Where to Find Capital to Start or Expand Your New Business

By Suzanne Fischer

William Blake (right) worked in the restaurant business for 25 years before opening his own place, Blake's BBQ and Steak, just over a month ago in Morganton. Not one to mince words, he readily admits to a mild case of the jitters. “Sure I'm nervous,” he says. “Anyone who said they weren't wouldn't be telling the truth. But I decided it was time to live and breathe on my own merit, not someone else's.”

It's this spirit that fuels the aspirations of entrepreneurs across North Carolina, where 98 percent of all companies qualify as small businesses. It can feel like a death-defying leap, moving from the relative comfort of a steady paycheck to the uncertainty inherent in any new venture. And whether the business is a sole proprietor, a mom-and-pop store, or a high-tech start-up hoping to become the next Red Hat, there's one experience common to all: the quest for financing.

Financing options vary widely depending on the type and size of the business and the stage of growth in which a business finds itself needing an infusion of capital.

In broad terms, the outlook for business financing appears rosy: interest rates, though recently on a slow rise, are the lowest they've been in years; the state's economy in general is going gangbusters; inflation is low; and North Carolina's established and informal networks of investors are stronger than ever.

“There's been an increase of capital here, which frees up entrepreneurs to spend time doing their business,” says Monica Doss, executive director of the Council of Entrepreneurial Development, a private, nonprofit organization whose mission is to stimulate entrepreneurial growth in the Research Triangle Park area. “This is great for a lot of reasons. Getting money is distracting. You may be competing with companies that already have money and can focus all their energies on what they do. If it sounds dog eat dog, it's because it is.”

The most vulnerable kids on the block are the small startups. Obtaining financing can be a challenge for these businesses because they have no proven track record by which lenders or investors can judge the likelihood of getting a return on their investments. But if growth in the girth of the state's Yellow Pages is any indication, startups happen.

The first place a startup business owner needs to look is in his or her own pocket. According to the N.C. Small Business and Technology Development Center (SBTDC), before a startup can even hope to get a bank loan, the owner should be prepared to make at least a 30 percent personal equity investment in the company. Not only does that decrease the amount a bank will have to loan, but the owner's investment shows a commitment to the business as well as some previous money management experience.

Where — besides her own banking account, stock portfolio, or retirement savings — can a prospective business owner come up with this kind of cash? Maybe from family and friends, who can either make a direct loan or gift or, possibly, serve as guarantors on a bank loan. “Family make investments for a significantly different reason than other investors,” says Booth Kalmbach, a co-founder of Coactive Systems and founder of a management consulting firm. “They are investors of the heart.” A home equity loan is another potential funding source: a second mortgage can be used as collateral.

With personal assets in hand and — needless to say — a solid business plan, the potential business owner would most likely next approach a local bank, which is the primary place to get a small business loan. Not all banks are created equally, however, so it pays to find out whether your bank is small-business-friendly. Ask for its stats on small-business lending and heed word of mouth among fellow business owners.

“We do an awful lot of small business loans,” says John Forlines, chairman of Bank of Granite in Granite Falls. Recently named by the SBA most business-friendly bank in the state, Bank of Granite, like many community banks, considers small business lending a big part of its mission.

For businesses that prove a bit more risky than the bank alone is willing to consider, the Small Business Administration created the 7(a) Loan Guaranty Program. One of the SBA's primary lending programs, it operates through private-sector lenders that provide loans which are, in turn, guaranteed by the agency. “Thanks to our friend Erskine Bowles (former head of the SBA), a lot of the forms were simplified and the application process is a whole lot easier,” Forlines explains.

But banks provide more than money. “We spend a lot of time counseling, offering personal service,” Forlines says. “We do decline more loans than we approve, but when we have to decline, we offer suggestions on ways to improve their potential of getting a loan next time they try.”

Blake, the restaurant owner, got his loan with the help of Judy Hendrix, a Bank of Granite vice president and office manager. Because Blake had a 10-year banking history there, some of it in commercial transactions from apartments he and his wife owned, the bank offered him a bridge loan to carry him over until the SBA approved its loan. The bank's trust in his track record allowed him to close the real estate deal and purchase the building in which his restaurant is housed.

“It all happened quite rapidly. I showed them where I was coming up with 20 percent down, my business plan, my projections, credit history and tax documents, and that was it,” he says. “It was amazingly easy.”

The situation becomes vastly more complex for startups that qualify, in the words of industry jargon, as “investment-worthy.”

