Economic prognostication headlines are everywhere this time of year.  Will Europe fall prey to a double-dip recession in the coming year?  If so, how deep and long will it be?  What will be the fall-out in Europe?  What are the economic growth prospects for the U.S. and the rest of the world for 2012 -- assuming a European recession, not-assuming a recession.  I recently was sent  of list of Top-10 Economic Predictions for 2012 compiled by the Chief Economists at IHS Global Insight  and thought it might be interesting to share some of those here. 

General premises:

• World growth will slow in 2012 - the question: by how much?  Most likely to around 2.7%, from 3.0% in 2011
• The U.S. economy will "muddle through"
• Europe will struggle.
• China will slow with uncertainty around how much and knock on effects of that trend 
• A Eurozone meltdown and/or a China hard landing would bring the growth rate down markedly and could trigger a world recession

We've discussed the results of the Pepperdine Private Capital Market Project several times in this blog.  We encourage you, as experienced business owners and executives to participate in future surveys as we believe that it helps to add transparency to the capital markets for small and mid-sized companies - which, as you are aware, is one of the primary goals of VFHUB.com!  You can view the Pepperdine CMP website here.  By the way the project also has a group on LinkedIn.

The project team has just published its Fall 2011 State of Small Business Report based on a survey of over 10,500 privately held U.S. businesses.  You may want to download the whole report, which sorts survey results by company size (from < $1 million in revenues to > $500 million), state and other parameters.  The results are not significantly different than the Fall 2010 report, more evidence that the business and economic environment is basically stuck in idle.  Here are the key findings of the report:

We've touched on the subject of Crowdfunding as a potential source of growth capital for small businesses for the past year.  We profiled the product and existing providers in our October 9, 2010 post and in more detail, including regulatory hurdles the need to be cleared in order to bring the financing product into the mainstream, in our December 12th and 18th, 2010 postings.  More recently in our October 9th blog post we noted that the product concept has been gaining attention in the U.S. Congress including being included in the recent Jobs package introduced by the White House. 

Bloomberg Businessweek now reports that the product seems to have bi-partisan support in Congress and the House of Representatives is expected to vote on bills to remove restrictions in the Crowdfunding this week.  Essentially the bill will increase the amount of money a business can raise before having to report to the SEC, which carries with it material upfront and ongoing costs.  The result may be that some of the Crowdfunding websites that we've discussed in the past may be able to facilitate the sale of equity to individual investors.

The PricewaterhouseCoopers MoneyTree Report has been released and shows some interesting trends.  For Q3 2011 venture capital firms invested $6.95 billion across 876 deals.  While those numbers were down from the prior quarter it still represented the second best quarter over the last three years (before the financial crisis started in late 2008).  The survey points out that the average deal size of just under $8 million is the largest since Q1 2007 ($8.5 million).  Those are the high level numbers, you can check them out in more detail here.

I find several facts and trends interesting ... although only time will tell if the trends continue. 

• Most of the investment has been focused on expansion and later stage companies, with less investment dollars directed towards seed and earlier stage companies.  The survey notes that first time fundings were at their lowest level since 2009.
• By industry, software companies led the funding parade.  Following that sector was: (2) biotech, (3) industrial/ energy, (4) medical devices and equipment, and (5) media and entertainment.  The ranking is not that unusual, however, I would have expected more investment in the energy sector. 
• Investment by region was also quite remarkable in my view.  Silicon Valley ($2.7 billion) represented the largest area of investment.  That wasn't a surprise as it has held that spot for many, many years.  However, the second ranking region was the New York Metro area ($.9 billion).  That trend has been noted in the press as more VC's are setting up offices in the region, however, I wasn't aware that it was already that large of a concentration.  In third place was Texas ($ .6 billion)!  Texas has always been an "up and comer" with technology oriented Austin, however, I wonder if it doesn't have a growing share of emerging energy companies.  Obviously these rankings might be skewed by large single transactions, but nonetheless they are interesting potential trends.

A last survey observation - VC's are expected to raise around $15 billion in new money in 2011, down from prior years.  That may be a consequence of weak performance of VC funds and/or a weak outlook for high quality / potential investments in the coming year(s).  Again, interesting to follow.

We profiled Crowdfunding as a potential funding mechanism for start-up and small businesses in our blog post of December 12, 2010.  We noted that Crowdfunding, raising funds for a project from a number of small contributors (not "investors"), has been used for years in the art world, however, the application of the concept is mow moving into the commercial realm. The hang-up in the U.S. is that Securities and Exchange Commission (SEC) regulations place stringent requirements on investors and also there is variance between states which also creates hurdles.  Check out that post for more background information.

The movement to remove or reduce obstacles to the formation of commercial oriented small-business crowdsourcing platforms has grown since last year led by three entrepreneurs. Sherwood Neidd, Jason Best and Zak Cassady Dorian, three friends and experienced entrepreneurs have spent considerable time thinking about the subject and have shared their thoughts on startupexemption.com.  They have asked those of like mind to sign an online petition.  They envision Crowdfund Investing Platforms (CFI) becoming an efficient channel to get much needed financing to start-ups / small businesses.

The September issue of CFO magazine has a nice article in its Capital Markets section entitled "Safeguarding Your Liquidity".  We've addressed this subject previously from a couple of viewpoints; first, don't take your existing funding relationships for granted in an uneven economy, and second, it is important to monitor compliance with lending agreements.  In the current economic environment it's worth repeating these points and the article does a particularly good job of pointing out common "Loan-Agreement Trip Wires".  If you don't subscribe to the magazine (it's free and also online) I'd recommend it.  The topics in the magazine tend to focus on subject more germane to larger sized companies, however, the articles are well written and many of the subjects also apply to small and mid-sized companies.  

The article outlines 5 different ways that CFO's can maintain strong lender relations and, therefore, access to capital.  They are:

Thoughts and notes for your consideration and comment.

• Today's financing markets remain soft and have been for an extended period of time.  Both lenders and investors have capital but have tended to be judicious as to how they deploy their funds, choosing, for example to focus on supporting existing customers / portfolio companies rather than more aggressively expanding new business efforts.  Businesses on the other hand, continue to "hunker down" and focus on retaining cash cushions based on continuing economic uncertainty.  
• Some of the large banks, both in the U.S. and internationally, are said to be factoring in another credit crunch into their contingency planning activities.  Expectations that such an event could occur within the next 9 months or so.  In effect they are conserving and closely rationing capital for that contingency.
• So we have both funding sources and businesses playing a "wait and see" game.  What are they waiting for?  What would be the catalyst for bringing markets back to a strong growth orientation.  

Your thoughts?  

There are a wide array of financial oriented websites on the world wide web.  For business executives looking for help in seeking capital in a challenging market we imagine it can be confusing to discern one from the other.  We ask ourselves regularly, what makes the VFHUB.com community different than the rest?  What value does our website community bring to those executives?  We thought it might be an interesting subject for a blog post - so here we go ...

As we survey financial websites we see four general categories:

1. News - provide general news concerning the financing markets and/or a specific industry.
2. Intermediary -  websites that attempt to match companies to finance sources.
3. Database - some sites simply provide access to databases of finance sources.  Several, for example, have listings of venture capital firms but generally not with robust search capabilities. 
4. Educational - educational websites look to educate users about markets, products and provide resources like calculators or checklists to provide assistance in cost effectively navigating finance markets. 

Let's look a little closer at each ... by the way, also note that within these groups websites may also differ by target readership (small businesses, technology or emerging growth businesses), market (venture capital, small business, etc.) or product focus (equity or debt financing) among others. 

