Co-sponsored by Upsize and Club E, drew a record crowd to the Minneapolis Club in May, proving the adage that capital is king for every kind of business owner. We interviewed many of the panelists in advance and present excerpts from their answers here, including what kind of entrepreneur is best suited for which type of capital, as well as what drawbacks owners should guard against.
BANK LOANS
Melissa Johnston, Highland Bank
1. Briefly describe your finance topic.
I will focus on conventional loans. Small- to medium-sized businesses with one to 50 employees with revenue between $1 million up to $25 million is kind of our main target lending area. Our legal lending limit is $10 million and my loan sizes average between a million and five million.
We do some startups. Half of those startups are franchises which makes it easier because they’ve proven themselves as a brand. We do a fair amount of business acquisition loans, which is considered a startup.
2. What can a business owner do to gain this type of financing?
For an existing business, the last two out of the three years you have to have positive cash flow, or we can’t do the loan. It’s an underwriting requirement. We need to know about the risks in your business. You can’t tell me this is a no-brainer. You would be amazed how many times I hear that. That is not going to work.
What actually impresses me is they know what the risks are, they share them with me and they explain this is how I’m going to mitigate the risk. Often times it’s the lack of collateral that’s a problem.
People don’t understand that the stock in their company has no value to us. We’re looking at cash flow, some equipment, accounts receivable, what’s your collateral position. And then why is the debt needed?
I get too many people who say I need $100,000 and they say it’s for working capital, and I say what is it for? What is the actual need? Explain to me why the debt is needed and what it will do for your company.
In terms of startups we really rely on your business plan. Cash is instrumental in a startup. You have to plan for cutting your revenue in half and doubling your expenses and determine, are we still going to have enough cash? I mean you know all about that as the co-founder of Upsize.
And do you have access to liquidity? And then your business experience, so if you were an executive at a company and you were a visionary and you had 250 employees, and now you are starting a business and you have to do everything yourself.
If you don’t have the skill set, we need to know how are you going to do it? But if you have already run a smaller company, you have owned another business, and then you’re doing a startup , it’s much easier to hear the story and lend on that, because starting a business is so different from a cushy corporate job.
3. What is a potential drawback of this type of financing?
From 2008 to 2011 banks were either not lending or reverse lending. In 2012 and 2013 it was getting better. Now in 2015 and 2016, we’re much more lenient in terms of banking. A lot of banks are getting really aggressive again.
The drawback of this type of financing, is if a bank is following what the FDIC wants us to do, with the monitoring and covenants and eligibility requirements—even if we like you, we have very specific param- eters that we have to follow.
Although we don’t have the control like a venture capitalist would, we still have specific items in our loan documents that are compliance-related. You have to perform and continue on the path that we signed up for.
Melissa Johnston, Highland Bank:
952.858.4798; melissa.johnston@highlandbanks.com; www.highlandbanks.com
ACCOUNTS RECEIVABLE FINANCING
Cathy Sedacca, Sage Business Credit
1. Briefly describe your finance topic.
Typically you would hear it called asset-based lending, and that’s really working capital for companies that don’t cash flow, they’re highly leveraged, they have a history of losses.
The amount of working capital available is in direct proportion to the business assets, such as accounts receivable, real estate, inventory, etc. If the company doesn’t cash flow well, the bank may not be able to help them, so this is an alternative.
There are different types of asset based lenders that specialize in different niches. Our firm has a couple dozen clients in our portfolio that range from manufacturing to service, some distributors. Some are as small as $50,000 lines of credit up to $4 million.
Asset-based lending is more prevalent than people realize. A lot of people have not heard about it until there is a need, and usually they find out about it through their banker.
Everybody wants to go to a bank for a loan, and when you find out you can’t get that, then the banker will refer you to an asset-based lender, assuming you have assets to lend on. These are companies considered high risk by a bank.
And like anything high risk it’s more expensive, but it’s not equity. Fees can be anywhere from 8 to 10 percent up to credit card rates or beyond. There is no regulation in this industry so it’s a wide range.
2. What can a business owner do to gain this type of financing?
That’s kind of a tough question, because they’re not usually actively trying to be an asset-based client. This is usually a default or plan B. The lender is going to need to understand the deal you made with your customer: whether you delivered, how you delivered, when.
They’re going to want to understand your inventory, so good inventory reporting is important. They’re going to want to know book value of your assets. So, being prepared that they’re going to ask different questions than your banker has asked.
It will be less about the cash flow, but more on the specifics of assets. In some cases they’ll send somebody to your location and spend a couple of days or maybe a week digging in. Obviously if you’re seeking to borrow based on equipment, they may require that you have an appraisal done.
