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BUYING A SMALL BUSINESS

How to Finance Anything

A user's handbook to the hidden cash sources of the '90s.
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From new businesses to new products. A user's handbook to the hidden cash sources of the 90s

If you've been beating the bushes for money and are coming up empty-handed, you're not alone. For the past two years business owners from Bangor to Bakersfield have seen the most severe credit tightening in recent times. Bankers in some areas of the country, especially those where real estate values have fallen furthest, have gone so far as to demand repayment on non-real-estate loans that were current in both interest and principal. It's reached a point where many lenders quietly admit they've all but given up making loans to smaller companies unless the deal is risk free. Among other things, lenders simply don't want to face more criticism from federal bank examiners.

Other established sources of money, like venture capital, are for now even further out of reach. To begin with, most venture capitalists are out of money; hundreds have ceased operations altogether. Those with capital available are saving it for the businesses they've already invested in (partly because they can't get banks to lend them money) or deals they can get in and out of quickly and profitably. Younger, smaller companies need not apply.

Will this financing environment improve anytime soon? Some people who've lived through previous credit droughts answer, without question, yes. When the flowers begin popping up in late spring, these optimists predict, bankers, too, will reappear with a new appetite for lending. Perhaps. But don't expect anything resembling the sorts of deals we saw in the 1980s. The scars are simply too deep.

So what should companies in need of money be doing these days? Well, the best (and cheapest) money around often comes from managing your business more efficiently. But if, after rethinking the way you handle different parts of your operations, you're still coming up short, we've pulled together some ideas for you to consider. Some of them are old ideas that merit a new look; others are newfangled responses to recent market conditions. We wish we could say they're all simple to execute, but many are not. They will require a lot of thought, time, and effort.

This catalog is not a comprehensive listing of every financing technique and deal around. Rather, our goal is to help you understand the range of possibilities, avenues to explore, and types of people who can help. We've used the following coding system to help you find what may work best for your company:

S = Service Company
R = Retailer
M = Manufacturer
S-U = Start-up
Leaning On Suppliers

For research-and-development support (S, M, S-U) This has potential for any business whose product or service is made up of things furnished by other companies. If you can show suppliers how they'll benefit from your product, you may be able to get them to front you products or services or both -- and even money -- during the R&D phase. The most obvious opportunity is in technology: a well-heeled backer gives you money or technical help to spur your development work. To provide a little extra incentive, you might give the supplier some options on your product -- say, a license to market it in a particular setting.

But such deals are by no means restricted to high tech. Take, for example, a home-design company we recently heard about. It arranged significant support for the development of new designs from a large manufacturer of building products. The help comes in several forms: cash, supplies, and marketing support. (The manufacturer will mention the design company in its ads.) While the manufacturer hopes the small company will become devoted to its products and spread the word, that's not guaranteed in the agreement.

To get a supplier to help with development is not an easy sell by any means. But when it works, the payoff is terrific.

For longer credit terms (S, R, M, S-U) If you're a young company, even a start-up, you may be able to convince your key suppliers that, by extending longer-term credit, they'll be nurturing what will become a substantial, long-term customer. True, many suppliers have become skeptical about such promises -- and there are plenty of stories of customers who try negotiating such deals when they're already in trouble. The key is to provide your suppliers with credible plans along with forecasts showing how they'll be paid.

A few years ago a start-up we know in the food-processing industry was in a cash-flow bind owing, in part, to the difficulties of one of its vendors. So the start-up asked one of its biggest suppliers (a large corporation) to provide about $200,000 worth of material over eight months and to stretch payment on those goods over two years. The company wasn't asking to delay payment on everything; indeed, it would pay for subsequent supplies it ordered within 60 days. What's more, it pledged not to squeeze the supplier on price. (It would buy from the supplier exclusively.) What happened? Well, the supplier agreed to extend payment at a rate 1% over its own cost of borrowing. The note was paid off on schedule, and the food-processing company is still buying from the same source. Clearly, the supplier took a big risk, but it gained a loyal and growing customer.

