How to find under $1 million - financing small businesses

Nation's Business, Nov, 1987 by Roger Thompson

Those who don't fall victim to "banker's mystique,' says Rennhoff, stand a far greater chance of getting the money they need, and on the most favorable terms (see box, Page 20).

Rejection, however, isn't necessarily the end of the line. There are other approaches. One of them is equity for services, in which an entrepreneur swaps pieces of a company for the services needed to get it into operation.

Al Behar went that route after failing to obtain a bank loan for the company he started 3 1/2 years ago in Herndon, Va. He started Health Innovations, Inc., to develop and market a high-tech device called LifeSign that he says will help people who want to stop smoking.

LifeSign paces smokers through a gradual withdrawal program. The device registers their smoking patterns and then calculates a withdrawal schedule. During withdrawal, smokers are permitted to light up only when the device sounds a tone and displays a "do smoke' sign.

Behar, an engineer by training, isn't surprised that banks have turned him down. When he launched his company, he had only an idea and no experience in marketing consumer products. After a prolonged research-and-development phase, aided by a grant from the National Institute of Drug Abuse, LifeSign hit the market last spring. Behar plans to take it national as quickly as possible.

Like most entrepreneurs, Behar initially used his own savings, then tapped friends and colleagues for an additional $145,000. But the real secret to his ability to operate on a financial shoestring during his start-up phase lies in equity-for-services swaps.

People who believed in Behar's idea offered their services in exchange for stock in the company. The engineers who developed LifeSign and the firms that manufacture and promote it all did so in exchange for shares of the company.

Says Behar: "If you can't get people to invest services in exchange for equity, you should give up, because you don't have a product that is marketable.' So far, he has swapped $1.4 million in stock for services, about one third of the company's value.

Once LifeSign hit the market, Behar was able to attract a $350,000 infusion from a Washington venture-capital firm. He's even optimistic about a bank loan "once we have established a solid cash flow.'

Rejection for a conventional business loan can also be turned to something of an advantage by some small firms. Two rejections in cities of 200,000 or more, and just one in smaller ones, make you eligible to apply for a loan guaranteed by the Small Business Administration --a lender of last resort. The loans are handled by banks, but guaranteed by the SBA for up to $500,000 or 85 percent of the principal.

The interest rate is capped at 2 3/4 percentage points above the prime rate. The guarantee means the bank gets its money from the SBA if the business defaults. This makes it possible for loan officers to apply somewhat relaxed standards in evaluating a guaranteed-loan application.

The SBA backed 16,766 loans last year for a total of $2.1 billion. The agency was authorized to guarantee $2.4 billion in loans in the fiscal year that ended September 30, and an equivalent amount has been requested in the fiscal 1988 federal budget.