While owners of mom-and-pops (also called lifestyle businesses) want to be successful, of course, typically they envision their enterprise as just that . . . theirs. They don't foresee a future of public stock options or corporate buyouts. They might dream of substantial wealth, but mostly they'll be pleased to make a comfortable living doing something they enjoy. And so these are the folks who secure loans from banks, which generally just want the business to succeed and pay back the loan with interest.

In contrast, take the investment-grade business, which in today's market will most likely be involved in high tech, health care, the Internet and computers, or communications. These entrepreneurial companies require substantially more early-stage financing than most lifestyle businesses but don't anticipate profits for at least three years. They offer the possibility of extremely high yields, although at considerable risk to the investor. These circumstances sound too much like roulette to the average bank so, instead, businesses like this might seek out venture capitalists, who are equity investors in small companies with grand potential.

“I'm definitely looking for the home-run business,” says Paul Jones, principal of Eno River Capital LLC in Durham, which helps companies in the seed stage. “Other types should look elsewhere.”

Proving that a business is venture-capital-worthy is no small task. “We generally take a top down approach,” explains Walter Wilkinson, a general partner with Kitty Hawk Capital, a venture capital firm in Charlotte. “First we look at the industry and the marketplace. How hot is the industry? Who are the competitors and how big are they? How unique is the business?”

Next, Wilkinson, like all venture capitalists, assesses the experience of the management team, whether it's complete and, if not, what or who it would take to make it so. Then he judges the merits of the business plan to see if the company stands out as “clearly exceptional” in its ability to make his decision to invest a sound choice.

According to the SBTDC, only five business plans in 100 are viable investment opportunities and only three in 100 result in successful financing. Getting introduced to a venture capitalist by your attorney or accountant improves your chances, as does taking a step back and viewing your business plan through the funder's eyes.

“Business owners tend to think in terms of what's in it for them,” says Booth Kalmbach, who has more than a decade of experience operating and capitalizing high-profile technology companies. “To be successful in getting financing, you have to take another perspective and think about what's in it for the investor.”

Research venture capital firms carefully. Some invest in very particular kinds of businesses, most have minimum investment amounts, and some specialize in financing businesses in particular growth stages.

If the idea of bagging millions in venture capital looks like the pot of gold at the end of the rainbow, be realistic and heed Jones' reminder that “equity is the most expensive capital there is. Equity investors will expect a 40 to 50 percent return.”

Also, by taking a bigger risk than other sources of financing would, venture capitalists buy a percentage of ownership, often serve on the company's board of directors, and approve major hires. This level of involvement from seasoned pros can be extraordinarily important to a fledgling company but, Kalmbach cautions, “objectives of investors are often at odds with those of the business owners. Owners could be satisfied with slow, steady growth, but investors want more serious money.”

Enter the “liquidity event,” or the way that companies that receive venture capital backing generally pay the piper. The first possible liquidity event is bankruptcy. The second is the disposition of the company, either selling it as an operating entity or selling its assets. The final main liquidity event is to go public, which Kalmbach calls highly publicized but exceedingly difficult.

“Some business owners have a strong emotional attachment, and these eventualities are something they should consider before searching out venture capital,” Kalmbach warns.

Private, wealthy investors called “angels” can provide an alternative to venture capital. “A good angel investor starts more companies than a good entrepreneur,” Doss, of the CED, says. “And there is a growing network of angel investors in this state. It's becoming clear how much private investors enjoy getting involved with new, young companies.”

SBTDC reports in its publication “Capital Opportunities for Small Businesses” that angel funds are “significantly greater than that available through traditional venture capital organizations.” Unlike venture capitalists, however, angel investors can be difficult to locate. ACE-Net, an Internet-based listing service sponsored by the SBA, provides information to angels on investment-grade businesses looking for financing. Investors and entrepreneurs both enroll with the service for a fee of about $450.

Established businesses can choose from an even wider array of finance options. Factors to consider when hunting for capital include what the money will be used for, the length of time funding is required, and the cost of securing funding.

Banks can issue a line of credit to businesses that need working capital when accounts receivables haven't been converted to cash but bills need to be paid or inventory purchased. For capital expenditures — like computer equipment, furniture and fixtures — businesses might consider a short-term loan. Securing this kind of capital is similar to applying for any other kind of bank loan: lenders will assess the financial strength of your business, looking not just at profits but at gross profits versus operating expenses.

Finance companies, rather than focusing on a company's cash flow and operating record, lend money based on the value of the enterprise's assets, such as accounts receivable, equipment and inventory. Asset-based lending is particularly valuable to businesses that experience quick growth or seasonal variations in business.