To finance inventory, part one (R, S-U) Say you're a retailer or a wholesaler and you want to accumulate inventory, but you don't want to -- or can't -- finance it. See if your suppliers will ship the merchandise on consignment, which means you won't have to pay for it until you sell it. The suppliers most likely to agree to this arrangement are those that need to get their products into the field in order to achieve their own sales goals. We know of furniture and clothing stores that have been able to take advantage of consignment selling. It's an arrangement worth exploring -- and maybe even giving up some profit for -- if you want to avoid additional borrowing.

To finance inventory, part two (R, M, S-U) Auto dealers have long relied on floor planning from manufacturers. You can adapt the idea for your company. Say you want to get the most favorable prices from suppliers, but you can't buy your entire season's inventory at once. First, you don't need it all at once; second, you can't pay for it. With floor planning, you get the products and the invoices in phases. A former Inc. 500 company that made components for car sound systems, for example, used to place one big order and negotiate the price up front. Included in the negotiations were two installments for both delivery and payment. The company was able to reduce its payables by thousands of dollars until it actually needed the parts.

To lease equipment (S, R, M) Leasing is a way to get equipment you need without tying up cash or inhibiting your borrowing ability. While leasing will cost you somewhat more than purchasing equipment, you may not need to list it as a liability on your balance sheet or even make a down payment, depending on how the lease is structured. What's more, most lease payments are tax deductible, whereas if you buy an asset, you need to depreciate it over its useful life.

Leasing companies are plentiful, and many banks have gotten into the business in recent years. Although you should always shop around for terms, you'll usually get the best deal from companies that specialize in the type of asset you're hoping to lease. You won't have to educate them about the equipment, and they're apt to offer a better price.

Lessors, like banks, will do extensive credit checks, but some will take on a higher level of risk in exchange for higher rates. The easiest way to find leasing companies is by talking to bankers, other lessors, or venture capitalists. Or you can contact the Equipment Leasing Association of America, in Arlington, Va., at 703-527-8655.

Leaning On Customers

To prepay (S, R, M) Whatever stigma once may have been attached to asking your customers to help you finance your business, it's not relevant in the current environment. People everywhere recognize that credit is tight. Indeed, if you explain the rationale for why you need your customers to pay on an accelerated timetable -- and point out how they will benefit -- there's a good chance you'll get some cooperation.

A number of equipment manufacturers, for instance, require customers to make big initial payments to cover the working-capital requirements (for materials, labor, and so on) on a particular order. Without that kind of financing, they'd have to turn down orders or work slower. But it's not just manufacturers that can use this approach. Service companies, too, have been successful at getting advance payments, provided they can cite compelling reasons for why they need them.

To pay suppliers directly (S, M, S-U) This is a way around having to raise money to pay subcontractors who insist on prepayment. You "presell" your product or service and get your customer to pay your suppliers directly.

We recently heard an example of this from someone who works with inventors. One of his clients had a patented idea for a promising houseware item, and a manufacturer that could make it. Problem was, the manufacturer needed a big advance payment, which the inventor didn't have. They presented the idea to a large retailer, which liked it so much it offered to help out. The retailer agreed to pay the manufacturer up front for part of the order and to pay the balance upon acceptance. The inventor gave up nothing -- and didn't have to raise money.

The only way these deals can work is if you have a customer who is dying for your product or service -- and it helps to have a patent. Another drawback: there's no system set up to put these deals together. Some managers do them on their own. Brokers and intermediaries specializing in them will do such deals either for a fee or for a piece of the action. But these specialists are not easy to find. Your best shot is to network and check ads in business publications.

For minority loans (S, M, S-U) If you are a minority vendor working on contract with a major company, there's a good chance you can qualify for a special loan under a program of the National Minority Suppliers Development Council Inc. (NMSDC), based in New York City. Nearly half of the Fortune 500 companies and hundreds of others participate in this program to provide money to ethnic-minority-owned companies that are having trouble obtaining it. The program, called the Business Consortium Fund (BCF), is four years old and has made loans to about 200 companies owned by African Americans, Hispanics, Asians, or others.

