Creditworthiness, Collateral & Capital

Nineteenth century poet and philosopher Ralph Waldo Emerson is credited with the aphorism, "Build a better mousetrap, and the world will beat a path to your door." He didn't consider the start-up and other business costs associated with getting a mousetrap business off the ground. And Emerson never had to seek out large-scale financing; by age 35 he had inherited funds equivalent to more than $620,000 in today's dollars.

Today's entrepreneur understands that while a good idea is a necessary ingredient, it's only the barest of a beginning for a successful venture. Many potentially successful business ventures never get out of the starting gate; without capital, ideas can often amount to nothing. If conditions -- and there are many -- are right, funds can be available to help bring a new venture into existence, or to nurture a fledgling one. But each funding source carries with it a host of characteristics and variables; some funding types may make perfect sense for one entrepreneur while being a poor fit for another. So it's important to become familiar with and understand the various categories of funding sources; only then can a business person seeking capital make an informed decision which to pursue.

What's in Your Wallet?
The first source to which most entrepreneurs turn for funding is themselves. Cash on hand, savings and assets that can be liquefied with relative ease can provide seed money. Oftentimes, credit cards are put into service; for an individual with good credit, many cards offer brief "no interest" promotional financing with up to a year to repay, adding a transaction fee -- typically 3% of the amount financed. This scheme imposes a stiff penalty of high accrued interest if the balance is not paid in full by the end of the promotional period. Still, for the entrepreneur who is sure that other funds will come by the end of that term, such an arrangement is as close to "free money" as can be imagined, but the amount available is customarily at or below the card holder's credit limit.

The "Friends and Family" Plan
The next source the entrepreneur might approach is his or her community: family members and friends. In the world of finance, this type of financing is known as "dumb money." In this context, the term refers not to the intelligence of those providing the funds, but rather to the fact that those individuals are making funds available to their friend or relative based on the relationship, not upon analysis of the worthiness of a business plan or the viability of the proposed endeavor. While some family members and friends may have a background in business and/or finance, in general, those with personal relationships to an entrepreneur are not innately possessed of any special skills that would allow them to judge the financial risks associated with an investment.

It's rare for "dumb money" financing to include a formal valuation of the business, and the agreement -- such as it is -- between entrepreneur and lender is often as informal as a handshake, with no documentation or specified terms whatsoever. In any event, even if the business owner is successful at enlisting the financial assistance from friends and family, the resulting funding often doesn't add up to enough to make a substantial difference.

And if the venture isn't successful (a measure that in this case can be a very subjective one) the cost to the entrepreneur might be measured not only in monetary terms but in lost friendships, or worse. So from here the entrepreneur often must explore other options, each with a character of increasing formality.

Crowdsurfing the Money Pit
Taking a page from the creative world, some entrepreneurs have ventured into the world of crowdfunding. A definite step up from "dumb money," the crowdfunding model requires that the business owner has and shares a business plan with potential funders.

Traditionally, crowdfunding is not investment per se; those taking part in the funding scheme may (and typically do) receive a premium of some sort as a recognition for their participation, but the value of that premium is relatively small, and certainly not commensurate with the amount of funds being provided.

Within the business world, however, the model has been altered to permit investing. The non-governmental FINRA (Financial Industry Regulatory Authority) notes that the Obama-era JOBS Act signed into law in 2012 "established crowdfunding provisions that allow early-stage businesses to offer and sell securities." The Act establishes annual limits; by way of example, a potential investor with an annual income of $200,000 and a net worth of $100,000 is allowed to invest no more than $10,000 each year.

From the perspective of the business owner, crowdfunding carries with it greater oversight and regulation than "dumb money" options. Companies are not allowed to offer crowdfunding investments directly; they are required by law to work through formally established funding portals or broker-dealer arrangements.

Banks: "Because that's where the money is."
In this hierarchy of capital sources, this is the point at which professionals enter the picture. On one hand, this inevitably means that the cost to the entrepreneur rises, but the rigor associated with bank loans often lends tacit or explicit approval, serving notice that the entrepreneur's plans have been vetted and found worthy.