1. News - there are many news oriented websites geared to small, mid-sized and emerging market companies.  These are valuable for pointing out trends, sharing ideas and providing general advice.  They also tend to be entertaining, which can be a nice break from the flow of data and images coming our way each day.   Examples of News focused sites: Businessfinance.com and Venturedeal.com.   
2. Intermediary - there are several websites that try and match companies in need of funding with either equity investors or lenders in exchange for a fee(s).   This can be appealing to businesses struggling to find financing and/or with limited experience or perspective on the marketplace.  Effectively the website is acting as a broker.  This category includes websites like Boefly.com (small business loans), Lendio.com (formerly FundingUniverse.com; small business loan focus), AngelList.com (equity investors for start-ups) and a few others.  While conceptually these have appeal, in practice the site is agnostic in its "loyalty".  The goal is to get the funding completed, not necessarily a deal in the best interest of the business.  We've seen several complaints in the news for this category. 
3. Database - a few websites offer databases of lenders or venture capital firms.  Essentially this is an online version of, for example, Pratts Guide to Private Equity and Venture Capital Sources.  They may have some searchability, but the capability level may vary.  Examples; Crunchbase.com and Privateequityinfo.com.
4. Educational -  there are few what we would call educational or user advocate websites.  Sites in this category focus on providing tools and information designed to be useful by a company and assist it in avoiding costly mistakes and/or negotiating the best deal possible. 

What category do you think VFHUB fits into?

Obviously a website may have a mix of elements integrated into its offering, however, we have classified sites based on what we view it's primary mission.  The primary mission for VFHUB is not to be "user agnostic" but to be clearly on the side of our members.  For that reason, while VFHUB has a strong, robust multi-industry searchable database, we view our community to be in the last camp - educational.  We aim to build a trusted network of members and VFHUB staff members that actively collaborates to provide members with information and services that assist them in not only finding the best provider, but also getting the best terms possible.   

As always, chime in ...  

With access to capital in the U.S. already constrained for small and mid-sized companies, the recent S&P downgrade of the U.S. will certainly not improve the situation.  The recent last minute raising of the debt ceiling was focused on spending cuts rather than additional investments to boost economic growth.  We've blogged previously about the $30 billion government effort to spur lending to smaller companies, only to find out that the funding has gone much slower than expected and the initiative is set to expire in the near future.  The Federal Reserve has confirmed that it will keep rates for bank borrowing near zero into 2013.  That action is intended to provide banks with low cost funding, which it can pass along to its customers.  On the flipside, however, federal bank regulators are pressing banks to build their capital bases and reduce risk.  The Fed's arsenal of tools to boost the economy is fairly limited at this point.

A recent FoxBusiness.com article noted that even if a business is paying its bills on time and growing it may be adversely effected by the challenging economic conditions.  That is because the business information and rating sources such as Dun & Bradstreet include in the prospective effects of the economy in their ratings of small businesses.  Lenders utilize those ratings, either directly or indirectly, in their underwriting of small business applications.  The article also notes that the Small Business Administration (SBA) dropped its guaranty limit on SBA loans from 90% to 75%, shifting more risk to lenders.  The FoxBusiness article reports that the guaranty reduction has tiggered SBA lending volume as banks are reluctant to absorb the increased risk.

That said, the intention here is definitely not to paint a picture of doom and gloom.  Instead we want to provide a realistic view of the current market and provide some suggestions as to how you might approach accessing funding.  Collaboratively navigating this sort of environment  is precisely what we had in mind for a "mature state" VFHUB.com!

With the economy remaining sluggish and many businesses finding it difficult to secure additional capital, it's more common for businesses to find themselves in a workout situation with their finance source(s).  Given that reality we thought it would be useful to provide some suggestions on how to navigate those circumstances.  All is not doom and gloom.  We've seen many companies successfully work through the process and even stay a customer of the lender.

Here are our suggestions plus links to additional resources ...

We recently posted a link in our Member Announcement area to a Wall Street Journal article that discussed the state of small business lending in the U.S.  The article noted that, through the first quarter of 2011, loans outstanding to small businesses (defined as loans less than $1 million) dropped 8.6% versus 2010 first quarter levels.  The WSJ also noted the results of the most recent Pepperdine University study (see our blog post of June 11th), which affirms that small businesses are having a difficult time securing loan funding versus larger companies. The Pepperdine report (1,221 business owners) shows, for example, that only 17% of loan seeking companies with revenues less than $5 million were able to find financing in the prior six months, in contrast to 37% of companies with greater than $25 million in revenues.  Time magazine echo's these observations.   These realities are a primary reason that we have tended to focus on small business lending topics in our posts.

"Change or die" was the mantra of GE's long-time CEO Jack Welch, and many years after his retirement those three words remain true.  Large, accelerating advances in technology have had a profound accelerating impact on the rate of business change.  Few businesses stay the same over long periods and, in my view, that timeframe is more likely than not to continue to be compressed.  The risk of being passed by competitors increases accordingly.

While there has been much written about the processes of managing change and developing innovation strategy I'm curious about the "root" of the latter.  How do you as a business leader or entrepreneur source ideas for innovation?  What inspires your thinking?  What resources do you use?  I thought it might be interesting to start the conversation (hint - please join the dialog!) by sharing sources that I have accessed to spark my thought process. 

Pepperdine University's Private Capital Market Project has just released its Summer 2011 Survey report.  The survey, as we've mentioned in prior blog posts, is intended to be a real world investigation of private capital markets.   Survey participants include a wide array of industry representatives.  In this case over 2,500 people participated including 1,221 private business owners and finance professionals operating in multiple segments, including; investment banking, angel investing, venture capital, private equity, mezzanine financing, bank lending, asset based lending and factoring. 

We recommend that you join in future surveys in order to gain access to information that may prove useful to you and your businesses.  Not only does the report aggregate survey results for business owners, but also by finance market segment.  So if you are looking for benchmarking for valuation multiples by size of company and industry, this report provides that information.  Other information includes expected finance source return expectations as well as trending data.

Signs of a return to pre-crisis commercial lending activities seem to be emerging.  The title of a recent article in CFO magazine notes, "Revolvers return, with some twists".  Other data seems to support that assertion and recent activities that I've witnessed first hand on the lending side are also aligned.  Commercial lenders are getting more comfortable that the recovery has stabilized and have been getting more aggressive in the financing terms they are proposing.  There is more competition for new transactions which is driving lenders to sharpen their pencils when proposing interest rates, covenants and other requirements.

The CFO article has a few interesting observations:

The complexity of ownership for company founders taking on new investors can be significant.  Investor terms are influenced by a number of factors including those that are company specific, those that relate to the environment (not the least of which are the supply and demand for capital) and an array of other intangibles.  You've undoubtedly heard horror stories of founders that sell ownership in their company only to run into unexpected issues regarding control and ownership dilution after the investors are on board.  

Those horror stories led to one unhappy founder formulating a model structure to protect founders from unexpected surprises.  An interesting recent New York Times article entitled "Founders Now Take the Money and Maintain Control" discusses a general shift in the current market towards greater investor reliance on retaining founders as C.E.O.'s.  Also the article tracks the story of how Sean Parker, the aforementioned unhappy founder now venture capitalist, has taken the pro-founder model structure and turned it into a template of sorts with assistance of experienced, like-minded people.  This strikes a chord with us as it is one of the core reasons we founded VFHUB.com, to level the playing field by sharing learning experiences and adding more transparency to financial services transactions.

The Startup America Partnership is an interesting organization with some serious support.  Started at the end of January this year as a U.S. Government initiative to drive innovation and job creation, Startup America is a non-profit, independent private sector coalition focused on facilitating the startup and accelerating the growth of U.S. companies.  Initial funding to cover costs of initial staff and operations has come from The Ewing Marion Kauffman Foundation and The Case Foundation.  However, many other notable organizations are supporting the effort through the donation of products and services, including: the U.S. Government, Cisco, IBM, HP, Intuit, Google, Microsoft and a growing list of others.

