Looking beyond VCs for startup financing

On the Money
From the January 2, 2002 print edition

The ever-critical financial backing small businesses and new ventures rely upon to succeed can originate-despite the ubiquitous “VC” buzz-from an amazingly wide variety of capital-rich sources. Approximately $37 billion is on deposit in Colorado banks today and with diligent effort, planning and presentation; some of that venture backing could be yours.

That’s not to ignore some of Colorado’s VC-funding facts: billions of dollars in start-up and stage-two venture capital have been channeled into Front Range high-technology enterprises, making Colorado fifth in the nation for venture-capital-backed investments. And, despite the potential costs of vc funding-commissions, fees, owner-equity and other forms of reciprocal compensation-84 percent of all Colorado venture capital goes to the high-tech industry.

Cash is a commodity that commands its own price. Cash is the fertilizer that makes any new venture grow. Without the participation of venture capital firms providing this fertilizer, where can the new business owner turn for cash assistance in the early stages of the company’s life? The key words here are cash now, premium, and reward.

Don’t rule out (or forget) your family and friends when searching for investors. If you believe in your venture, and have a good business plan, your close contacts may be an excellent source of funding. However, be prepared to accept investments from your friends professionally. Execute proper promissory notes. You can find these legal forms in most office supply stores or on any number of dozens of web sites like www.uslegalforms.com.

If your company is a corporation, consider issuing stock under the private placement regulations. Do remember however that just because the investor is a relative, you are not exempt from the SEC regulations regarding equity issuance. To get started, first review SEC Regulation D which describes smaller private stock offerings at (www.SEC.gov).

Another very viable, but not often thought of source of capital is the sub-prime lending industry. You’ve probably seen the ads offering loans to people with less than perfect credit. These loans are usually backed by collateral such as automobiles or real estate. However, the sub-prime (also sometimes called non-conforming) lending arena is filled with companies who will loan money based upon non-traditional collateral, such as horse trailers, art collections, boats, and even livestock and farm crops.

Many of the people in the sub-prime industry are there because they have come to expect high returns from high risk ventures. Developing a personal relationship with a non-conforming lender could very well lead you to a source of start-up capital issued in exchange for equity. Search the web for “sub-prime finance” or “non-conforming lenders.” The results will encourage you.

Yes, you will pay a premium interest rate (21-35 percent) and you can expect an up-front fee (3-9 percent). However, because the people in this industry are used to high-risk activities, they will understand your situation far better than a federally or state-chartered bank.

One more capital source often left untapped is contract financing. Contract financing is frequently provided to businesses that do not produce their own products but rather contract out manufacturing and fulfillment to another company. Example: You have a valid Purchase Order from XYZ Company for 1,000 units @ $200 a unit. Your manufacturer tells you they will need $100,000 to produce and deliver.

With contract financing in place, the money is provided by the investor to have the product produced, insured and delivered to your customer. Fees tend to be higher and advances lower than with factoring because of the greater risk to the investor.

There are over 3,500 companies in the US that specialize in financing contracts. Exploring this avenue requires two things: that you have a bona-fide contract that will act as collateral, and that you are willing to pay a premium to have the cash now.

It may be an added bonus that many of the companies that finance contracts also operate in the “sub-prime” arena and therefore possess a higher tolerance for risk. Search for “contract financing” or “factoring” on the web to get started.

Equally important to know is that the same companies that provide financing for your contract may also be willing to finance your first customer’s contract with you. This could be a powerful sales tactic in obtaining your initial stream of business.

In addition to manufacturing contract financing, other types of contracts that are routinely financed include: trade school tuition, educational seminars, performance contracts with “payment upon completion” terms, and computer equipment leases. If your firm is involved with these products or services, make sure you have a contract financing source in place for your customers.

Turning over unconventional, or non-vc-funding rocks can often turn up money sources that aren’t necessarily those avenues creating the most buzz in lending circles. But then it is often those very unconventional-thinking ventures that enjoy the greatest success.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.