Clearly, creditworthiness is the most basic criteria considered by a lender. But in and of itself, an excellent credit rating is rarely enough to secure a bank loan. An informal survey of lending officials with five banks and credit unions servicing Western North Carolina reveals consensus concerning the key qualities lenders look for in someone seeking capital for their business venture. Unsurprisingly, having a solid business plan tops the list. When reviewing funding requests, bank lenders take measure of the experience level of the company's principals; several note that a succession plan for leadership must be in place before they'll even consider a loan.

Collateral is important, as is the level of equity investment in the project by the principals. Perry Hendrix (Senior Vice President and Commercial Lending Manager at First Bank) looks for the borrower's equity to represent 25% of total funding. "When it's less, we can look to the SBA, USDA and other programs to assist with leverage," he says. Ability to pay is among the most basic requirements; so too is [emphasis added] "a payment history that shows a willingness to repay," says Ross Sloan, Market President at Asheville-based HomeTrust Bank.

Banks also look at the market as a whole, considering forecasts regarding the future of a given market segment; funding requests from a business in a market with an uncertain future are less appealing to characteristically risk-averse bank lenders. The entrepreneur should be able to demonstrate potential access to other funds as well as a secondary source of repayment should the first one fails. And lenders like to see reserves that will support the business' future working capital needs.

Relationships play a part, and that's where working with a locally-based lender (or one with a significant local presence) makes sense. Bankers look more favorably upon a request from an entrepreneur who has done business with their bank in the past, as well as those who are likely to do additional business (in the form of loans or other bank services) in the future.

The bankers interviewed for this story indicate funding ranges anywhere from several thousand dollars up to (in some cases) $10 million or more. The cost to the borrower -- based on Prime rate plus additional interest -- also varies based on the bank's assessment of risk.

Bank lenders are by their nature fiscally conservative, so they're on the lookout for red flags. The most commonly-cited causes for concern center around the potential borrower's lack of preparedness, lack of capital, an under-qualified team, and reluctance to provide all of the information needed for a thorough credit report.

In Western North Carolina, manufacturing and retail are currently attractive areas for bank funding. Jane Hatley, WNC Regional Director and Business Development Officer at Self-Help Credit Union specifically mentions her institution's interest in renewable energy and/or efficiency-related fields. And because CDFI's (Community Development Financial Institutions) have a brief that differs from traditional banks, they often add an additional criteria into the mix. Hatley notes that a new program will soon be launched by the City of Asheville and Buncombe County. "The Mountain Community Capital Fund will have a special focus on making loans to people of color," she says, "and Self-Help is one of the lenders in that program." (The other two CDFI lenders in Western North Carolina are Mountain BizWorks and the Carolina Small Business Development Fund; more on those below.)

Most bank lenders interviewed agree that some business areas are overexposed (or in danger of overexposure) in Western North Carolina. Small retail establishments, coffee shops and start-up restaurants are viewed as riskier than other businesses, say. The hotel and multi-family construction markets are being closely watched. "We have to monitor occupancy data on a constant basis in order to determine how much additional growth our local economy can absorb," says Hendrix.

Bank lenders serving the Western North Carolina market cite successes in the expected areas: real estate, microbreweries, hospitality and retail. Self-Help points to its role in helping many Asheville-based businesses get started; that list includes Salsa's, West End Bakery, Shoji Spa, Regency Park Child Care, Blue Ridge Biofuels and others. Chris Youngblood, Commercial Banking Relationship Manager at PNC Bank says, "We have a 'box,' so to speak, that we work within, one that mirrors what we're best at. When we stick to what we're good at doing, the bank has very little losses, and our clients and borrowers have the best experience.

"The dollars that different banks and funding organizations loan to businesses look and feel the same," says Youngblood. But as a group, the bank lenders surveyed agree that the one-on-one business relationship they can offer is a chief advantage to the potential borrower. "Doing business with a smaller institution like ours means that you are dealing with a decision maker," says John Kimberly, President and CEO of Carolina Alliance Bank. And Hendrix says that the professional advice that comes with his bank's financing makes it a better option that crowd funding.

