Need Cash? Your Biggest Competitor Is Offering--For A Price
BY Jeremy Quittner
A growing number of big companies want to fund small businesses in their industries, but be careful of the terms.
Every small business worries about having its lunch eaten by its largest competitors. So it's a big step to go from eyeing your most formidable competition warily to depending on them as a source of financing.
Although banks are beginning to re-open the spigots now for small business loans, the recent recession spawned a boomlet in alternative financing like factoring and asset based lending from non-bank sources. One alternative that's blossomed recently is financing from large companies, some of which have begun to sponsor accelerator programs for startups in their industries.
So far, about half a dozen big companies have done this, choosing a handful of businesses each year to support. While that's a drop in the bucket in terms of small business' overall financial needs, the programs address a seed funding gap for startups that banks and venture capitalists don't address. The financing typically comes as a loan or a stake in the fledgling company.
Small businesses benefit not only from the cash but from the access to a group of knowledgeable mentors within their industry. The big businesses benefit by having a direct path to innovators. But repayment terms can be higher than traditional financing, and some of the programs force nascent companies to give up equity right out of the gate.
Microsoft and Nike, for example, offer financing to as many as 10 startups annually, in partnership with start-up accelerator TechStars. Both companies give the startups $20,000 in return for TechStars taking a 6 percent stake. The entrepreneurs go through multi-month business courses, perhaps in marketing or finance. These courses are usually offered at or near the corporate campuses, where the companies are also given space to work. At the end of this mentoring process, they are introduced to potential venture capital investors. In return, the bigger businesses get access to a promising company that may be useful to them in the future.
"Corporations have traditionally struggled with innovation, so you're seeing a few examples of them outsourcing this activity" through these programs, David Cohen, chief executive and founder of TechStars wrote in an email.
Others, like beer Boston Beer Company, which produces the Samuel Adams brand, offer micro-loans to brewers and other companies in the food industry. Its Brewing the American Dream program has assisted some 230 small businesses with about $2 million in total loans since 2008.* The loans are generally less than $10,000, have interest rates between 10 percent and 11 percent, and are repaid within three years. (Although bank loans have proved quite difficult for small businesses to find in the past five years, their interest rates are generally two to three perentage points lower.)
"The best applicant we get is somebody who has a small business and is doing fine, but they have an opportunity to expand and they need money for it," says Jim Koch, founder and chief executive of Boston Beer Company.
One such company is microbrewery ROC Brewing Company, of Rochester, New York, which received a microloan of about $8,000 from Boston Beer in 2011. ROC specializes in golden ales, English pale ales, and Cullan's Irish reds. It produces about 600 barrels of beer annually, and part of its production is outsourced.
Founders Jon Mervine and Chris Spinelli had rounded up $150,000 in financing from family and friends to start the company, which broke even after the first six months. To make sure ROC stayed on top of quality control, the company needed a keg washer to scrub out the barrels. But there wasn't a lot of extra free cash for the $10,000 item. Banks didn't really understand ROC's need for the washer, but Boston Beer did, Mervine and Spinelli say, and in April of 2011 Boston Beer gave them the equipment loan.
"It allowed us to do larger scale production, and without that our business would not have been able to grow," Mervine says.
Today, ROC, which is staffed only by Mervine and Spinelli, has revenues of $170,000.
For his part, Koch says the program is mostly philanthropic and actually loses money due to origination and administrative costs. But Koch feels strongly about continuing to offer the program, he says, from his own years as the owner of a start-up who wished he could access mentors who could help with specific problems.
"When I started out, there were two things I would have loved to have that were not available: one was loan money and the other was nuts and bolts business advice," Koch, a Harvard Business School graduate and former Boston Consulting Group consultant, says.
Small business finance experts generally laud these programs, saying the mentoring and advice small businesses can get from seasoned industry experts is invaluable. So, too, is the seed financing for startups, which is generally in short supply. But that doesn't mean start-ups should get involved without a second thought; they should carefully consider the terms.
"I don’t like to see any early stage company give out any percentage, if at all avoidable, because once you start diluting the ownership it affects longer-term access to capital," William Brigham, director of the Small Business Development Center at the University at Albany-SUNY, which offers its own loan program and takes into account character analysis, among other qaulifying factors.
"But there are so many pitfalls and weaknesses that small businesses can fall into, and having somebody who has been through this, mentoring you in these areas, that is where the value comes from," Brigham says.
*An earlier version of this story understated the total dollar amount of Boston Beer's micro-loans. The correct amount is $2 million.