Despite the involvement of the aforementioned heavyweights, Startup America is really "by entrepreneurs, for entrepreneurs."  The idea is to surround high potential entrepreneurial ideas with experienced mentors, advisors, funders and service providers to get numerous companies off the ground and ramping up operations (and hiring).   The objective is to reduce startup barriers for new companies, particularly those focused on new technologies.

Good financial transaction benchmarking information is very hard to come by for small and middle market companies.  As our members know, we started VFHUB.com to address that issue, creating in a mature state a real time repository of data.  We've run across other sources of general benchmarking information and there is one that we believe is worth pointing out to you and investigating further.

Pepperdine University's Graduate School of Business runs surveys and reports on U.S. Private Capital markets.  The initiative, led by Dr. John Paglia an Associate Professor of Finance at the school, regularly surveys professionals operating in a wide range of financial service sectors and, also gathers input from private business owners and executives.  Paglia and his team then sort through the data and put out nicely constructed reports that provide very useful data.  The number of contributors tends to be just over 1,000 (and growing), but despite a somewhat limited survey size, the output is directionally aligned with what my colleagues and I see in the markets.  If you like what you see at the Pepperdine site, we recommend that you sign up for future surveys and reports and if you want to stay more closely connected you can apply to be added to the LinkedIn group organized by Paglia.

I was recently reading through a report from late last year and thought that you might find some of the information interesting and useful.  Again, if you check out the Pepperdine website you'll have the ability to download reports to review more deeply.

One very interesting piece of information from the survey noted the expected returns by capital providers on new investments.  It generally runs as you'd expect ... i.e. venture capital firms expect a higher return on their investments than banks, but there was at least one surprise for me (see if our thoughts align).  Here is the list from lowest expected returns to the highest:

1. Banks:  3 - 6%
2. Asset Based Lenders (ABL): 4 - 18%
3. Mezzanine Firms:  18 - 22%
4. Private Equity Groups:   20 - 30%
5. Venture Capital Firms:   25 - 40%
6. Angel Investors:   30 - 60%
7. Factors:  39 - 75%

My surprise?  Factors.  I would have expected the returns to be around the level of Mezzanine or even between ABL and Mezzanine.  Of course, the data may be off based on a low level of survey participation by Factoring professionals, but interesting nevertheless.

The Pepperdine surveys also provide additional data useful for businesses, such as:  trends in financing markets, expectations for the next 12 months, evaluation metrics for the average borrower (i.e. financial ratios), collateral advance rates and others.  Again, the survey roughly lines up according to expectation between risk classes.  For example,

Bankers indicate the following median financial evaluation metrics for borrowers:

• Current Ratio:  1.4:1  with an approval limit of 1.3:1
• Debt to net worth ratio:  2.0:1 with an approval limit of 2.4:1

Asset based lenders surveyed provided the following:

• Current Ratio:   1.0:1 with an approval limit of 1.0:1
• Debt to net worth ratio:  2.1:1 with an approval limit of 2.5:1

As expected, the bank lenders indicated tighter financial requirements for borrowers than the ABL group.  That said, I've seen ABL lenders be much more aggressive on the ratios mentioned above!  Again, that may have something to do with survey sample size.

A few more bits of information that might be interesting or helpful to you.

ABL all-in 1st quartile (most credit-worthy) rates charged for working capital loans depending on deals size (note: median term if 36 months):

• $1 million:   6.1%
• $5 million:   5.0%
• $10 million:   3.2%
• $25 million:   3.0%
• $50 million:  3.0%
• $100 million:   2.6%

Equipment Financing all-in 1st quartile (most-creditworthy) rates by deal size with a median term of 48 months:

• $1 million:   7.0%
• $5 million:   5.3%
• $10 million:   3.9%
• $25 million:   3.5%
• $50 million:   3.4%
• $100 million:   3.0%

Of course, as we've noted many times, there are multiple variables involved in financial transactions, well beyond rate and term.  We encourage you to contribute transactions to the VFHUB database so that you and your fellow members can gain the benefit of strong, real time, detailed information for your use.

Are there any other surveys like this that you believe would be valuable to other VFHUB members?  If so please let us know!

Among the funding debt or equity funding options in the U.S. markets today are a relatively small group of Small Business Investment Companies (SBIC's).  SBIC's are private companies, partially funded  and regulated by the U.S. Small Business Administration, that focus on providing debt and/or equity financing to qualified small and emerging growth businesses in the U.S.  As these companies are often considered to be an attractive alternative to "mainstream" venture capital funds and/or debt sources, we thought it would be helpful to put together a brief overview and provide resources to allow our members to investigate deeper if desired.  Don't worry you haven't missed considering these firms, SBIC's are already in the VFHUB database, so as you sort through potential financing providers they are incorporated into your search results! 

The SBIC program has been around since 1958 and, according to the National Association of Small Business Investment Companies, SBIC's have provided almost $60 billion in long-term debt and equity funding since that time to more than 107,000 companies.  Those companies include Compaq, Federal Express, Jenny Craig, CostCo Wholesale Clubs and Outback Steakhouse.  One of the trademark's of SBIC companies is their "sweet spot" in providing financing in the $250,000 - $5 million range.

Every so often we like to provide you with a high level update on trends in the U.S. venture capital and angel investment markets ... levels of investment, industry segments gaining the most investment dollars as well as other news that might be of interest to you.  We'll do that in this post and, by the way, if you'd like more frequent information please check the Tools & Resources tab for links to data sources and remember to use the Forum area to connect with other members if you have information or other needs.

Venture capital investment activity has increased over the last year or so in line with improvements in the U.S. economy as you might expect.  More confidence for VC's that they will be able to access funding and more confidence that investee companies will face a more positive demand landscape.  The PricewaterhouseCoopers / National Venture Capital Association MoneyTree survey indicates that for 2010 VC funding totaled $21.8 billion over 3,277 deals, a 19% increase in dollars invested over 2009.  They report that the increase was spread across almost all industry segments and importantly almost 30% more new companies received funding than in 2009 when investments were focused on funding existing VC portfolio companies. 

Equipment leasing is a common financing tool in many markets.  The Equipment Leasing & Finance Association puts annual U.S. leasing volumes at over $ 1 trillion - this includes everything from copy machines to "large ticket" items such as aircraft.   This is big business!  However, as we've noted before, like all finance products the product terms can vary markedly between finance sources (or "lessors" in leasing terminology). 

To that end we thought it would be beneficial to point out some of the more costly areas that are commonly overlooked by companies ("lessee's") when they enter into equipment lease transactions.   As always, we welcome your comments and experiences on this subject!

Before we get into our list of costly areas we want to note that from a legal and accounting perspective not all "leases" are alike.  In a true leasing arrangement the lessor (finance company) is the owner of the asset and agrees to allow use of the asset to a lessee (company) for a certain period of time in exchange for rental payments.  At lease maturity, the lessee returns the equipment to the owner or may have a contractual right / option to continue to lease the asset or purchase it.  In today's marketplace there is a mix of lease structures and it is important to understand the structure for accounting, tax and legal purposes (although accounting treatments are changing).  Generally there are two types of leases:

1. Capital Leases - are in effect loans and are commonly treated as such for legal and accounting purposes.  These financing agreements are commonly structured as transactions with a payment stream and a fixed purchase price at lease end ($1 is common for small ticket items).  In the leasing business these are know by a number of terms such as: quasi-leases or Dollar-out leases. 
2. Operating Leases - these are the true leases described above.  The risks of ownership are retained by the owner/ financing source.  As a result the lessor also retains the right to depreciate the asset for tax reasons, which provides it with an economic benefit (not the lessee). 

