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July 14, 2005

Consider the Benefits of Funding Alternatives

By Mark Hendricks

With bank credit and venture capital scarce, alternative financing arrangements look increasingly attractive. Here are some ways that small businesses are finding the money to fuel their operations.

Donna LaVoie didn't ask a bank or a venture capitalist for money to launch her corporate-communications company in the fall of 2001. The Swampscott, Mass., entrepreneur waited until she signed her first client, Emisphere Technologies Inc., in Tarrytown, N.Y. Then she requested upfront payment of a third of her fee. She used the advance to hire her first employee and officially open LaVoie Strategic Communications Group.

"You don't need a bunch of money," Ms. LaVoie says of her start-up financing strategy. "You just need a client."

Her approach is good news for budding businesses at a time when bank credit and venture capital are drying up. According to a February survey by the National Association of Manufacturers, a Washington, D.C., trade group, more than a third of small and medium-size manufacturers reported it was harder to get credit from their banks as compared to last year. And the National Venture Capital Association of Arlington, Va., says the number of companies receiving venture money fell to 3,736 in 2001 from 6,245 in 2000.

In such a climate, alternative financing sources can be far easier to tap than conventional funding, say entrepreneurs who've pursued substitutes for harder-to-obtain bank loans or equity investment. Such sources range from customers and suppliers to corporate lenders and government programs.

When it comes to customer financing in particular, paperwork can be minimal. "We just asked them to pay a third upfront, and they did," Ms. LaVoie reports. But keep in mind that advance payments may be common for professional services but are rarer in other industries.

Why buy when you can lease?

Few people pay upfront for a glass of beer, which kept Kai Adams from employing that tactic to finance Sebago Brewing, a South Portland, Maine, restaurant and brew pub. Mr. Adams and his partners found leasing offered a solution to their capital needs. He was able to lease items including a $30,000 point-of-sale computer system and a $4,000 commercial dishwasher through an equipment-leasing company.

With leasing, says Mr. Adams, "we don't have to lay out all this cash. We just make a monthly payment. And we don't actually own it. They maintain it and if it breaks on a Friday, they come in and fix it. That's great for us."

Leasing does require filling out a detailed application, and lease payments tend to be higher than purchase payments. But avoiding down payments and maintenance hassles attracts companies of all sizes to leasing. And equipment-leasing firms are aggressive in seeking small customers, Mr. Adams reports. "I have companies calling us looking for people [who want] to lease equipment," he says.

Uncle Sam may want you...or at least your ideas.

Small Business Administration-guaranteed loans may be facing funding cutbacks, but S.B.A. loans aren't the only government financing available. Hermosa, S.D., entrepreneur Scott Thompson financed the start-up and growth of RealTronics Corp., a research/development and distribution company, largely through government grants.

While still in college, Mr. Thompson sought venture capital for a high-tech research-and-development enterprise, but was rebuffed. A professor suggested a South Dakota economic-development grant program that offered up to $30,000 for collaborative-development efforts between entrepreneurs and state universities. "That was the first grant proposal that I wrote and it was funded," reports Mr. Thompson. That was in 1992.

Then he learned about Small Business Innovation Research (S.B.I.R.) grants. This federal program provides up to $100,000 to a small business for initial efforts to commercialize technologies of interest to various arms of the government. Second-phase grants can reach $750,000. That got Mr. Thompson's attention and eventually he landed more than $1 million of government money to refine designs for sensor and tracking equipment. "By the end of the year," he adds, "I expect to double that."

S.B.I.R. and the similar Small Business Technology Transfer Program are, however, highly competitive. Mr. Thompson applied 11 times before his first win. You can learn more about S.B.I.R. and S.T.T.R. at www.sba.gov/sbir.

Some suppliers will finance your inventory.

Trade credit from suppliers is one source of working capital that almost all companies, young or old, can employ. Mr. Thompson financed the distribution side of his business for several years by ordering products from office equipment and other suppliers, selling them and collecting payment from customers before he had to pay his vendors.

That kind of bootstrapping can limit growth, however, because suppliers don't like to let new companies get too far in debt. Mr. Thompson kept his distribution operation alive, but couldn't push revenues past $300,000 because venders wouldn't advance more credit.

"I finally expanded by forming shared purchase-order agreements with my suppliers," he says. Under the arrangement, he set up an escrow account to receive payments from his customers. Only the supplier could withdraw funds from the account. The supplier charged a fee for setting up the arrangement, paid itself for goods shipped to Mr. Thompson's customers and sent him a check representing his profit. Despite the higher fees, "this approach enabled me to triple my office-supply revenues," Mr. Thompson reports.

Some companies like a piece of the action.

Financing also can come from deep-pocket corporations. Alisa Nessler got $12 million in venture capital last December for her two-year-old Austin, Texas, company, Lane 15 Software. Three of the eight investors weren't venture-capital firms, however; they were investing arms of Dell Computer Corp., Intel Corp. and Quanta Computer Inc., a Taiwanese computer maker.

While some corporate venture capitalists have hit hard times just as conventional venture capitalists have, corporate investors aren't looking for only financial returns, according to Ms. Nessler. A corporation may invest in a young company to get access to innovative technology or to encourage development of products that it would like to see reach the marketplace. "If they want to enable the infrastructure, one of the ways they do that is through investment," Ms. Nessler explains.

Corporate investors offer more than money, too. Because Intel owns part of it, Lane 15's software engineers, who are working on next-generation data-network-management tools, get early looks at microprocessor designs. There's also the hope that its big investors may turn into big buyers of Lane 15 products. "Traditional VCs aren't going to give me early access to Intel silicon," Ms. Nessler says. "And they aren't necessarily going to be able to provide introductions to the product groups in these companies."

Article from WSJ Startup Journal. Written by Mark Henricks

Posted by dspringer at July 14, 2005 10:50 PM