3. What is a potential drawback of this type of financing?
Some companies will do ongoing collat- eral exams, maybe quarterly. They usually cost the business owner. Also it’s time. So that’s something to know: will there be quarterly exams?
What is the cost? Usually there is a daily rate, like $800 to $1,000 a day. So typically a collateral exam will be a couple of days. We do a lot of participations with banks. Sometimes we bring in an investor to take a piece to make it happen.
Sometimes people don’t like the stigma of being with a finance company; they think it means they’re failing or weak, but really the biggest fear we encounter is how do we get out of this contract some day.
Understanding all the fees and contract terms is important, because it’s an unregulated industry so everybody can run it the way they want to. Get a referral from a banker or attorney that you trust. There are a lot of positives working with an asset-based lender, such as more
flexibility, but you have to know what you’re getting into.
Cathy Sedacca,
Sage Business Credit: 952.314.7072; csedacca@sagebusinesscredit.com; www.sagebusinesscredit.com
ECONOMIC DEVELOPMENT
Justin Erickson,
Essex Capital
1. Briefly describe your finance topic
I focus on economic development-related incentives, which include local, regional, state and federal grant programs, forgivable debt programs, non-bank lending programs and tax and other cost-mitigation incentives.
These incentives/cash programs are often underutilized or worse, not pursued at all, as companies are unaware they exist or do not know how to pursue them. Most any business can participate from early stage companies to seasoned, 8-figure businesses, though retail and service-related firms are tougher to qualify.
For most any company who is looking to expand operations – equipment, facility and/or labor – or who is open to / actively looking to expand into a new location/state, these incentives/cash programs apply.
We can put together $50,000 incentives or we can put together $7.5 million. We look at a couple of things to value the project, and it’s not the typical thing the investor looks at or a bank looks at. With this crowd the return is the impact on the community. So we look at: what is the job creation impact; what is the tax creation impact.
2. What can a business owner do to gain this type of financing?
No. 1, ask for help. Unlike finding equity/ investors or traditional bank lending, most companies have limited – if any – experience in exploring public cash incentives. As such, most, understandably, do not know what to ask for or who to reach out to.
I used to explain there are two options. You either go to the bank and plead, or you go out to get investors and give up equity and wonder why you started your business in the first place. Or you can go after these grants. The question is where do you begin?
If you want to get a loan, plenty of banks advertise. If you want investors there are all sorts of networking events. But where are the forums and the groups that are doing economic development? I find a lot of companies have misconceptions,
No. 2, understand what is important to the groups providing this financing – most are not looking for ROI the way an investor would, nor are they exclusively focused on collateral and risk mitigation the way a bank would be.
They are interested in the growth of the business – job creation, infrastructure (facility, leasehold improvement, capital investment, etc.) and the impact through tax revenue.
3. What is a potential drawback of this type of financing?
Setting an expectation around X number of jobs created or other milestones they may not hit. There can be clawback provisions on some programs and, in general, it’s simply another expectation a company has set with someone who is providing financing to them.
I find sometimes people say it never occurred to me that there would be clawback provisions or the like. The reason investors want to control your company is because they’re the least protected.
I see people get a forgivable loan, then things don’t go as planned, and I suppose by definition that’s life. I will admit you can renegotiate loans. It’s rare that I see companies sitting in court mediation because that’s not people’s intention on the economic development side. It’s usually if there’s something more nefarious.
You have to get the right fit and see what incentive programs apply to you. It takes a little bit of time, and then you enter into a formal contract. And it spells out clearly the terms and hopefully you and your attorney know what you’re getting into.
Justin Erickson, Essex Capital, Community Venture Network: 612.281.4648; justin@essexllc.net; www. communityventurenetwork.com.
FEDERAL RESEARCH GRANTS
Pat Dillon, MN-SBIR
1. Briefly describe your finance topic.
To small high-tech firms we offer non- dilutive federal funding through government research grants and contracts.
So every year there are $2.5 billion available through the federal Small Business Innovation Research program, so small businesses that are interested in competing for those dollars have to submit research proposals, and about 20 per- cent of the companies that submit proposals are awarded.
So in Minnesota, it’s all very fluid but we have about $25- to $30 million a year that companies are winning. It’s a very, very competitive program and a tremendous amount of focus and recognition given to the commercialization of the technology. It’s really about early stage high tech startups and taking a technology and getting it commercialized.
So having a very clear value proposition, who’s your customer, what’s your intellectual property position.
2. What can business owners do to gain this type of financing?
They have to look at this source of funding as something that augments what they’re currently doing, and use it to help develop an innovative idea or project that has commercial potential.
The keys are: to have a strategy to do that, and to be patient and persistent and tenacious, and to form re- search partnerships with academics or other businesses, where it’s important to have that collaboration.