Here's how it works: Once you've been certified by an affiliated regional council, you periodically receive a listing of the companies in the program. If you have a purchase order or contract from a company on the list, you take it to a participating bank. The bank verifies the contract and, assuming the banker thinks your business is viable and therefore able to deliver on the contract, it recommends the loan to the BCF. In giving its nod, the bank agrees to lend 25% of the loan, with the NMSDC lending the rest.

Borrowers are limited to total loans of $500,000 under this program; the term can't be longer than the length of the contract or exceed four years. As for the rate, the nonbank portion is at prime, while the bank gets to charge 30% over prime, a sweetener to do the deal. For minority company owners looking to establish their creditworthiness and a relationship with a bank, this is a great way to do it. For more information, call the NMSDC at 212-944-2430.

* * *

Dressing Up For Bankers

To allow inventory as collateral (R, M) Among a banker's darkest nightmares is to make a loan using inventory as collateral and then get stuck with a failed business and vanishing inventory. That makes many career-conscious lenders reluctant to place much value on inventory these days. But in the current credit crunch, we've run into an unusual breed of financial intermediary. For a price, these people will stick their necks out and help clients get financing. They actually guarantee the value of your inventory. That gives lenders confidence that, if things unravel, they won't have to write off the loan.

Naturally, this service isn't free. To get someone to say the inventory is worth x% of its original cost may run you around 2% to 3% of the guarantee; getting a guarantor to commit to a dollar value is more expensive -- 5% or more -- because the guarantor has to ensure the inventory is actually there. Finding these guarantors is tricky because they are few and far between, and don't usually advertise. To track them down, talk to financial people who know your industry, particularly the liquidation end of it.

To finance new orders (S, M) What can you do if you need money to finance the inventory, payroll, and other expenses associated with a specific contract or purchase order? If you can produce documentation for the contract, you may qualify for a guarantee from the Small Business Administration under a provision of its 7(a) loan program designed for just such financing. Most service and manufacturing businesses that have been around more than a year and that fall within the SBA's size restrictions can qualify. A service company must have revenues of no more than $3.5 million; manufacturers can't employ more than 500 people.

To pursue this, check first with your own bank. The incentive for a bank is that it can off-load most of its risk onto the SBA, which guarantees up to 85% on loans up to $750,000 (90% on smaller loans up to $155,000). For collateral, the SBA usually takes an assignment of the proceeds from the contract and a personal guarantee from the owners. This is short-term money. The loans, priced at a maximum of 2.25% over prime, typically have to be paid off within 12 months.

If your bank has never done a deal like this, suggest that it do the loan jointly with another bank with more experience. Currently there are more than 600 certified or preferred SBA lenders around the country. They all have the ability to either approve the guarantees themselves or get responses from the SBA within a few days. For a list of the certified and preferred lenders in your area, contact one of the SBA district offices, which are located in state capitals. For more information on this and other SBA programs, the national hot-line number is 800-827-5722.

To get seasonal lines of credit (S, R, M) Say you make beach toys or snow shovels, or perhaps you sell them. If you can't buy your materials or products in time, you'll miss the market. The SBA's 7(a) program is set up to guarantee seasonal lines of credit to companies that meet the age and size requirements noted above. The terms also are essentially the same as those for the contract loans. Once again, you should begin by contacting your banker.

To get revolving lines of credit (S, R, M) Even if your bank is showing every sign that it has no interest in lending against your inventory and receivables, take heart. You may be able to get credit anyway -- if you happen to be based in one of the six New England states. The sponsor, once again, is the SBA, which unveiled its one-year revolving-credit program last year to assist companies caught in the region's severe credit squeeze.