“Unlike banks, we look at the value of a company and lend money against those assets,” explains Steve Sargent, managing director of GE Capital Commercial Finance and president of GE Capital First Factors. (NCCBI Chairman Phil Phillips is chairman and CEO of First Factors.) “Typically, banks have fairly strict loan policies and if a company is experiencing difficulty or growing more quickly than the company can fund, banks need to dispose of that customer as quickly as possible.”

Because asset-based lenders take greater risks than banks, the costs of the capital can be relatively expensive, as much as prime plus 10 percent, according to the SBTDC. But the advantages are clear for businesses that don't qualify for traditional loans.

Factoring is another option for fairly steady, moderate-growth businesses with a stable customer base. Factoring companies buy the accounts receivables of a business at a discount and then collect those accounts at face value.

Large finance companies, like GE Capital Commercial Finance, offer these services and others such as lines of credit, trade finance, term debt, leasing and fleet management to non-investment grade businesses. “It's a huge opportunity and a decidedly underserved market,” Sargent says. “Our pitch is to listen to what clients need and then create custom programs for them based on these needs.”

Small business investment companies (SBICs), created by a congressional mandate in 1958, offer another possibility of assistance to qualifying small businesses. Privately organized, privately managed investment firms, SBICs use their own capital plus funds borrowed at a favorable rate from the federal government to provide venture capital to small, independent businesses. In general, SBICs offer financing in the form of long-term loans, equity securities or debt funds. Debt funds are loaned money, but are subordinated debt, which means investors get paid off after general and secured creditors. For assuming a greater risk, providers of debt funds can command a higher interest rate and a “sweetener.” The sweetener is usually a warrant or option to buy equity in the company at a set price for a certain number of years.

As with traditional venture capitalists, SBICs provide financing to businesses at varying growth stages: some prefer to work with relatively new companies, some with well-established businesses.

Centura Capital of Charlotte, one of five licensed SBICs in North Carolina, supplies debt funds to high growth companies that are producing a product or service but that may not be generating a profit, and it helps finance more mature companies that want to make major expansions.

“We work with Main Street USA companies, in the small to middle market,” explains Bob Anders, managing director of Capital Markets Group and president of Centura Capital. “Whereas other banks look at much larger businesses, $750,000 is a good-sized investment for us.”

As with other financiers, SBIC lenders, according to Anders, “make a bet on the future. The number one thing we look at is the management team. We'd rather invest in a great management team with a so-so product than a so-so management team with a great product.”

Another option for some larger businesses is investment companies like Carousel Capital in Charlotte. The company invests in “middle market” businesses with predictable cash flow between three and four million, with a value between $20 and $150 million.

“Venture capitalists look at ideas. Although people with good ideas might not know how to run companies, so venture capitalists will bring in a management team. We, on the other hand, look for companies who, as much as possible, have an established management team,” explains Nelson Schwab, managing director of Carousel Capital. “We add to, not obliterate. We want the individuals to be incented to increase the value of the company.”

Carousel makes equity-based investments, either preferred or common stock, and doesn't specialize in any particular sector. “We're opportunists in our selection,” Schwab says. “We look for businesses for which an infusion of capital will make them grow even faster.”

The search for capital can be complex and overwhelming, particularly for new and small-business owners who might not have a great deal of background in the ins and outs of high finance. All the experts we talked to recommended surrounding yourself with a good team of advisors: an attorney, accountant and mentors who've already made the journey. Educational opportunities and research materials are available from a wide variety of local, state and federal agencies, including the SBA (www.sba.gov), CED (www.ced.org) and the N.C. SBTDC (www.sbtdc.org), which publishes a fantastic guide to small business finance.

NCCBI has recently created a 50-member small business advisory council chaired by Erskine Bowles and Steve Zaytoun, president of Zaytoun and Associates Insurance.

“While NCCBI has many of our state's larger businesses as members, it is far from being a big-business dominated association,” says Chairman Phil Phillips. “To the contrary, more than 80 percent of our membership is made of smaller and midsize companies that dominate the North Carolina economy. The council will bring forward those hot button issues and problems that need to be addressed with the legislature.”

So while William Blake rustles up an order of ribs for his next customer, money changes hands across the state bringing entrepreneurs' plans to life. “Business has been great so far,” Blake says. “I'll just hope that it keeps up.”

Suzanne Fischer can be reached at sfischer@nccbi.org or at 919-836-1412.

COPYRIGHTED MATERIAL. This article first appeared in the August 1999 issue of North Carolina magazine.