Here is our checklist of three important areas for you to focus on:

• Lease End Options - make sure the lease end options are clear and you understand them well.  Common options are:  (1) return, (2) renew / continue the lease, or (3) purchase the equipment "as is".  Returning equipment often requires: (i) meeting certain return standards - if they are not met it will cost you, (ii) returning the equipment at your cost to a point of the lessor's choosing - make sure to restrict the return point.  Renewal - see point # 2 below, plus if you renew you should revisit the: rental payment amount (lower if possible) and the purchase option price (reduce it)!  Regarding the purchasing option - seek a firm option price (preferable) or a cap on the price.  We recommend you avoid FMV (fair market value) purchase options.  

• Notification Periods - a very, very common oversight by lessees.  The way this works is that the lessee is contractually required to formally notify the lessor of its lease end intentions within a specifically defined period of time - commonly within 90 - 120 days prior to lease maturity (but no sooner).  If the lessee does not provide the prescribed notice, the lease is deemed to be automatically renewed for a stated period of time.  So if a lessee misses the notification period it will continue to receive monthly invoices and continue making payments as it had done for the prior 3 - 5 years.  Lessors generally are not required to remind the lessee and many lessors make significant income from renewal payments, in fact some states have been moving to require lessors to provide notices to the lessees to remind them of their need to provide notice.  Make sure you understand the lease end notification period.  If possible require the lessor to provide you with notice and/or create a reminder mechanism for your business to ensure that you do not overlook this potentially costly requirement. 

• Costs / Pricing - most often proposed lease agreements will only quote payment amounts and a firm repayment term, plus potentially a purchase option amount.  Leasing companies prefer to quote payments only because it does not allow a company to calculate the cost of the lease - or, put another way, the "implicit interest rate."  Lessors are also more frequently quoting "bundled payments" ... so you have financing of the asset, maintenance or service plus potentially insurance or other services included in the lease payment.  Again, this makes it extremely difficult for a company to understand the true implicit cost of the transaction.  Remember also that in a true leasing arrangement the lessor also has value through tax deductions for depreciation ... so theoretically the lessor could pass along all or part of those benefits to its customers to lower the implicit rate below even a market loan rate.   We recommend that you de-bundle all lease offerings to understand the cost of each component.  For the base equipment lease - to calculate the "implicit rate" you need three variables: the cost of the equipment, the number and amount of payments including the purchase option (state price if you've negotiated one or the capped price + any associated costs).  You should calculate the implicit rate in order to compare it to, for example, the cost of a loan (we can provide that calculation service if you need assistance). 

This is quite a complicate subject, but we hope that this post has provided you with broader perspective on equipment leasing.  We should note that true equipment leasing is almost always more costly for a company than acquiring equipment via a loan. 

Feedback?  We'd love to hear from you! 

The Wall Street Journal published a recent article entitled "Credit Unions Push For Small-Business lending" that I thought was a very interesting subject for a blog post.  Personally I've always seen great value in credit unions because they are non-profit and exist for the benefit of their members so as a result their objectives are aligned with mine.  Credit unions are great places to get good, low cost financial services such as checking accounts, car loans and even home loans.  So in my mind when I put credit unions in a business context it has a strong appeal. 

Credit unions have historically done a modest amount of business lending to their members (by law CU's can only provide services to members), including SBA loans.  In 2007 27% of roughly 8,000 U.S. credit unions reported having business loans on their books with an average loan balance of $180,710.  I have also seen other information indicating that some CU business loans reach upwards of $1 million.  As you might imagine business lending activity was greatest in larger institutions.  Credit unions tend to be small relative to banks, at the end of 2009 only 355 had total assets of $500 million or more (that's roughly the size of a decent sized community bank). 

I ran across an article in the November 2010 issue of Inc. magazine entitled, "When banks won't lend, companies try customer financing", that presented a few alternative financing options for small and mid-sized businesses.  One of those options was - direct public offerings.  As the article describes it: "DPO's have existed for decades as a way for small businesses to raise capital from wealthy individuals ... Regulators in 47 states has been allowing businesses to raise up to $1 million a year ... using a financing technique called the small corporate offering registration, or SCOR."

The article notes that businesses are using SCOR to invite customers, employees or other interested individuals to invest via their websites or product labeling.  A wikipedia posting on the subject indicates that the a DPO can be completed within 9 months for a cost of around $100,000.  This is a financing route that I haven't seen previously but one that I thought could be of interest to come of our members ... so let's take a closer look.

Since its founding in 1953 the U.S. Small Business Administration (SBA) has grown quite significantly, and provides quite a few resources to small businesses in the U.S.  We've long encouraged our members to visit the SBA website for sources of information and even better, to visit one of the state SBA development centers or one of SCORE's 800 business counseling centers (Note:  SCORE also even offers online access to expert advice!).  

These are resources that are worth checking out and regularly accessing even if your firm is not directly looking for governmental financial assistance!  They are simply good, inexpensive (largely free) resources. 

The SBA was established to assist the growth of small businesses through counseling, making some direct loans, encouraging the formation of and funding small business investment corporations (SBIC's) and, primarily by, providing loan guarantees to banks that lend to small businesses that otherwise would not be able to access funding.  We thought it would be useful to our members to at least provide some high level information and helpful web links.  Speak up if you wish us to drill down in any particular area in future blog posts!

When does it make sense to use a third party intermediary to raise debt or equity capital for your company?  What is the cost?  How do I find a good firm?  Those are some of the questions we will touch on in this post and, of course, the benefit of your experience on the subject is very welcome!

The "king" of intermediary groups are investment banking firms.  Investment banks are specialists in financial engineering and linking companies to capital markets for large sized transactions.  Common specialties of i-banks include: merger and acquisition advisory (both buy and sell-side), private placements of debt and equity, restructuring and capital markets advisory services.   Often these firms will have geographic, industry and/or market niche specialties (for example: middle market sized companies) and can vary markedly in staff size.   Large commercial banking groups often have investment banking groups within their organizations.

Alongside i-banks, there are myriad third party brokers operating in the marketplace.  They are commonly small groups (or even individuals) that have experience as investment bankers or commercial lenders and relationships with a funding source(s).  At times in the debt marketplace these groups may even present themselves as a "principal", i.e. a funding source, which can lead to potential mis-setting of expectations and negative consequences.

On the cost side let's start out with a common investment banking fee arrangement.  While these arrangements will vary depending on variables such as the type of activity, size of transaction, the competitive environment, etc. the common structure contains three component pieces:

• Retainer:  $25,000 - $100,000 non-refundable upfront.  Often times this can be creditable against the transaction success fee.
• Success Fee:  A negotiated percentage of the total value of the transaction.  For smaller transactions there may be a minimum success fee.  Also the fee percentages may vary (increase) based on the value to the client -- i.e. an incentive to maximize value.  The definition of "value" is important to focus on as it may exceed the actual cash benefit the client is receiving.  Additionally the timing of the payment of the success fee needs to also be clear, ideally tied to when you, the customer actually receive the benefit vs., for example, close a transaction in escrow with conditions remaining for payout.
• Expenses:  are costs incurred by the i-bank for the account of the client?  Which costs?  Out-of-pocket?  Are the costs capped?

At the risk of over-generalizing, I've always heard the following fee ranges used for intermediary fundraising efforts:

• Debt:  up to 2% of the transaction amount
• Equity:  3 - 5 or 6% of the transaction amount  

When does it make sense to use a third party intermediary in capital raising?  That largely depends upon a number of factors such as:  experience and time availability of your management team, size of the transaction, the profile (risk or investment) of your company,  the extent of your contacts in the debt and investor markets and complexity of the transaction.  The more experienced and connected your management and the strong your company's profile, the more likely you are to be successful going it on your own with support from your legal and financial advisors.