To qualify, a business needs, among other things, to be at least one year old, meet the SBA's size requirements described earlier, have enough collateral to secure the loan, and provide reasonable cash-flow projections for the 12-month period. Since the program is still relatively new, many New England bankers are in the dark about its workings. But it's worth pursuing, since the SBA has pledged to maintain the program at least until 1994. Again, your best sources of information are the SBA regional and district offices and banks that are active with other SBA loan programs.

To finance exports (S, M) Banks are queasy about lending money for exports for fear that any number of things could go awry. So if you want to do business with foreign customers, it pays to know about the programs that make bankers more inclined to help. The SBA, for example, has a special program that guarantees working-capital loans for businesses needing money to buy materials to develop and supply accounts. For companies meeting the basic criteria for SBA loans, the agency can guarantee revolving lines of credit of up to $750,000. Unfortunately, a great deal of paperwork is involved with this program, and it's tough to find bankers who will take the time to understand how it works.

The Export-Import Bank, in Washington, D.C., has a similar program for working-capital loans. Although you and your banker still need to invest time in the paperwork, this program, which has been growing in the past few years, can guarantee up to 90% of the principal. You can reach the Export-Import Bank at 202-566-8990.

If you're able to get by without working-capital loans, and you simply want to finance your foreign receivables, the easiest way to do it is with export credit insurance. The main option for companies exporting less than $5 million a year is the Foreign Credit Insurance Association, with offices in New York City and other cities. Such insurance isn't cheap -- expect it to cost 50¢ to $1 per $100 of coverage (depending on the country your customers are located in). But with it, banks are usually willing to lend against the export receivables, on the same terms that they'll lend against other receivables. The association's New York number is 212-227-7020.

Finding White Knights

To shore up your shaky credit (R, M) If you're a retailer and, because of your slipping credit, suppliers won't ship you merchandise, know that some people will see your headache as their opportunity. These middlemen didn't exist when the economy was hot and banks were aggressively lending money. For a fee, they will inject themselves between you and your suppliers, thus enabling you to get the inventory you want.

The go-betweens become the buyer; because their credit is better than yours, they're often able to get a better price, although that's offset by what they charge (around 6% of the purchase). Also, they want payments at least every week. In the event you can't pay, the go-betweens can take control of the inventory and sell it. Most people who do this get involved because they really know the inventory -- and how to get rid of it. Few people are in the business, though, and most don't advertise. The best way to find them is by talking to factoring companies and others who know the ins and outs of your industry.

With expertise (S, R, M, S-U) Finding the money to pay technical or management advisers can be difficult. But in the current environment many qualified people are willing to reduce their rates in exchange for equity or some other form of payment. Individuals who have recently left jobs with generous termination deals are prime candidates, as are independent consultants who may be looking for steady clients.

These relationships are all over the map. Here are some of the arrangements we've recently heard of: an engineering consultant offering to cut his up-front rates to a start-up in exchange for promises of future work; a package-design firm taking its fees from a start-up and investing the equivalent sum back into the business (thus permitting the start-up to get a tax write-off for the consulting costs); and a consultant taking part of his payment in a royalty interest on sales of a specific product.

Some businesses, of course, have more opportunities to structure deals than others do. First, find the managers or experts you might be interested in working with -- headhunters and outplacement firms would have some leads. To make sure you're not exposing your company to unforeseen risks, run your ideas by an adviser you trust. Once you come up with a plan, make a proposal. The worst that can happen is that you'll get no for an answer.

Turning Assets Into Cash

With royalty deals (S, M, S-U) Looking for money to market your product or to do further development or expansion, but cool to the thought of selling equity? An alternative is to give investors a royalty interest in a product or an area of the business. Unlike equity, you don't dilute your ownership. And in contrast to debt, there's no fixed obligation; you pay a slice of the revenue stream. (Royalties are also tax deductible.)

