How to find under $1 million - financing small businesses

Nation's Business, Nov, 1987 by Roger Thompson

How To Find Under $1 Million

Two hundred and fifteen bankers did something out of the ordinary last spring. They gathered for a two-day conference in St. Louis to learn how to improve loan and other services to small companies--the first such event ever sponsored by the American Bankers Association.

"This [small business] is where the new business is coming from, where the new jobs are being created and where some of the most profitable [banking] relationships come from,' says Deryl K. Schuster, vice president of the ABA's small-business committee and chief executive officer of the First National Bank of Liberal, Kan. The conference was such a success that it may become an annual event.

Says Mary Oliverio-Sansone, vice president for commercial banking with Bank of America in San Francisco: "It seems to be in vogue these days for banks to be going after small business.'

Even so, many entrepreneurs still go begging for start-up and expansion money for a variety of reasons, such as insufficient equity, collateral or cash flow. For this group, there is new hope on a couple of fronts.

First, venture-capital hot lines in 11 states are making it easier for entrepreneurs to link up with wealthy individuals interested in sinking money into new businesses (see box, Page 18). William E. Wetzel, Jr., the University of New Hampshire professor who has pioneered research in so-called business angels, estimates that they privately pump upward of $5 billion a year into 15,000 to 20,000 small companies.

Second, states have jumped aboard the small-business bandwagon with an array of programs to promote economic development. "Small-business financing programs of various types are the hottest area in state economic development,' says Miles Friedman, executive director of the National Association of State Development Agencies in Washington. More than half now offer some sort of venture-capital and loan-guarantee programs.

What does all this mean for small businesses in search of a cash infusion? Certainly not that the people with money are giving it away. It has always been tough for small firms to find debt and equity financing, and it remains so largely because small business is very risky business. Dun & Bradstreet Corporation, a major marketer of business information, reports that 61,232 businesses failed last year, most of them small.

Not surprisingly, the people who control the purse strings aren't going to loosen them for just any small-business owner who walks in the door. In fact, start-ups typically go without bank or investor backing. They rely instead on the owners' savings and money scraped together from friends and relatives.

Sooner or later, however, almost every small business that has survived the critical start-up period needs additional capital to establish itself more securely. The founders try to borrow money or latch onto investors willing to buy into the company. The vast majority seek less than a million dollars. In fact, sums less than $1 million may be the toughest money to come by. Often the company has been successful enough to generate additional financing needs but has not yet acquired the assets, expectations and good will of a more established firm.

Even so, many banks apparently are trying harder than ever to accommodate these special demands because it makes good business sense. "I think it is easier now for small businesses to borrow,' says Joseph A. Campanella, director of the corporate-finance department of the Koptis Organization, a Cleveland business-consulting firm. "What a lot of the commercial-banking community is discovering is that there is growth to be found in privately held companies.'

The question for small-business owners is how to cash in on new financing opportunities. The nearly universal response they hear from bankers, consultants and business owners alike echoes the Boy Scout motto: Be prepared.

The chief problem, says Campanella, is that most business owners do not know how to ask for a loan. "Probably 70 percent of all the business owners who walk in to see a loan officer are unprepared,' he says. Before you reach that stage, you should have developed a strategy for obtaining the loan you want. Here are some key components of a successful strategy:

Determine The Type of Financing. Start by figuring what kind of financing your business needs: debt or equity. Borrowing money may drain a substantial portion of your firm's income into debt repayment. But small businesses typically prefer debt financing because it does not diminish the owner's control. And the tax structure treats debt favorably by allowing interest paid for a loan to be deducted as a valid business expense.

Equity financing--selling pieces of your company to investors--does not burden the books with loan repayments, but it does diminish your stake in the business.

Project Growth. After deciding on the type of financing, project your company's growth over the next 12 to 24 months. "Most bankers want to see a solid operating plan spelling out in detail how you will use the funds, what markets you are in, what the management is like, what the results of the loan are likely to be and the strengths and weaknesses of the firm,' says Daniel Morris, president of Morris Anderson Associates, a Glenview, Ill., management-consulting firm.