How to Successfully Capitalize a Small Business : Financing: Irvine seminar aimed at struggling entrepreneurs will detail the many options for raising cash when the banks balk.
In hard times, a cash-starved small business often gets nowhere with its local bank. But experts say struggling entrepreneurs may have more cash-raising options than they realize.
“There are now many, many different ways of financing a company,” said Tiffany Meyer Haugen, director of a small-business development program at the UCI Graduate School of Management. “The more you know about the options, the greater the chance you will pick a financing tool that’s right for your company.”
That will be the topic of a seminar today sponsored by Cruttenden & Co., an Irvine brokerage. Also participating in the “Meet the Money” conference, which is designed to help companies pick financing options, are accounting firm Ernst & Young; Sutro & Co. and Robertson Stephens & Co., two San Francisco investment banks; Foothill Capital Corp., a Los Angeles lender; and Riordan & McKinzie, a law firm.
While banks have historically been the source of capital for small, rapidly growing businesses, the current banking crisis has reduced the amount of money for new loans, especially for start-up ventures. Aggressive bank examiners and nervous lending officers have put a chill on most small-business loans.
A June survey of the members of National Small Business United, the nation’s second-largest organization of small-business owners, found that 68% of small and mid-size businesses had problems obtaining loans during the preceding 12 months, compared to 52% during the previous year. Because of a cash shortage, 39% of the companies were unable to expand operations, and nearly 20% were forced to lay off workers, the survey found. The situation is even worse for start-up companies, with 58% of new ventures reporting an inability to meet capital needs in the 12 months preceding the survey.
But as conventional money sources dry up, other financing techniques are filling the gaps, experts say. They advise start-up and emerging growth companies in Orange County and elsewhere to look to other arenas: special venture-capital funds, so-called “business angels,” friends and family members, federal grants, public stock offerings, debt and private placements.
For someone busy running a business, however, getting financing is not the only challenge; equally tough is figuring out what capital options are available, then choosing among them. Deciding where to go for venture capital--hooking up with a wealthy investor, forming a strategic partnership, selling debt or going public--can be the most important decision a company makes.
“There’s nothing sadder than seeing a company spending a lot of time trying to raise money from the wrong source, such as a biotech company trying to get money from a venture-capital firm that doesn’t lend to biotech,” said James W. Loss, a managing partner with Riordan & McKinzie, a Costa Mesa law firm. “I think the market for capital is getting much, much tougher and increasingly complex because there are so many options available.”
The National Small Business survey found that fewer than half of small businesses--defined as those having fewer than 20 employees--relied on bank loans for capital, with 24% opting for private loans and 17% choosing credit cards to meet their financing needs.
Whatever the option, experts say, it is important for entrepreneurs to determine which financing technique will cost a growing business as little as possible.
“No one gives you free money. They want control, and they want to make a lot of money off you,” Haugen of UCI said. “Sometimes we run into entrepreneurs who don’t know the difference between equity and debt.”
Venture Capital
This a major source of financing for start-up companies that entail risk but may provide big profits later. In return for their investment, venture capitalists are usually awarded some combination of stock, profits or royalties on sales.
But financing experts say companies should be aware that venture capital funds are more cautious now than during the mid-1980s.
David Berkus, president of Berkus Technology Ventures in Arcadia, said that, because of some consolidation in the venture-capital industry during the past few years, new funds like his have formed. His small, $2-million “resource capital” fund targets high-tech companies and will take an active role in a business’ development.
“A resource capitalist is positioned to give more than money. We can provide seasoned experts in the industry and valuable contacts to the company,” Berkus said.
Other venture capitalists, however, argue that they, too, are looking at start-up companies and often work closely with a new venture.
“We’ve even looked at business plans from a few guys that don’t even have an office yet,” said G. Bradford Jones, general partner with Brentwood Associates, a Los Angeles-based venture-capital fund with $450 million under management. The fund, which usually takes a $1-million to $3-million equity stake in a company, specializes in emerging high-tech concerns, specifically in electronics and health care.
Business Angels
If a company has exhausted the possibilities in the venture-capital market, it might turn to an informal network made up of wealthy individuals called “business angels.”
The problem for a company is how to find those wealthy investors. As attorney James W. Loss with the law firm Riordan & McKinzie in Costa Mesa put it: “You can’t just look up these angels in a book.”
An SBA study done in the late ‘80s found that an estimated $86 billion is available nationally to start-up business, about 10 times the amount in the formal venture-capital market, said Tiffany Meyer Haugen of UCI’s Graduate School of Management.
While some of this money is never matched with a company, Haugen said, UCI has a confidential computer service that will match up start-up entrepreneurs with wealthy investors.
Another financing tool often overlooked is federal grant money.
Haugen said more than $1 billion each year is available through Small Business Innovative Research Grants, which provide $75,000 to $750,000 apiece.
“There is a lot of federal grant money out there if you know how to tap into it,” she said. “A lot of people don’t know about this, and it’s free money.”
Going Public
Start-up companies can also turn to Wall Street to cash in on the investor demand for so-called small cap stocks--shares of small, typically fast-growing companies.
Though it is not for all companies, especially start-ups, it can be an option for businesses with strong balance sheets if management doesn’t mind losing some company control.
Finding the right investment bankers and knowing whom to trust is the hard part for many entrepreneurs, who may be scientists or computer experts but not financiers.
“When a business is looking to raise money for growth, it is very difficult for them. They are running their business on a day-to-day basis, not running all over Wall Street,” said Byron Rothe, managing director of corporate finance for brokerage Cruttenden & Co. in Irvine.
According to Securities Data Co., a New Jersey research firm, five Orange County companies went public during the first half of this year. That compares to six during the same period in 1992. The five this year are CoCensys of Irvine; Music Source USA, Newport Beach; St. John Knits Inc., Irvine; Pacific Sunwear of California, Santa Ana; and McGaw Inc. in Irvine.
Another way for small companies to sell equity is through the Small Corporate Offering Registration program, which operates in several states, including California. Through SCOR, a California company can sell as much as $1 million in stock. The company fills out simplified and less-costly registration filings than for a typical national stock offering.
The Pacific Stock Exchange recently received tentative approval from the U.S. Securities and Exchange Commission to allow it to list SCOR securities, which could give added liquidity to the market. After a 45-day comment period, the SEC is expected to give final approval, and the PSE could start listing the securities early next year, said Dale Carlson, spokesman for the stock exchange.
