How to find under $1 million - financing small businesses

Nation's Business, Nov, 1987 by Roger Thompson

Some 500 small-business-investment companies offer another government-assisted source of financing. SBICs are privately run but have access to federal funds by pledging to offer long-term debt or equity financing only to small businesses. Minority enterprise small-business investment companies [MESBICs] specialize in assisting socially and economically disadvantaged entrepreneurs.

The average size of an SBIC investment is $180,000, according to the National Association of Small Business Investment Companies (see box, Page 16). A number of SBICs are subsidiaries of banks.

Russell Smith, president of Action Auto Rental, Inc., of Solon, Ohio, says he didn't know his bank had an SBIC until he and three partners went looking for funds to start their firm three years ago. They managed to land a $1 million stock purchase from the bank's SBIC. Today the company has 330 employees and after-tax profits of over $2 million. It works with auto-insurance companies to provide temporary rental replacements for damaged cars undergoing repairs.

No amount of planning and patient searching for the right banker will produce the loan you need if you don't have enough of your own money sunk in the business. As a rule of thumb, expect to supply about half the funds needed for a start-up. If you don't have sufficient equity, you need to find investors who will kick in the required amount. This is where business angels come in.

Angels comprise the most elusive source of major investment in American business. Finding them is largely a matter of having the right contacts. Wetzel's research indicates that they typically are people with net worths of more than $1 million and annual in-comes over $100,000. Most are self-made. By his rough calculations, about 250,000 of the nation's most affluent individuals fit this category. They control a venture-capital pool of between $25 billion and $50 billion--about twice the amount managed by professional venture-capital firms.

"The typical firm financed by angels raises [a total of] about $250,000 from three or more investors,' says Wetzel. "The typical investor provides between $25,000 and $50,000 per firm, about half in the form of equity and half in loans and loan guarantees.'

By contrast, roughly 600 professional venture-capital firms raised about $4.5 billion for investment in 1986. The typical deal involves an investment of more than $1 million, holding the total number of transactions each year to less than 2,000.

Howard Nifong, vice president of Appalachian Technologies Corporation in Charlotte, N.C., and his two partners unsuccessfully approached nine venture-capital groups before turning to angels. The trio left a high-tech outfit to start their own manufacturing company last year.

Nifong, who formerly worked for a Big Eight accounting firm, used his business contacts and referrals from friends to tap 14 well-heeled individuals for a total of $750,000. In exchange, the investors got a 25 percent stake in the company. "It wasn't a hard sell,' says Nifong. "We were asking a minimum investment of $30,000 and succeeded on one out of four calls. One investor sent us to four or five of his friends.'