If you engage with third party intermediaries, here are some suggestions to keep in mind as you move forward:

• Meet with multiple potential partners - go the formal RFP route.
• Know exactly with whom you are dealing with - firm size, time in business, ownership, call references, broker vs. principal (see notes above), financial strength (yes, ask for financial statements), etc.
• Insist on full transparency - make sure engagement terms are clear particularly compensation.  Is the intermediary getting compensation from anyone else?  (We've seen this way to much dealing with small / individual debt brokers who get fees on both ends!).
• Get it in writing - reviewed by your legal counsel.   
• Set Deadlines - set a reasonable timeline for the engagement.
• Debt intermediaries for small transactions - often no need to pay an upfront fee (only success fee) and no need to give an "exclusive", you may very well have more than one intermediary working to find funding for you (it's not uncommon).  

Finding a firm?  Look no further than VFHUB, that's what we are here for and that is what our community is all about.  You will find third party intermediaries in the VFHUB database in 3 provider categories:  (i) investment banks, (ii) intermediaries - debt, (iii) intermediaries - equity.  You can pull up listings by doing an advanced search using the variables most appropriate for your situation.  Again, we always counsel to consider searching broadly, for example, considering national firms alongside local or regional options.  As always, let us know if you have any questions or need assistance on this front.

Other resources for your further reference:

• Entrepreneur magazine article
• Investment banking fees white paper
• Law firm primer on investment banking relationships
• Another law firm overview on investment banking do's and don'ts

We're interested in your experiences here!  What have we missed?  Have you rated all the third party intermediaries that you've done business with in the VFHUB database (if not PLEASE DO!)? 

We took note of a recent press release put out by specialty finance company Hercules Technology Growth Capital (HTGC), a provider of venture debt funding for emerging growth companies.  The release highlighted that HTGC expected to book an $8 - $8.5 million gain from the sale of one of its customers, InfoLogix, to Stanley Black & Decker.  It further noted that the sale would provide it with an estimated internal rate of return in excess of 30%!

Since both companies are/ were publicly owned, we thought it was an interesting opportunity to take a closer look at the chronology and details of the financing relationship.  We characterize it as a venture debt deal gone wrong given the fact that the relationship didn't track as originally anticipated ... this presents a potential learning opportunity for companies looking at venture debt as a potential funding source.  What learning points can we take away?

Let's look at the chronology ...

Covenants have long been a reality in debt financing arrangements.  They function to establish boundaries and expectations for a business that allows a lender to gain comfort that the company will operate in a way that aligns with their range of expectations and, importantly, which should put them in a position to repay debt timely. 

But … are all covenants reasonable?  Our view is that it depends on where the boundaries are set, embedded in the details of the contractual language.

As we’ve noted in our two prior blog posts, covenants: (i) are not the same across all lenders, and (ii) are negotiable (assuming we are not talking about small transactions).  Avoid thinking of documents as “boilerplate”.

In this article we’ll end our series by discussing financial covenants.  However, before doing that we want to recap the two other types for our January Newsletter readers … please note, these discussions relate to primary lending relationships (not small transactions: where covenants should be narrower).  Also refer to our prior posts for more details and recommendations.

Affirmative covenants – are promises made by a borrower to do something over the course of a debt financing.  We outlined eight common covenants that we see as reasonable to both parties provided that the language – the boundaries – make sense, they are:

1.      Government compliance – maintain the business' legal existence and good standing.

2.      Taxes, pensions – pay all taxes, pension obligations and other charges when due.

3.      Collateral – maintain the lender’s collateral according to certain standards.

4.      Assets – preserve and maintain all material assets used in the business.

5.      Insurance – insure the assets, collateral and the business.

6.      Financial reporting – provide ongoing financial information to the lender and others where required. 

7.      Notices of material events – provide notice of litigation or similar material events.

8.      Inspection and site visits – gives the lender the ability to inspect its collateral.

Negative covenants – are promises made by a borrower that it WILL NOT do certain things over the course of a debt financing.  We outlined nine common covenants that we see as reasonable to both parties given, of course, reasonable boundaries.

1.      Dispose of assets – will not dispose of material assets.

2.      Changes in business or management control – will not liquidate or change ownership control.

3.      Mergers or acquisitions – will not merge or acquire another party (within limits).

4.      Indebtedness – will not take on more debt (within limits).

5.      Encumbrance – will not allow additional liens on lender’s collateral.

6.      Transactions with affiliates – will not engage in material transactions with affiliates.

7.      Distributions and investments – will not make loans or pay dividends or distributions (some exceptions).

8.      Subordinated debt – will not repay any subordinated debt beyond its contractual terms.

9.      Indebtedness payments – will not prepay other indebtedness or accelerate payment of any debt.

The third category of covenants is financially focused and is usually the first thing that jumps to mind when the subject of covenants is mentioned.  From a lender's perspective, financial covenants serve to place boundaries around the financial performance and condition of a business.  Lenders view these covenants as trip-wires, where violation of a covenant may be an indicator of negative change in the borrower's risk profile.  They are virtually always quantified and are more frequently being tied to pricing / costs in the marketplace -- i.e. trip a covenant and not only may you need to pay a one-time "waiver" or "reset" fee, but you may find the interest rate being charged may increase going forward.  So tripping a covenant can be very costly, which is why it is critical that they are set carefully and appropriately by borrowers taking into account seasonality, future plans, market trends and similar items.

Financial covenants are usually set around risk areas that tie to a company's ability to repay debt, for instance:  cash flow coverage, levels of liquidity, capital base size (cushion to absorb business shocks) and financial leverage.

Here are our recommendations for negotiating financial covenants (note: many of these principles also apply to negotiating covenants generally):

• Review proposed covenants early in the process.  As we've suggested in prior blog posts, at the time of proposal works best ... i.e. in a competitive setting.
• Make a case for having no financial covenants and present this early.  Your ammunition might include some of the following:  long time in business, a track record of strong financial results, the lender is over collateralized, short-term duration of credit risk for the lender, other guarantees made, the value of your business to the lender (i.e. depository accounts, other services used) and similar.   
• Be prepared - understand your company's future plans including financial projections.  Pinpoint areas where you see most potential volatility financially.  You'll want to negotiate covenants away from those areas.  "Stress testing" by assuming worst case scenarios and projecting the resulting effects on financial measures/ ratios will be helpful if a covenant is inevitable in the vulnerable area.
• Limit the number of financial covenants.  If the inclusion of financial covenants is required, negotiate to keep the number to a minimum, one or two if possible.  The more contractual "trip-wires" the less flexibility you have to operate and the greater the likelihood that you are going to violate a covenant.  Frankly the more covenants that are introduced, the more likely that they are simply redundant, effectively touching on the same area of risk.  Pointing those overlaps out is an effective "defense".
• Leave your company ample room to operate.  Check the covenants relative to your business plan, projections and stress tests to make sure that a small deviation won't cause you to trip a covenant.

Lastly, we'll reiterate our general covenant checklist: 

• In addition to a business review, your attorney should review all covenant language in the context of your documents. 
• For general covenants, establish minimum thresholds before triggering violation.  Also establish limits on waiver fees in order to avoid surprises. 
• Provide for reasonable cure periods in order to provide you with time to rectify any breaches without adverse consequences (your attorney should be reviewing this relative to the Events of Default section of the agreement). 
• Establish a systematic / regularly reviewed methodology for monitoring covenant compliance. 

Here is a good article on covenant setting that might be of further interest to you.

Have we missed anything?

As always, please share your experiences and comments! 

As the title conveys, negative covenants are items that a borrower promises a lender that it will not do over the course of the financing arrangement.  As with our last post on affirmative covenants, in this post we'll attempt to summarize the most common negative covenants that we believe are reasonable from the perspective of both the company/ borrower and the lender.  PLEASE NOTE: these covenants apply to primary lending relationships not smaller, one-off transactions.