The deals are often set up as limited partnerships with one or more investors. Recently, we've seen them in software companies, but also with consumer products and service businesses. In setting the royalty rates and other terms, think about the potential revenues and the time it might take to reach your sales target. Also, think about whether you want to put a ceiling on how much money investors stand to make if revenues take off. One possibility is to build in an option to buy out the investors at a set price before a certain date. You'd offer them an attractive price, perhaps even some stock, in exchange for some long-term flexibility in case you want to restructure the royalty deal to attract other investors.

By selling licenses or marketing rights (S, M, S-U) If you're a young company or a start-up with an interesting product in hand -- or even in the works -- you might look into raising money by selling off the rights to market your product in geographic areas or industries secondary to the ones you're aiming for. Consider, for instance, a new filtration technology that has potential applications in several industries. Assuming you don't have the money to tackle every market at once, find someone to license the product in, say, pharmaceuticals. Or you could decide to sell marketing rights for your product in Europe or Asia. Either way, think of this as trading markets for money. As lawyers and others who have hammered out these deals will tell you, you can structure them in any number of ways. You can set them up as exclusive or nonexclusive agreements, get the cash up front, or take it in yearly license-renewal fees or as royalties on sales.

With licensing deals, you retain the equity. But there is an Achilles' heel. We've heard several companies complain that their early licensing agreements turned off later potential investors who felt there wasn't enough of an up side left for them. If at all possible, then, try to sell nonexclusive licenses or work out legal provisions for amending deals to attract future money.

By selling a department (S, R, M) If you're looking for a quick shot of cash, here's a technique that's just emerging. It's suitable for companies that rely heavily on their data-processing departments, and so far we've seen it primarily on the East and West coasts. The idea is to sell the department off to a company specializing in data processing, then contract with it for the services you need. Initially, it will deliver the services using your people and systems on-site; eventually, however, it will almost certainly make changes, which might include reassigning your former employees, weeding out those who aren't needed, and having people work on multiple accounts at once. To protect key employees, you may be able to negotiate management contracts.

People who have engineered these types of deals say the players pursuing the arrangements most aggressively are companies like EDS and IBM. How much you can expect to raise is tied to the size of the department. A five-person department with a payroll of, say, $200,000 (the smallest payroll of the deals we've heard about), could be worth around $1 million if you're willing to sign a 10-year service contract. To do a deal like this, you need to feel comfortable that the data-processing people will no longer be under your direct control.

By selling equipment and leasing it back (S, R, M) Suppose you have some assets you want to continue using, but you also have a pressing need for cash. One battle-tested technique is the sale-leaseback. It works the way it sounds: you sell the piece of equipment or real estate to an investor (a bank, a finance company, or even a wealthy individual); the investor gives you money, takes title to the property, then leases it back to you. If you want access to the asset for an extended period and want to keep your payments low, arrange for a long-term operating lease (which assures the lessor of a payment stream for the length of the lease).

Whatever cash you get from the sale improves your balance sheet, while the leases may not have to be on it. (That depends on some intricate accounting rules.) Many investors are wary of deals involving real estate, but opportunities with computers and other equipment exist. The financial benefits aside, you often can pass off to the lessor the risk of your equipment's becoming obsolete.

The big downside? That you'll need to replace the equipment at the end of the lease (operating leases don't have bargain purchase options), or that you won't need it for the full term of the lease. Also, because of some recent bankruptcy-court decisions, leasing companies and investors are extremely reluctant to do sale-leasebacks in many states. (Without modifications to the uniform commercial code in those states, courts have said, even after sale-leasebacks, the lessees still own the equipment.) If you're interested in talking to someone about a sale-leaseback, start with your banker or accountant. If neither does this sort of transaction, chances are good that one or the other will know someone who does.

By bartering (S, R, M, S-U) More companies are turning to barter as a way to avoid draining their cash. By bartering, you're really not converting assets into cash. You're trading what you have (surplus inventory, spare time, space) for goods and services you need but don't want to (or can't) buy. By trading your product at the full price (the cost plus profit), you can boost your buying power.

