. For instance, if you need to raise severalmillion dollars, then venture capital, a stock offering or perhapsa well-heeled angel investor will be your best bet. On the otherhand, if you need only $10,000, hidden personal wealth or one ofthe SBA's microloans may be your best bet. Financing lastingmore than a few years is usually going to come from equityinvestors such as VCs, angels or friends and family, unless you arefinancing real estate, in which case a bank loan would besuitable.
The reason you need the money will also come into play. A bankis unlikely to lend you money to allow you to increase yoursalary-that's going to have to come from someone with apersonal interest in your business, such as an angel investor or afamily member. That same family member, on the other hand, will beunable to help if what you need is an international letter ofcredit to wrap up an across-the-border deal. Matching yourfinancing source to your need will eliminate manypossibilities.
Control is another issue. If you want to maintain maximumcontrol of your business, stick to hidden personal wealth, family,friends and bank financing. Angels, VCs and public markets are muchmore likely to want to see themselves or their handpickedassistants in the driver's seat.
Excerpted from Entrepreneur magazine's BusinessStart-Up Guide #1812,Growing Your Business.
David Worrell is Entrepreneur's "RaisingMoney" columnist.