We reiterate comments made in our last posting - while covenants often look like "boilerplate" contract language, the text can vary significantly between lenders and the covenants are certainly negotiable.  Our hope is that the following list, together with any associated member comments, can serve as a checklist of sorts for your future use.  Let's roll ... borrower will not:

As noted in our December 30th blog post, affirmative covenants are promises made by a borrower to do something over the course of the debt financing.  These promises serve as inducements for the finance source to make a loan and provides it with assurances that the business will be managed in a certain manner going forward, one that protects the lender's interest and is aligned with its expectations.  Please note that failure to comply with these covenants usually results in an Event of Default under the contract, and brings with it associated pain (time, costs, etc.).

Our objective here is to present a set of common affirmative covenants that we view as reasonable from a borrower's perspective.  This should provide you with a helpful baseline to use when reviewing debt documents. 

In our December 30th post we noted that often covenants, other than financial covenants which tend to be customized to the lending situation, are thought of as "boilerplate".  Usually lenders have a standard set of affirmative and negative covenants that form a part of all transactional documents.  HOWEVER, please do not assume that:

1. Affirmative covenants are the same across all lenders, they are not!
2. Covenants, even those that are "boilerplate", are not negotiable, they are!

As we've noted in prior blog posts, too often companies fail to review financing documentation until after they've selected a finance source.  Instead much of the attention is focused primarily on costs and key terms.  While that is appropriate, it can be a costly mistake to delay reviewing standard documentation terms until later in the process.  That approach can put a company in a bind if they find an unacceptable or problematic provision in the legal documents and need to close the transaction to receive funds.  

Tight funding markets over the last two plus years has spawned a couple of "new" niche financing options for businesses that have been highlighted in the media during the past several months.  The Wall Street Journal recently took a look at Royalty Financing as "An Alternative Financing Option for Start-ups" and the Journal also published a nice overview article on Crowd Funding.  Despite the "new" moniker - the products are not truly new, both have been utilized for many years in different niche markets.  That said, it is interesting to see how they are being developed for wider commercial use in the small business marketplace.  [Side note: when the word niche is used in the world of finance it almost always = expensive!]

Let's define each product in the context of small business financing:

Royalty Financing - a form of debt financing where debt is repaid based on the amount of revenue collected by the borrower.

Crowd Funding - an individual or business receives relatively small amounts of money from a range of third parties that are not professional investors.  In return the third parties generally only receive a token reward.  Crowd funding has its roots in financing charitable causes and the creative arts for funding art projects.

We've discussed both in our last couple of blog posts, but want to highlight some of our general findings for readers of the VFHUB Monthly Newsletter.  So, let's summarize the key take aways on these products and then we'll provide what we think are the most relevant resources for you in the event you want to find funding and/or explore further (if you do please let us know what you find!).

Key Take Aways:

• Both products are very immature in terms of their availability and utility for small businesses. 
• Funding amounts are modest, under $50,000 and usually much less.  The level of financing is likely similar to levels you might see from "friends and family".
• The products look to have garnered some interest and institutional funding, more so for the Royalty Financing Product.  So depending upon levels of demand and, importantly, investor returns, the product offering may grow and evolve further.
• Product attributes seem to be evolving.  In the case of Crowd funding one large obstacle in the U.S. (and likely other countries) is the regulatory environment.  But if the returns to the funding sources and their investors are large enough, I imagine that they will find a way to work through the obstacles.
• As we noted above - these products are more costly than traditional financing sources such as banks, angel investors or VC's.

Based on our review of the various niche players in these markets, we would point to the following business oriented providers if you are interested in exploring further:

Royalty Financing:

• Arctaris Capital Partners - www.arctaris.com
• Revenue Loan - www.revenueloan.com

Crowd Funding:

• www.profounder.com
• www.rockethub.com
• www.kickstarter.com

We've added all the firms that we've reviewed into the VFHUB database.   You can find them listed as "Specialty Finance" companies.

Let us know if you have comments, experiences or other thoughts on this topic!

In this post we'll take a look at another niche funding option - Crowd Funding.  This method to source capital has been in the news quite a bit lately including a recent article in the Wall Street Journal that provides a nice overview.

If you take a look at the Wikipedia posting (it's an interesting and informative read) for Crowd Funding you'll read that this form of fundraising has its roots in charitable causes and in the creative arts where artists, filmmakers, musicians, writers et al raised money, usually in small increments, to support their efforts - commonly around projects.  In most instances the amount of funding raised through this channel has been relatively modest - say under $50,000.  Here is a nice example of an artist's crowd funding pitch on Kickstarter.com.

So has this form of funding reached the business world?  The answer is yes, but in a very modest way, however it looks like there are efforts to find a way to bring it to the commercial markets in a bigger way to leverage social networks.  Let's explore a bit further ...

The tight funding markets over the last couple of years have spawned a couple of "new" financing options that have been in the news recently.  I say "new" because often when you reduce these products to their substance, they tend to be similar to existing products.  I find them to often be more of a "branding" exercise than a groundbreaking approach.  That said, it's worth us taking a closer look at two products that have been getting attention this year.  They are: Royalty Financing and Crowd Funding.  In this post we'll take a high level look at Royalty Financing and follow with Crowd Funding in our next blog post.

To start, let's define each:

Royalty Financing - a form of debt financing where the debt is repaid based on the amount of revenue collected by the borrower.

Crowd Funding - is a bit more difficult to define because there is wide variation in the funding structures, however, the essence of the product revolves around a company receiving relatively small amounts of money from a range of individuals and businesses that are not professional investors.  

As we've noted in our prior two blog posts, presentations to potential funding sources need to be tailored to the audience.  We've provided you with some thoughts and resources on presentations generally and on presenting to debt providers specifically, now we take a look at presenting to equity investors.  If debt / loan providers are primarily focused on judging your company's ability to repay the financing, what are equity investors focused on?  Equity investors are interested in a compelling return on their investment.   Of course there may be variations in, for example, return targets (i.e. friends and family would likely be different than an institutional investor), and other transactional elements like time horizon's, but theoretically their interest is investing at a base value and then exiting / liquidating that investment at a higher value.

That said, we believe that the range of equity investors in terms of risk appetite and market focus is broader than debt providers.  So we'll discuss some high level areas that a presentation to investors should include and also give you some web-links to other resources that might be useful to you.

As noted in our November 13th blog post, your business plan presentation should be tailored to your audience.  In this post we'll focus on the elements your presentation should address when interacting with debt financing sources.  Keep in mind that the focus of debt providers centers around the likelihood of repayment of their financing.  So along with understanding your business and financing need they will be considering "exit strategies" in the event repayment from operations is not possible.  For example, they will be weighing the value of collateral and their ability to liquidate it if needed or the value of obtaining a personal guaranty as a potential source of repayment.

One of the most effective ways to pitch to debt providers is to address the 5 C's of credit (see our November 7th blog post) within the presentation - basically providing the lender representative with "ammunition" to support your financing application.  I would not recommend doing this overtly (i.e. a 5 C's of credit slide!), but would fold the relevant information into the body of your presentation.  Keep the tone factual and not overly "salesy".

Here are some content related suggestions to help you address the 5 C's within your presentation.

Character:

• Include your mission statement and/or state your position on corporate social responsibility and/or treating your customers with integrity.  Message - you value your reputation.
• Time in business.  If your business has been in operation for many years, underscore this, particularly if you have survived adversity/ economic downcycles.  If you have a younger business, emphasize the cumulative experience of the ownership/ management team.
• Highlight your track record of repaying debt obligations on a timely basis.  If you have repaid transactions of the same size that you are requesting - state it!
• Have credit references (financial institutions and trade creditors) as well as customer references available to validate your business and character.
• Include management team profiles.  Start with the CEO / Owner, but also include experienced managers to show organizational depth.

