By J. Howard Kucher, Senior Vice President, Garland McPherson & Associates, Inc.
(Published November 1, 2004)

Getting funding from a venture capitalist is not easy and the odds of getting funded are small. Taking out a loan is certainly a viable option, but smaller companies can face some daunting issues at the loan officer’s desk. What many entrepreneurs don’t realize is that their business, in and of itself, has a value that can be leveraged to help it grow.

So, class, if you’ve been paying attention, you know a few things by now. First, you know that you need capital to grow your business. Second, you have learned that getting funding from a venture capitalist is not easy, and the odds of getting funded at all are just slightly better than the odds for the Orioles wining the World Series next year (now hold on, I’m an O’s fan myself. But let’s be realistic here, OK?). So where do you turn? Most minds immediately turn to your friendly banker.

Somebody loan me a dime

Taking out a loan is certainly a viable option. However, smaller companies, or ones with out a significant track record, can face some daunting issues at the loan officer’s desk. First and foremost, collateral can be tough to come up with. Most entrepreneurs start off out of a spare bedroom or basement (I know one, quite successful now, who literally started out of the backseat of his car). Also, while the digital age has made it much easier start a “virtual” company, most banks won’t collateralize “virtual” assets. Add to that the notion that you are selling what is often an unproven product or service, and you’re left with nothing more to back the loan than your personal guarantee. But that, too, can present challenges. Unless you have demonstrable current income (i.e., still have your day job) you are in tight quarters, even if you have significant hard assets (like pledging the house, car, dog, cat, kids or your baseball card collection). Some lenders will finance off of proven cash flow, but the odds are that you don’t have enough of that either. So, welcome to that lovely location between a rock and a hard place. And even if you do get the loan, you will be expected to pay it back (banks are funny that way). So, now your cash flow is negatively impacted by the need to service the debt load.

Realizing the power within

What many entrepreneurs don’t realize is that their business, in and of itself, has a value that can be leveraged to help it grow. (OK, wise guy, how the heck do I put a number on that? More importantly, how can I utilize it to my advantage?) I’m glad you asked.

What am I worth anyway?

The first thing you need to do is get a handle on what the business might be worth. Obviously, you should consult a professional so that whatever you come up with has the endorsement of a legitimate third party. But what methods will they use? The simplest one is to simply take the revenue of the company and apply a multiple to it. A more sophisticated approach will look at earnings, typically before interest, tax and depreciation, and apply a multiple to that number. Lastly, you need to find a few comparable transactions to use as a benchmark. Sometimes the three are weighted and averaged to come up with a number. Factors affecting the multiples and weighting include the nature if the business (what industry you are in), the level of maturity (how long you’ve been around), past performance, future prospects, and the management team (no surprises there). Typically, multiples can range from .05 to 3 times revenue and 2 to 10 times earnings.

Show me the money

So, now I go back to the banker with my professionally prepared business valuation and they write me a check, right? Maybe, but maybe not. Maybe the VCs will see you in a different light once you are able to produce a hard number. Then again, maybe not.

The urge to merge

One of the best ways to leverage this value is to find a merger partner to combine forces with. Now, maybe the thought of bringing in a partner is not particularly attractive. But if you have a debt obligation (a.k.a. a loan) or a venture investor, you’ve got a partner anyway. Why not work with someone who shares you passion and can add value by bringing in complementary skills, additional customers, and other resources? And it can all be done without exchanging tons of money.

Quid pro quo

A great tool for mergers is a stock swap, where each company trades some of its value for an equal value in the other company. You need to be careful here that you have accurately and fairly valued the businesses and that it is an equitable exchange, but it can be done with little or no cash. Also, make sure that you think through and put in writing things like who is in charge of what, who owns what percentage of the new entity and how to handle conflicts between the owners.

Selling your children

Another option is to be acquired by a larger more established firm. While this may seem contrary to the spirit of entrepreneurship, it is done more often than you might think and is a great way to realize capital for the founders of the company. And, contrary to popular opinion, most acquirers want the founders to stay around and also to continue to exercise a significant amount of control and influence over the company. After all, it’s the strength, drive, and vision of the founders that has brought the business this far. If an acquirer is going to realize the maximum value from their investment, they’ll need and want you to stick around. And often they’ll pay you quite well to do so.

Bringing it all back home

Obviously, this is an extremely brief overview of alternatives that can get quite complex in execution. However, you need to remember that you do have options and that there are any number of ways to solve the problem of raising capital, even for a young small business.

J. Howard Kucher is Senior Vice President, Business Development, for Garland McPherson & Associates, Inc., a management consulting firm specializing in mergers, acquisitions and financial advisory services. Please contact him at jkucher@gma-advisors.com or see www.gma-advisors.com for more information.

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