For small business owners, these are tough times to be seeking capital. Faced with the triple threat of recession, weakness in the banking system and the fear of prolonged combat, financing sources are closing the spigots on loans and investments, forcing many companies to face the harsh reality of a capital drought.
But as difficult as the picture appears to be, it is not without hope. By applying creativity to the financing process, entrepreneurs can secure sufficient capital to assure liquidity or to fuel growth.
"One approach is to allow key employees to buy into the business," says Andrew Sherman, an attorney specializing in corporate financing for the Washington law firm of Silver, Freedman & Taff. "It works this way: In return for a cash investment, senior employees are offered shares of the company's stock. Although this means employees will have equity in the business, they need not gain voting rights. By issuing a special class of stock, management can deny voting rights to the new shareholders.
"Allowing employees to buy equity in this way accomplishes dual objectives: It gives key employees a stake in the business, thus increasing their motivation to grow the company, and it provides capital that may not be available from traditional sources."
Consider these additional money-raising strategies:
* Explore asset-based loans. With this type of financing, lenders base their financing commitments on a percentage on the value of assets used to collateralize the loans. These assets can include real estate, inventory, plant, equipment and receivables. Because asset-based loans involve minimal risk, lenders are more apt to flash the green light.
"But many companies complain that they don't have the assets to collateralize loans," Sherman says. "Here again, creativity can overcome an apparent obstacle. This is done by having a third party -- perhaps an employee that wants to buy into the business -- pledge an asset of his own in return for equity in the company. In a hypothetical example, assume your general manager pledges his vacation home as collateral for your asset-based loan. As compensation for this, he gains 5 percent of your company's stock. This helps secure financing for your business and simultaneously gives your key employee the wherewithal to invest in the company."
* Turn the tables on a key customer by selling him a stake in your business. If the customer considers your product or service to be indispensable, he may be willing to engage in some form of creative financing.
In one viable approach, a major customer prepays for a year's supply of your product or service, viewing this commitment as a way of insuring your company's continued viability. In return, you agree to keep the prices you charge that customer at current levels even if the deliveries will be made throughout the financing period.
"Similar arrangements can be struck with suppliers," Sherman says. "When a company in the home improvement business needed capital to expand into new markets, management struck a deal with a key supplier providing for a $50,000 loan and consulting services. This was viewed as an interim step designed to tide the company over until it could secure a $500,000 capital investment it was seeking.
"Under the terms of the agreement, if the home improvement firm was successful in obtaining the capital infusion, the supplier would be repaid for the interim loan plus accrued consulting fees, or it could apply these sums to purchasing equity in the company under the same terms as the prime investor."
* Make a pitch to a venture capital club. A network of clubs structured to bring together entrepreneurs and venture capitalists have sprung up nationwide. Most have monthly meetings allowing those in search of capital to present their plans to the money men in attendance. The idea is to make the kind of connections that can generate investment capital.
"People attending club meetings have secured sums ranging from seed capital investments of $10,000 to more than $1 million," says Carroll Greathouse, president of the Stamford, Conn.-based International Association of Venture Capital Clubs. "Those that are most successful are capable of presenting the gist of their concept in an appealing manner within the short time period allowed. Interested parties then meet with them on a one-on-one basis to pursue the idea further."
The association's Directory of Venture Clubs is available for $9.95 by writing to P.O. Box 1333, Stamford, Conn. 06904.