Capacity:

• This is primarily a financial review - backward and forward looking.  The focus is on cash flow and the associated ability to cover repayment of the proposed debt.  You should be clear about this and note the key assumptions surrounding your analysis.
• Show that you understand and are not overlooking risks.  You can do this by stating them and creating a base (expected) case and worst case scenario for debt repayment.  Ideally you will be able to show that your company has ample cash flow "cushion" to absorb any surprises.
• Highlight the stability of revenues.  Do you have a diversity of long time customers?  If so, that is a significant strength and it should be highlighted.
• Do you have high variable costs that will allow you to quickly reduce expenses if necessary to preserve your repayment capacity?
• Lastly, add any details around your ability to access additional capital if needed: bank credit lines, investors/ ownership and trade credit for example.

Conditions:

• Include a discussion of macro and micro/ local economic as well as industry conditions and trends.  Cite or footnote reputable information sources if possible to add credibility to the data and analysis.
• Discuss how that information may positively / negatively affect your company.  How are you planning for it and mitigating potential risks?

Collateral:

• Since collateral is a primary exit strategy for debt financiers (i.e. via liquidation) you should discuss the collateral relating to your transaction in terms of quality and value over time (covering the length of the financing).  For example: if collateral is primarily receivables - show the diversity and/or credit strength of your customer base and describe how you manage the credit granting / collection process (you are on top of it!).  If the collateral is equipment, discuss appraisals you've had completed and/or similar equipment you have resold to evidence value retention.
• I recommend only including a focused discussion on the collateral that you are willing to pledge for the financing.  Lenders will often ask for additional collateral if they believe it is available!

Capital:

• Lenders look at a company's capital base (net worth) as a "cushion" to provide financial support to the firm if necessary.  Practically speaking, the company could generate cash to repay debt through excess cash from the liquidation of assets and retirement of any associated debt.
• Emphasizing asset quality and value will support a lender's evaluation of capital adequacy (see collateral discussion above).
• Similarly, where debt levels are relatively low (vs. capital) that should be emphasized to illustrate your "prudence" and "balance sheet" awareness.

Concluding your presentation with a concise summary of the request and reiterating the primary 5 C's messages will bring your message together nicely for your audience.

Do you have any debt presentation experiences you can share with us?  Comments?

Whether you are looking for a material amount of debt or equity funding, you will need to present your company's business plan to others.  This is often a critical element in the funding source's due diligence process, not only for the content but also because it gives them a chance to interact with you and, as a result, allows them to assess you!   In this post I'll provide you with some high-level suggestions on presenting your plan along with some links to online resources that may be helpful.  In subsequent posts we'll focus more narrowly on presenting to two distinct audiences - debt providers and equity investors.  I do this because each group has a different orientation, and that should shape your presentation.

Many have you have been through this process - successfully and unsuccessfully - what have you learned?  Please share!

When selling a product or service, negotiating with someone or even giving a gift, it is always beneficial to put yourself in your counterparty's shoes.  What are their needs, desires, motivations and values?  With this perspective you are better able to craft your message or business proposition to meet their needs.  

Applying that approach to a search for business financing, you should ask yourself - what do lenders look at when they are reviewing a loan application?

In the commercial lending world there are five key focal points considered when granting credit.  These elements have been taught for many, many years to bankers and credit analysts worldwide and are widely known as "The five C's of credit".  In this blog post I'll introduce those "five C's" to you to help you gain some perspective around the thought process of the lending community.

Before the last recession hit there was no shortage of funding sources in the marketplace.  With an oversupply of capital it was a buyers market and that supply / demand relationship had been stable for many years.  So a "buyer" (borrower/ equity seeker) had a wide range of choices and, if the buyer wasn't satisfied with a financing source, there were plenty of other funders waiting for an opportunity.  In today's market the supply / demand equation has changed and, as a result, it makes sense to reconsider how relationships with your capital suppliers are managed.  Vincent Ryan wrote a timely article on this subject in the October issue of CFO magazine called, "Take Control of Your Bankers" and it had some good, practical suggestions for managing financing source relationships worth sharing. 

A couple of years ago I came across an academic paper on Tradeoff Theory.  Amid all the heavy formulas, prior research findings and hypotheses, one sentence fragment caught my attention, it read something like: optimal debt structure hinges on which party has bargaining power in the event of a workout.

It caused me to consider how the concept of bargaining power applies to debt transactions.  I'd like to share one area that immediately came to mind as well as some practical tactics you should employ when negotiating new loans, leases and other debt transactions in order to preserve your bargaining power.

While the paper primarily focused on workout situations, the first experience that I thought of was a couple of situations where companies needed to retire debt early.  I recall at least two circumstances where biotechnology companies were being acquired by large pharmaceutical firms and the acquirers did not want to assume any debt with the acquisition.  Both biotechs had venture debt obligations.  One company has no prepayment rights, and the other had very high prepayment penalties.  Clearly neither company anticipated the need to prepay the debt when they were negotiating terms and therefore prepayment rights provisions were not an area of focus. 

At the time of acquisition, both companies had limited bargaining power.  They were required to pay off the debt early even though they had agreed to unfavorable terms in that regard.  The companies could not realistically dangle prospects of future business with the lenders, because the lenders were niche players and would not be able to be cost competitive against the pharmaceutical companies funding sources.

After attempts to negotiate improved prepayment terms, the biotech companies wound up paying off the debt at the contractual terms ... i.e. with prepayment penalties around 5% of the debt being prepaid.  In at least one of the cases, the penalty was around $500,000!  Afterwards I remember one of the lenders putting out a press release noting that its return on the transaction was over 18% (the original anticipated return was in the 10 - 12% range), PLUS potential upside from warrants it held!

Why would a lender require a prepayment penalty?  Fundamentally all finance companies invest time and money in sourcing loans and therefore need to keep those assets on their books in order to recover those expenses and, thereafter, earn a return.  The prepayment penalty is a way to ensure that costs will be covered and serves as a mechanism to dissuade companies from paying off their loans early.

For your reference, in my decades of commercial lending experience, prepayment rights were never a "deal breaker" when competing for business.  So, as you review (re-negotiate) existing loans or go to market for new debt financing, you may want to consider a couple tactics:

• Request details on prepayment rights in your request for proposal (RFP) document, on two dimensions: time and amount.  This tells the competing lenders that this is an area of focus and importance for you.  As you receive proposals you can leverage the best proposed terms against the competing proposals.  If you can't eliminate the fees in total, you should limit them to the first year only and to a nominal fee (say no more than 1% of the loan balance).  One other tactic might be to carve out certain events ... i.e. no prepayment penalty if your company is acquired.
• Request that sample documents accompany all proposals (see our July 15th blog on this subject).  Among other items, you should review the prepayment rights.  What is the scope of your right to prepay, costs and associated calculations (note: we've seen some based on the original loan balance not the current loan balance at the time of payoff!).   

Do you have any experiences on this subject to share?  Tactics to add?

If you've been active in reviewing the VFHUB Transaction database you may have seen our comments regarding a new loan provision that has popped up during the economic crisis.  We've seen it given several provision titles, including:

• Additional Costs
• Increased Costs
• LIBOR rate, increased costs adjustments

We've highlighted it in our transaction comments and thought it would be worth highlighting further in our blog because it has potentially very costly implications for your company and we're seeing it more frequently. 

Does your company rate its banking relationship on a regular basis?  What about investors or insurance companies?  If so, on what basis?  What are the key rating criteria?  We believe one of the most valuable benefits for VFHUB members is the sharing of experiences with financial service providers through, among other things, a standardized rating process.  An honest assessment from a peer can be very valuable in avoiding mistakes and, on the flipside, finding and rewarding the best finance partners.

We regularly become aware of websites offering funding or designed to connect small businesses to funding sources, both debt and equity.  Some are traditional sources, some are newer concepts like "crowd funding" which is effectively a peer-to-peer funding model.  At some point we will investigate these sites, however, we thought it could be useful to at least pass along the links to you to investigate if you have the need, time and inclination.  If you do please let us know your thoughts and experiences by posting a comment to this blog or sending us an email.  At some point we'll compile this information and present it here.