To get into the 20 percent that get awarded: I like to think if they work with the Minnesota SBIR they’ll have more of a chance to be successful.
3. What is a potential drawback of this type of financing?
The major drawback is the timing, and sometimes the nature of their business or the nature of the project doesn’t always lend itself to the process. The time it takes plus how long it takes the federal agencies to do the review and make their selections, and then the competitiveness of the program.
Four to six months it takes to select. A lot of academics are used to that timeline, but a lot of small businesses are new to this type of activity. To start with this program and move along this continuum, it takes maybe 3 to 5 years.
Pat Dillon, MN-SBIR, Metropolitan Economic Development Association: 612.259.6561; pdillon@meda.net; www.meda.net.
GROWTH CAPITAL
Keith Bares,
Convergent Capital
1. Briefly describe your finance topic.
We formed Convergent Capital 18 years ago now. We’re called an SBIC, a small business investment company, so we have to invest in small businesses. Small businesses by the U.S. Small Business Administration’s definition is equity up to $18 million, and up to $6 million of net income average over the last two years.
The SBIC program was start- ed in 1958. Basically, Congress at the time said the way to grow jobs in the U.S. was to get capital to small businesses, but we don’t know how to do it ourselves.
So they decided to license groups of people like us, and we raised money through investors, banks, family offices, and then we can sell through SBA two times that amount in leverage. It’s about the only program in U.S. government that doesn’t cost taxpayers a penny.
We’re kind of a regulated entity like a bank. The last 10-year money we got was at 2.507 percent, so a very nice rate. Plus we amortize another 1 percent of it for those additional fees. We’re on our third fund, this fund with our leverage is about $160 million. Over the 18 years, we’ve invested in about $300 million in about 75 companies all over the country.
The second type is recapitalizations. So one owner wants to buy out another owner, the management team wants to buy out the owner, we’ll work with them. We’ll put in equity, they’ll put in equity, and we’ll add debt , and we’ll buy companies together, and we’ll take a very minority position.
Example: An IT services company needed $5 million more to finish a management buyout, because they’re up to $13 million in cash flow now, but then we’ll have a warrant.
Third: We work with private equity funds. They’ll buy a company, they’ll put in equity, we’ll put in subordinated debt. Other times we’ll put in some equity too.
2. What can a business owner do to gain this type of financing?
Our companies generally need to be at least $10 million in revenue, and a million and a half or $2 million in positive cash flow. There are about eight SBICs in town here, and almost all of us deal nationally.
It’s really going to be about the sustainability of cash flow. How did they do through the recession? It’s a good management team, it’s a good industry, those kinds of things that everybody looks for.
Recurring revenue is especially great. Good financial statements are really a key. If it’s just internal Quickbooks financials, it doesn’t mean we wouldn’t look at it, but having at least reviewed or compiled financial statements is good and obviously audits are even better.
3. What is a potential drawback of this type of financing?
It really should be a growing company because the capital is not inexpensive, and it’s only part of your capital structure. So you have to make sure with your blended capital that you’re going to earn a rate of return higher than that on your business.
Other- wise it doesn’t make sense to take down 15 percent capital and you’re only going to make 5 percent on your business. We’re going to look over their shoulders and make sure they’re doing the right things. There’re institutional requirements, so owners have to run the company more professionally, which is usually a good thing.
Keith Bares, Convergent Capital: 612.800.6481; kbares@cvcap.com; www.cvcap.com.
CROWD- FUNDING
Zach Robins,
Winthrop & Weinstine
1. Briefly describe your finance topic.
This topic is very fresh; so fresh that when we had our panel on Thursday, May 19, regulation crowdfunding, the federal rules, were only three days old. In short, regulation crowdfunding is the last piece of the JOBS Act, which was passed in 2012.
The JOBS Act was passed by Congress in response to small businesses having a challenging time to access capital, be that bank debt or equity investment. The consensus was the SEC laws of the early 1930s were outdated.
One of the more meaningful parts was Title 3, which has the moniker of regulation crowd- funding. It’s the answer to the question: hey, why can’t just anyone invest in something online. And it was an answer to Kickstarter, which provided benefit to the companies but not the investors.
It’s intended for smaller businesses or startup businesses which are seeking to raise capital. There’s a state component called MNvest which will go live within the next month as well. It’s suited for those businesses that struggle to find venture capital, private equity investors and/or are not bankable.
Big companies have very large balance sheets, and they can get the deals done, but if you’re a smaller developer and have an amazing building and the support from the community, but don’t have a balance sheet, you can go to the crowd. The sweet spot is probably half a million dollars in terms of minimum to raise.