The most oft-mentioned tip from regional bank lenders is simple and straightforward: don't go it alone; seek advice from peers and experts, they suggest. "Sometimes it's not about having the best or greatest ideas," says Hendrix. "It's about execution and focus on your plan."

"Smart people learn from their own mistakes," says HomeTrust's Ross Sloan. "Really smart people learn from the mistakes of others and spare themselves the pain."

Small Business is Big Business
Small business lenders share a perspective similar to that shared by bankers, though because the nature of their business focuses on providing financing for a particular segment of the overall business market, their priorities differ in some key ways. And within the small business lending community, specific resources are available to help the entrepreneur navigate the process of seeking capital.

The basic criteria for those seeking funds are similar to the ones laid out by banks. Patrick Fitzsimmons, Executive Director at Mountain BizWorks, looks for "entrepreneurial zest and good character" as well. He favors potential borrowers who "have participated, or are willing to participate, in our business training or coaching programs. We are here to help businesses start, grow and thrive." Zurilma Anuel is Latino Program Director for the Carolina Small Business Development Fund; she says that project feasibility is a critical element: "Does it make sense, and is it accomplishable at the stated amount?" she asks borrowers.

Mountain BizWorks provides microloans and small business loans from $1000 to $250,000 with interest rates in the 7% to 10% range on a five year term. The CSBDF typically makes loans in the same range, with fees of 2.5% to 3% of the loan amount. Anuel says her organization also does larger loans, "primarily involved with or secured by real estate."

Lack of preparedness tops small business lenders' list of red flags; Anuel notes that if other parts of the borrower's plan are solid, "pre-loan technical assistance will be required before capital can be committed."

Fitzsimmons says that Mountain BizWorks finds business proposals attractive that deal with agriculture, manufacturing and job creation, as well as ones from companies "owned by entrepreneurs of color." Anuel says that her institution doesn't prefer one industry group over another, but points out CSBDF's Veterans Direct Loan Program, with its "added focus on funding businesses run by veterans who have a strong business plan." As far as business plans that are less likely to gain approval, Anuel cites the national market. "Food trucks, hair salons, and bakeries are over-saturating the market; too few are bringing a unique product or brand that will attract and maintain customers."

Small business lenders do not typically take an equity interest in their borrowers' business, but they do want to see their clients "have some skin in the game and [be] committed to success," according to Fitzsimmons. Anuel says for loans from her institution, "any person with a 20% or more ownership interest in the business must personally guaranty the loan. In general we require a 10% equity injection into the project." Loans involving real estate require higher equity injection, she says.

Mountain BizWorks can point to a long list of successful ventures in Western North Carolina. Fitzsimmons mentions two in particular. "Marion Fabric and Upholstery is a mission-driven business that hires ex-offenders as workers and is owned by two longtime industry veterans," he says. "Hi Wire Brewery started with us as a learning client several years ago; they participated in our program thoroughly, opened a tasting room, later expanded and now employ dozens of workers." Mountain BizWorks also provided the first capital for FLS Energy; that firm grew its business and "sold last year for millions," Fitzsimmons says.

Zurilma Anuel cites the success story of Alejandro Hernandez Herrera, an Asheville entrepreneur originally from Mexico. Herrera developed his skills working with a painting company, with plans of starting his own business. A loan from CSBDF helped him acquire transportation equipment to launch his own company, King of Kings. "I didn't know I could but I did it," Herrera told Anuel.

Mountain BizWorks makes training and coaching a key component of every loan. "We believe in the value of small businesses to our economy and in the likelihood of their success when we provide the nurturing they require," adds Fitzsimmons. CSBDF has a similar focus, accomplished through "our business advisors, women's business/entrepreneurial centers and other standing programs," Anuel says. "We also consider our underwriting criteria and terms more flexible than traditional lenders, providing more broad access to capital."

