Some Assembly Required

Small companies often have to draw financing from several different backers. Here are several questions to answer before entering a layered financing arrangement.

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Business 101
Looking for financing? Sometimes you have to bring many backers together

Back in 1995, Bob Burnham, the chief executive of Nortec LLC, needed capital to bring his young company's optical-character-reading technology to new markets. But bankers wouldn't give Nortec, a Wilmington, Del., data-processing company that had about $500,000 in revenues, the time of day. "We were hard to collateralize," notes Burnham ruefully.

Like a growing number of entrepreneurs, Burnham found another, more fruitful option: a so-called layered or structured financing arrangement, in which a company raises money from several sources at or near the same time. Though layered financings have always taken place, until recently they've far more often been the domain of large corporations. What's different now is that because of the vibrant state of the U.S. capital markets, financial deal makers are willing to structure often-complex capital arrangements involving small sums and small companies. That's why these deals have become much more accessible to many growth companies.

Layered-financing deals often include some type of private-equity investment, whether from angel investors, small investment pools, or the venture-capital community. In the best of all worlds, the equity capital is supplemented with bank debt. But other types of money can also get added to the mix, whether through factoring, royalty-based financing, or other debtlike arrangements.

Take Nortec's case. "We raised $100,000 by selling equity to an angel investor," explains Burnham. "Meanwhile, we raised six-figure sums, on two different occasions, from the Delaware Innovation Fund, a private venture-capital fund that makes seed-capital investments in companies based in our state. Those two arrangements gave us the growth capital we needed." At the same time, Burnham adds, Nortec improved cash flow by conducting a sale/leaseback of some computers and worked out a factoring arrangement so the company could borrow against its accounts receivable.

The good news about layered financings is clear. By broadening the scope of your capital hunt and offering interested parties the chance to spread risk around, you can vastly increase your company's potential for fund-raising success. The bad news about layered financings? They're anything but simple, so you need careful preparation before you begin.

Money hunters, beware. There are some pitfalls that can trip up even the most promising layered-financing candidate early on. Poor financial preparation is the biggest one. Rather than putting together a slapdash proposal that might satisfy your friends or relatives--but wouldn't get you through the revolving door of your local bank--you should prepare one well-thought-out package that will meet the toughest standards you'll encounter. If your company's internal financial staff can't handle the work, investigate your outsourcing possibilities, which might include hiring an outside accounting firm or a temporary chief financial officer on a special-project basis.

Rick J. Burrock, the managing partner of Boulay, Heutmaker, Zibell & Co. PLLP, a Minneapolis accounting firm, recommends that your package include audited, up-to-date financial statements, three to five years of business projections, and a solid business plan. "We're working with one now that's about 35 pages long, which is about what you need to be able to give all kinds of potential lenders and investors a comprehensive sense of your business and its prospects," he says.

It's also important that you--or an outside expert--place a realistic valuation on your company's stock. "The key to raising money, especially the part that comes from the private-equity world, is having an accurate valuation for your company," says Ben Boissevain, managing director of E Technologies Associates LLC, a New York City-based investment-banking boutique. "If you're basing your financing efforts and projections on a business valuation that isn't realistic and well documented--or avoiding the valuation issue entirely--the odds are very strong you're going to fail."

Finally, don't expect fast results. "I've been amazed at how long it's taken," confides Brad Galle, the chief executive of Square Earth Inc., a three-year-old New York City-based developer of Web-site applications that had 1997 revenues of $2 million. Galle had hoped to conclude a round of financing relatively quickly--especially once he won an initial commitment from a bank that was willing to be part of a larger package.

Instead, Square Earth spent more than six months pursuing private-equity deals with individual investors. "There's a tremendous amount of back-and-forthing that you've just got to expect when you're trying to bring all these different parties to the table," Galle explains. In fact, Galle ended up selling his company to a larger industry player instead of concluding the smaller private-equity deals.

Throughout all conversations with potential backers and investors, open communication is essential. "These days, the key to carrying out a layered financing is informing everyone, up front, that you know you need some kind of private-equity investment and some kind of debt, and this is how you're going about trying to raise all that different money, and this is the stage you're at now," says Douglas A. Fineberg, a banking-industry consultant based in North Hampton, N.H. One benefit of that kind of openness, Fineberg emphasizes, is that business owners can often involve prospective lenders or equity investors in weighing various options. "You can go to a banker and say, 'If I raise this much from investors, how much could I borrow and what kind of covenants would you insist on? How could I improve the terms or size of the loan?"

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