2. What can a business owner do to gain this type of financing?
Obviously you have to have a strong business plan and a strong team, but to take it one step further, those companies who really understand in this new era of social media that your offering is no different than marketing your products to consumers.
You need to have a very strong marketing/PR/advertising plan, and the right types of partners that can help you get the eyeballs from prospective investors. Build a strong team; build a strong business plan; produce a comprehensive marketing, advertising and public relations plan.
3. What is a potential drawback of the type of financing?
The first thing I want business owners to be aware of is that this, not unlike the capital it takes to launch any business, is costly. There are obviously legal fees, there are accounting fees, there are fees for portal opera- tors or other websites that will host your offering online; there are fees for marketing, advertising.
I’d say all in it would be challenging to do it for less than $30,000. It may not be any more than a typical capital raise, but I say this because a lot of people who are jumping into crowdfunding have never done a capital raise before.
Crowdfunding is not the most ideal method of raising capital. If you can raise money from an angel investor, you’re probably going to be better off doing so. It’s an old cliché, but the devil is in the details here.
Most crowdfunding rounds I work on, the investors have little to no voting rights. If I’m an institutional investor, it would be tremendously foolish to outright disregard all companies that have had a crowdfunding round. To counter that, the advantage of crowdfunding is it’s really about having brand ambassadors.
So you can see how consumer-facing businesses can take off by having the right types of investors who are also consumers, because they have a vested interest in seeing the company succeed.
I’m very excited generally about the larger landscape of entrepreneurs having a whole set of tools to now work with. I say that because there is no one silver bullet. What I get excited about is companies now get access to all different capital types.
Zachary Robins, Winthrop & Weinstine; 612.604.6487;
zrobins@winthrop.com; www.winthrop.com.
SBA / COMMERCIAL LOANS
Patrick Grinde,
Strategic Business Group
1. Briefly describe your finance topic.
We are speaking on two topics. One is start-up or growth financing using the U.S. Small Business Administration loan guarantee program. This is a loan program that is often used by franchise business owners to finance their first, second or third location.
You may know that a commercial lender (bank or credit union that participates in the SBA program) accepts the borrower’s business plan and then determines if that business plan appears to be credit-worthy.
If the lender determines the loan is credit-worthy it requires the business owner to invest 15 to 25 percent of the total business loan request in cash. The lender gets a loan guarantee of up to 75 percent of the loan. Thus the lender’s risk of a loan loss is reduced to 25 percent.
The other business loan is known as a commercial uninsured loan, meaning the SBA is not providing any loan guarantee. This loan is more difficult to obtain as the lender’s loan loss is 100 percent; often the collateral securing the loan is either gone (sold to customers) or has little or no economic value. This means the borrower needs to have a strong balance sheet (liquid assets or solid equity in fixed assets) to qualify.
2. What can a business owner do to gain this type of financing?
Three items:
1. Have a realistic business plan. Do market research on similar companies. The Internet can be very useful to find basic general information on types of businesses and their sales, expenses and profit ranges.
2. Research the area in which they plan to locate their business. Does that area have good traffic flow (numbers and ease of entry and exit to your planned location), are there compatible businesses that are nearby so that each can “feed” business to the others (that’s why malls are successful).
3. Can you and your family live on a reduced salary of $2,500 to $3,000 per month plus income from a spouse or other fixed income? What is a potential drawback of this type of financing?
The number one thing is to NOT be sure that he/she will make a fortune. Do their research and find out what typi- cal sales, expenses and profits are. Go a public library and ask to see RMA (Risk Management Association) book that gives thousands of businesses listed by standard industrial code showing ranges of income and expenses. It’s an excellent source and what lenders use to compare a prospective borrower’s financial statements, too.
Patrick Grinde and Denny Campbell, The Strategic Business Group:
651.686.7847; pgrinde@strategicbusinessgroup.com; dcampbell@ strategicbusinessgroup.com; www.strategicbusinessgroup.com.
VENDORS
Steve Wardleworth,
Wardleworth Consulting
1. Briefly describe your finance topic.
My process is driven to reduce the capital already in use in the business through changes in relationships with suppliers. This is achieved by active management of inventory ownership, inventory levels, negotiations and terms. The best suited company for this process is one that holds inventory and where that inventory is a large part of their assets.
2. What can a business owner do to gain this type of financing?
Get involved with actions to actively manage inventory levels. Understand the tools that can be used to build a Vendor Managed Inventory program. Don’t allow clerical staff to manage a large cash content asset on their balance sheet.
3. What is a potential drawback of this type of financing?
Potentially giving up a point or two in gross margins for an improved cash position.
Steve Wardleworth, Wardleworth Consulting: 763.221.3399; stevewardleworth@gmail.com; www.wardleworthconsulting.com.