Anuel and Fitzsimmons agree that seeking guidance and advice is critical to the success of a new business venture. And knowledge about the types of financing available is one of the most important subjects the entrepreneur should explore. "While there are only a few 'types' of loans,"Anuel cautions, "the ultimate cost to the borrower -- fees and interest -- can vary greatly from one lender to the next."

"Knowledge is power," says Sandra Dennison, Regional Center Director of the Small Business and Technology Development Center at Western Carolina University. "Managing a business means making serious and difficult decisions, but you don't have to do it alone." The SBTDC does not administer loans, grants, or investment capital; instead Dennison says that her organization "can help identify sources and increase the quality of applications and proposals." She says that all lenders focus on the "five C's of credit: character, capacity, capital, collateral and conditions." The SBTDC helps entrepreneurs address each of those concerns.

Several SBTDC counselors have specialized financing knowledge in business credit, real estate finance analysis, loan packaging procedures, negotiating and problem solving skills and deal structuring techniques, Dennison says. The Center helps businesses prepare for a wide variety of funding types including traditional bank loans, SBA-guaranteed loans, Federal R&D and commercialization funding, equity capital investment and even international export financing. Dennison says that in the last three years, "SBTDC at WCU has helped businesses obtain over $11 million in revenue to either start or grow their business."

Our Better Angels: Adventures in Venture Capital
Venture capital differs significantly from bank and small business loans. While the acquisition of venture capital has the same goal -- funding a business -- the cost to the entrepreneur is quite different. Rather than simply providing a collateralized loan, venture capitalists -- some of whom are described as "angel investors" -- assume a stake in the business itself.

In some ways, the documented creditworthiness of the entrepreneur is less important to the venture capitalist. "Generally, the companies we consider investing in have little or no operating history and consequently have difficulties receiving funding from traditional sources," says Michael McLamb, Managing Director of the Pinnacle Enterprise Fund, LLC, a self-described angel investment fund focused on early and growth stage ventures in Western North Carolina. Though each deal is unique, he says his fund will "invest up to $100,000 of preferred equity for a minority stake in the company."

Asheville Angels and VentureSouth are similar in that respect. "At Asheville Angels, we're interested in early-stage, high-potential companies that typically raise between $250,000 and $1,000,000," says Clark Duncan, who is now Executive Director of the Economic Development Coalition for Asheville and Buncombe County. "We consider this an institutional seed round," he says.

VentureSouth Managing Director Paul Clark says his fund looks for companies raising similar levels of capital. "We invest $100,000 to $800,000," he says. "We invest equity, so there isn't really a 'cost' of funds" to the entrepreneur, he says. "However, we are buying a share of the company, generally 10% to 35%, depending on the valuation of the company." McLamb says that Pinnacle "require[s] representation on the Board of Directors, voting, liquidation and information rights."

For venture capital/angel investors, a primary focus is ... focus. "We expect entrepreneurs raising capital to be 100% focused on the company for which they are raising capital," Duncan says. "If they have two companies but are only offering equity in one of them, we will pass on the deal. We want to see a 100% commitment to growing the value of our investment."

McLamb has a similar perspective. "We're interested in scalable businesses that have skilled, focused and determined management teams, not small or lifestyle businesses," he says. Pinnacle looks for companies with management that is "coachable" and possessed of a strong desire for an eventual exit from the capitalization. McLamb is wary of companies run by people with unrealistic expectations, relying excessively on ifs and whens: "If we can get a sale..." "When we have this, we can..."

ALFIE Loans focuses exclusively on real estate bridge loans. "We've established a fund that's over $24 million now," says Todd Fowler, the firm's Chief Financial Officer. "All of the underwriting and credit decisions are made this office, and the 120 members of the fund have an equal portion of all of our current 88 loans; it's a pool fund." Fowler say that his fund's largest current loan is $4.2 million. Unlike typical venture capital arrangements, ALFIE charges interest instead of investing equity. "Our current interest rate is 10.75%," Fowler says. "We're in that high risk part of lending that is the interim where an investor has an idea and a little bit of money and a property, and we help them get from there to a completed project."