Many companies go directly to trading partners to negotiate mutually beneficial deals. But an increasing number of transactions are done through barter exchanges. Through an exchange, you can trade your products for whatever is being offered (accounting services, restaurant meals, heating oil).

While bartering can help preserve your cash, don't expect any tax benefits from it. As far as the Internal Revenue Service is concerned, anything you trade should be reported as income; the value of products and services you receive can be deducted as long as they're legitimate business expenses. To locate an exchange in your area, contact the trade associations of the industry: International Reciprocal Trade Association, in Great Falls, Va., at 703-759-1473; and National Association of Trade Exchanges, in Euclid, Ohio, at 800-733-6283.

By borrowing against receivables (S, M, S-U) If you're tired of customers taking longer and longer to pay their bills, factoring may be something to look into. Factors specialize in lending against invoices (based on your customers' credit, not on yours). Once signed on, factors will advance anywhere from 50% to 95% of an invoice within days of a job's completion; the balance, minus administrative costs and fees, is forwarded upon payment by the customers.

Most factors want companies to sign contracts committing to a certain volume of business, but spot factors are sometimes willing to consider individual transactions. For the additional documentation costs and risk (they won't be able to deduct their advance from future invoices), though, they'll want to charge more. To get the attention of most factors, you need to have a minimum of about $25,000 in monthly invoices.

Factoring is expensive. Most factors charge according to how long the receivable is outstanding; for 30 days you might pay anywhere from 3% to 8% of the value of the invoice. After 60 days, many factors will give back the invoice (making collection your problem). To find a factor, get referrals from industry groups, bankers, or accountants, or contact the Commercial Finance Association, in New York City, at 212-594-3490. Check references thoroughly, since this industry has its share of slippery characters, some of whom ask for up-front fees and then can't deliver.

Finding Equity And Other Long-Term Money

From distributors (M) Normally, you wouldn't think the folks who distribute your product would also be interested in providing you with capital. But don't underestimate what people might be willing to do to protect their own interests. Recently, for instance, a Danish distributor of audio equipment became very concerned that its cash-starved U.S. supplier might not be able to provide enough product to meet the distributor's demand -- or worse, that it would go out of business. So in response, the Danish company offered to provide the manufacturer with equity to the tune of $300,000, which it accepted.

Through economic development grants and loans (S, M) In the '80s many state and local governments got into the business of helping companies get money. The underlying objective of many of these efforts is job generation or retention. Depending on where you are (or where you're willing to move to), there could be some good opportunities. Michigan, West Virginia, and Oregon, for instance, have loan-insurance programs, to encourage banks to make riskier loans than they would make on their own. Other states, including Wyoming, offer outright grants to businesses willing to locate within the state's borders. (The underwriting standards on many of the programs are relatively rigorous.)

In addition to your banker, for more information, contact the U.S. Department of Commerce's Economic Development Administration office in your region; state economic-development agencies; local community-development corporations; or local business groups, like the chamber of commerce.

From foreign investors, part one (S, M) Over the past few years billions of dollars of foreign capital have flowed into U.S. companies. The attention has been focused on the big deals (like Sony's purchase of CBS Records and then Colombia Pictures). But a significant share of the foreign money goes into minority equity positions in smaller companies. While European investors are still active, the biggest players in recent years have been the Japanese, Taiwanese, and Koreans.

Asians, in particular, often buy more than just stock. They're frequently looking for a strategic or tactical benefit as well -- rights to manufacture products or to sell them. In light of this broader interest, they're often willing to pay more than other investors. While foreigners most often get involved with businesses that have some technological feature (a design or a process, for example), we've also heard about retail and restaurant operators' receiving money.

Finding overseas investors is tricky. If you know a foreign company that might be interested in what you do, you can try approaching executives of its U.S. arm. Another route is through U.S. venture-capital and investment firms with close ties to overseas companies. Also, you can contact foreign-trade commissioners through embassies or consulates or look in the yellow pages fo

Last updated: Apr 1, 1992




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