by Kenneth H. Marks
Many companies experienced tough business conditions throughout 2008 and 2009. Some may have had losses or diminished revenues with minimal profits resulting in a weaker balance sheet. Many firms trimmed costs and become more efficient, but are now ready to rebuild in 2010, yet their bank has likely tightened the reins on available credit. While augmenting a company's capital or equity base might be an option, numerous private and institutional investors have pulled back on funding commitments as they have seen their own sources of liquidity dry up.
Finding the right capital depends on having a solid, well-thought-out strategy and operating plan, and a strong management team. With the fundamentals in place, you can find investors or lenders that align with the type of funding required to implement your strategic initiatives. Here are four sources of capital for emerging growth and middle-market companies that you and your leadership team should consider:
Asset-Based Lenders
There is a wide range of asset-based lenders (ABLs), starting with commercial bank-owned lenders that lightly monitor collateral, to very aggressive loan-to-own privately held financiers. Most likely, the bank ABLs are going to be nearly as tight as their corporate finance counterparts given that they have some of the same regulatory pressures and risk aversion.
Non-bank, non-regulated asset-based lenders are a more likely source-those that can tolerate higher debt leverage ratios and an inconsistent earnings history. They typically provide working capital based on accounts receivable, inventory and in some cases customer contracts or purchase orders.
In the past, some ABLs would tolerate current operating losses on the short-run or even slightly negative cash flow, but not in today's market. Most of these ABLs have credit facilities that are lines of credit with daily or weekly monitoring. There are also hybrid factors that provide working capital in a line of credit type facility, making these less intrusive solutions.
Growth Equity
For initiatives requiring permanent capital, growth equity may be an appropriate alternative for your company. Think of growth equity investors as being at the intersection of venture capital and non-control private equity funds in their appetite for risk balanced with cash flow and control.
Unlike a venture capitalist whose interests extend to start-up or early-stage opportunities, growth equity investors do not make investments expecting many to fail, so their risk tolerance is lower. These investors are looking for operating companies that have revenues, a proven technology or service and proven market demand. In some cases, growth equity investors may be willing to fund a partial recapitalization or minority shareholder buyout.
Mezzanine Capital
Mezzanine funds are similar in their positioning in the world of private equity relative to growth equity. However, their investments are primarily in the form of subordinated debt with an equity kicker (warrants to purchase stock) that allow them to participate in the value growth of the business. As debt they have a defined repayment period to recapture their initial investment (usually four to seven years).
Mezzanine is thought of as a hybrid type of financing providing a lower cost of capital while having some characteristics of equity, given that it is subordinated to any bank or senior debt and that most banks will exclude subordinated debt in the total debt calculation for testing leverage ratios.
Repayment is typically interest only with the principal due at maturity. Keep in mind that mezzanine capital only works if your company is generating positive cash flow, which will likely need to be at least $1 million in EBITDA (earnings before interest, taxes, depreciation and amortization). Typical uses of funds include an acquisition, major new initiatives like product launches or business unit startups, and partner buyouts or recapitalization.
Key Partners
In almost a counter intuitive move, strategic supplier and key partner relationships are providing capital as many companies seek to stabilize revenues and earnings. The capital provided is not usually in the form of direct investment, but rather in the form of providing services, resources or new business on increasingly favorable terms to lock-in or secure sales and margins.
This technique of obtaining working capital may be the most inexpensive and quickest form of fund raising for many companies. Look at your company's customer and supplier relationships to determine who has the most to gain by your success. Then seek creative deals or relationship structures that provide value to both parties while not jeopardizing the opportunity for the company.
You will find that there are no silver bullets in fund raising, especially in difficult times. But it helps to understand the overall financing environment, clearly align your funding needs with the lender or investor and their priorities, and to seek out financing before you actually need it. Proactively manage your capital structure as you would any other aspect of your business.
Kenneth H. Marks is managing partner of High Rock Partners, providing growth-transition leadership, advisory and investment. He is the lead author of The Handbook of Financing Growth published by John Wiley & Sons. Contact him at khmarks@HighRockPartners.com.