Pinnacle Enterprise Fund is attracted to business that can generate at least a 50% annualized return on investment for five years after an investment is executed, McLamb says. "We're really looking for companies that are building rocket ships for growth, so to speak," says Duncan. And while his fund doesn't focus on one specific type of business or industry, McLamb says that Pinnacle prefers companies based in (or with operations in) Western North Carolina.

For entrepreneurs considering venture capital or angle investment, it's important to think big. "We don't invest in companies that are solely serving the Asheville market," Duncan says. "We invest in companies based in Asheville that have plans to become national and global companies."

But some businesses aren't a good fit for their model. "We receive a lot of requests for capital for breweries, which do not really fit our investment criteria," says Clark. And while McLamb says that the alcohol and brewery market nationwide remains attractive, that's not as true in Western North Carolina. "Locally, that market seems saturated," he says.

Regionally, venture capital and angel investments have enjoyed high -- and high-profile -- levels of success. Duncan mentions two recent ventures. "In Asheville, we've invested into Plum Print and Brightfield, both of which are primed for future growth." And Asheville Angels recently saw its portfolios' first exit event, returning capital to investors with the acquisition of FarmShots, a firm that analyzes satellite and drone imagery of farms, by Swiss-based agribusiness Syngenta AG.

Paul Clark points to some of VentureSouth's recent successes. "We have exited two portfolio companies this year, one of which generated a 2x return in 1 year and the other a 9.5x return in just over two years." Locally, the fund has invested in Asheville-based Brightfield Transportation; "they have some very interesting growth opportunities ahead of them now," Clark says.

Vendor Registry is one of Pinnacle's portfolio companies. Offering a procurement platform for small and mid-size municipalities to procure services in a more competitive and efficient manner, Vendor Registry recently "saved the taxpayers of Myrtle Beach $90,000 on a single project," McLamb says.

All of the high-end investors interviewed for this feature agree that venture capital only makes sense if the entrepreneur's commitment is rock-solid. "Our funding is appropriate for entrepreneurs building high-growth companies who will go through walls to do what it takes to make that happen," says Clark Duncan. But for those with the drive, venture capital funding is worth serious consideration. "There are very few [other] places in the southeast where you can find risk-tolerant equity capital," emphasizes Paul Clark.

And when conditions are right, things can be set in motion quickly. "We give a quick 'no,'" says Clark. "And we generally complete our diligence and funding in two months." Venture capital of the sort provided by VentureSouth and Asheville Angels has another advantage: simplicity. "Even though we might have 50 investors participating in a given investment, the entrepreneur only has one entity on his/her share register."

"Our skin is in the game," emphasizes Michael McLamb. "We invest to make money, but we're ready and willing to help you execute the business. Oftentimes we'll be able to make some key introductions and facilitate partnerships to help the business gain traction and scale." And the experience and expertise of VC/angel investors can be invaluable. "Most angel investors are entrepreneurs themselves," McLamb says. "They've been where you are, know and understand what you're going through and have realized success from their ventures."

The experts have some simple (if familiar) advice for the entrepreneur seeking capital: Do your homework. "We lay out on our website exactly what we are looking for and even how to pitch to us," Clark says. "We have frequent educational events, webinars, etc., too. Entrepreneurs that review these materials before approaching us make a much better first impression than those that do not."

"Study from other successful entrepreneurs," McLamb says. "You don't have to reinvent or create new ways to build a business. Get outside of your comfort zone, acknowledge what you don't know and learn as much as you can while still executing the business."

The Bottom Line
The entrepreneur seeking business funding has many options. Each carries with it a number of unique characteristics; there's no one-size-fits-all solution to accessing capital. Each business owner must practice due diligence and weigh the advantages and disadvantages of each; with increased funds come increased demands. For some entrepreneurs, yielding an equity stake to investors may be the most straightforward and effective means of securing the capital needed to move forward. For others, more conventional methods -- bank loans, business loans -- might be a better solution. The unifying reality is that the only way to know which means of funding is most suitable is to take at least some of the advice proffered by the lending experts quoted here: seek advice from those with experience, be flexible, be thorough and forthright, and -- most of all -- be ready to learn.

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