Access to capital is a challenge in today's marketplace and the array of debt financing options and providers can often be confusing and even overwhelming.  All you want is access to funding when you need it, at a fair price and with reasonable terms.  So how do you make sense of it all and navigate your way forward? 

Before chasing potential solutions we suggest that you first consider taking the following two steps to gain a realistic view of your options.

In late August a member asked in the Forum area for a sample template to be used to solicit proposals from finance providers for an equipment financing transaction.  We passed along a form to JOHNJ77 and noted that we would also publish it for the benefit of all members (in the absence of being able to post it for member download!  We've added that functionality to our list for future development).  The template we provided is presented below.  WE WELCOME YOUR THOUGHTS AND SUGGESTIONS AS TO HOW THE TEMPLATE MIGHT BE IMPROVED UPON!

I once read an article, actually an academic paper, on Tradeoff Theory.  The theory looks at optimal debt and equity structure (A LOT of big hairy equations!), you can check out the link if you desire to learn a bit more about the subject.  One line from the paper read caught my attention.  It read something like this: optimal debt structure hinges on which party has bargaining power in the event of a workout.  I began to think about how the concept of bargaining power applies to debt financing and considered some of the experiences I have encountered where bargaining power came into play.  I thought it would be a very good subject to discuss here.

I ran across a relatively recent blog post (April 2010) on mezzanine financing that provides a nice summary of current deal terms in the marketplace.  The post includes some high level pros and cons along with criteria that mezzanine providers are currently looking for in a borrower profile, plus the range of standard pricing and terms that borrowers are getting.  I've found that it is rare to find information like this online.  What was just as interesting was a comment on the post by a reader who works at a moderate sized private equity company.  He had what I believe is a little more realistic view on pricing - i.e. 19% at the low end (in the riskier end of the market -- smaller EBITDA, < $10 million), and well into the lower 20's at the high end.  He also makes the point that in fact the current cost of mezzanine financing is in the range of equity funding.  Given the narrowing of costs between the two, he suggests that businesses need to look more critically at the two alternatives.  That is prudent advice.

As noted in our recent press release (see the News area), the initial focus for VFHUB has been on building membership in the U.S. before expanding internationally.  That said, we intentionally designed the VFHUB platform to accommodate an international audience.  So you will find providers that operate internationally and of course new providers can be added by our members no mater where they are located.  I write this blog post from Ireland and will be traveling to The Netherlands next week.  As I read the press, speak to people in the financial services markets outside the U.S. and observe business practices it is very clear to me that the impending changes in financial regulations, being developed in virtually every major country, are likely to bring closer international alignment among the finance sectors.   

The National Venture Capital Association and Pricewaterhouse Coopers recently released the U.S. 2010 Q2 venture capital investment activity results (you can find them >> here).  While the total amount invested improved 30%+ over Q1, the levels remain well below pre-recession levels (roughly 30% below the first half of 2007 for example).  The good news is that the activity is up over 2009 which generally parallels the slow, ongoing economic recovery.  On the subject of venture capital, I'd like to share with you a couple of good articles on the process of securing venture capital and company valuation.  I hope they will provide you with some helpful perspective.

The advanced search function is a powerful tool for our Members.  I thought a brief, simple example of how to use the search function would be helpful.  So in this blog post I take one of the Forum topics submitted by Lisa and show how she might identify, in this case, a group of factoring companies as part of her search to identify potential financing sources.  VFHUB has a provider database of around 10,000 across a wide variety of provider types (venture capitalists, private equity firms, banks, equipment leasing companies, investment banks, insurance brokers and more) and we add more virtually every day.  If you see "gaps" please let us know and we'll fill them! 

For Members who are not familiar with this product – it is niche debt financing for venture capital backed companies operating in emerging growth markets such as; biotechnology, internet enabled services and other high technology sectors.  The debt financing comes with a high interest rate and almost always with equity participation, commonly in the form of warrants.  It is an interesting market that has been around for a couple of decades, but seems to have evolved since the mid-2000’s towards more “risk taking” on the providers part … but is that really true?  Do venture loans offer real value for companies? 

In my experience most borrowers do not review lender documentation as part of the process of evaluating lender proposals.  Instead they wait until they close the financing, which is often just as they need to take delivery of an asset, or need to make a payment to a contractor.  In other words, at a time when they have less leverage with the finance company.  Do you as a business executive ass-u-me that all commercial finance documents are fairly "boilerplate"?  Or ass-u-me that they really are not negotiable?  The practice of not reviewing documents at the time you are evaluating competing proposals can be a costly mistake.  When do you review documents?

I thought I'd share some lighter thoughts as we enter a new week, including a (hopefully) recurring segment we'll call Links to Laughs.  I'm not sure about you but I can always use a good laugh ... not enough of those these days.  I was in search of laughs recently and saw the movie Grown Ups with Adam Sandler, Kevin James, Rob Schneider, Chris Rock, Salma Hayek, et al.  Unfortunately I didn't get many laughs and would not recommend it ... unless you're hitting one of the $1 movies from the vending machine at your local grocery store.  I did, however, see a movie this weekend (via NetFlix) that I enjoyed very much.  It is called:  180 Degrees South.  A recently released documentary, basically an adventure oriented movie with a healthy, but not over the top, environmental message.  Great music and videography.  I've added it to our Members recommendations area.  Did you know that in the Tools & Resources section we have a Members favorites area for Movies and Books?  You should check it out and feel free to e-mail in your recommendations - we'll add them to the selections!

Henry Ford once said, "Coming together is a beginning. Keeping together is progress. Working together is success."  Well, with the assistance of many talented and insightful people, we have created our initial version of VFHUB.  Our site is dedicated to meeting the growing need of business executives for greater transparency in financial services markets.  Together we have conceived it, tested it, tweaked it, populated an initial database, re-tested, re-tweaked and, with a good foundation, are now beginning to promote the site.  We expect that our new Charter Members will provide a big boost for us as we work together towards success.  And so it begins ...

Do you involve an attorney in all your financing transactions?  At minimum, do you have an attorney review the documents that you sign?  My experience tells me that this is usually a threshold issue.  So, for example, for small transactions many businesses do not have an attorney involved at any level, and "standard boilerplate" documents are signed with only a review of key terms - primarily repayment terms.  For equity transactions, my suspicion is that an attorney is almost always involved in the transaction.  Where do you draw the line?  What is your policy?

A recent economic survey of small (sales < $10 million) and middle-market companies (sales $10 - $500 million) revealed an expectation of increased sales and profits over the next 12 months along with a corresponding need for capital.  However, the same survey group reported that debt financing has become more difficult to obtain during the second quarter of 2010.  Persistent, tight credit markets have required businesses to focus on (get back to?) working capital management fundamentals and get creative where necessary.  How does your company rate in terms of working capital performance?  Do you track working capital metrics?

It's a very interesting time to be in business these days.  In many ways it is like we are all, collectively, living a Harvard Business School case study.  I made that comment recently to an executive of a global finance company who laughingly agreed with the analogy.  He can chuckle about it now that his company has found its footing, but times have not been easy over the last couple of years.  Businesses and financial service providers alike are navigating their way through the recession and are learning lessons.  A recent survey of CFO's, in the U.S. and other countries, underscores a realization that it is a riskier world to navigate financially.  We hope that you will actively share your learning experiences here on VFHUB, so that we may all benefit from them.  Here are some of the risks those surveyed indicated were of high concern ...

You may have noticed that VFHUB's transaction area provides a large number of fields to capture a range of information about debt and equity transactions.  Why?  I'll resist turning to clichés to answer the question and simply say that it is precisely in the details where costly mistakes can be made.  Once we go live with the website we'll start dissecting transactions on this blog to highlight areas to focus on ... believe me, it is not only about the interest rate or dilution rates.  We also attach constructive comments on transactions in the VFHUB database, making them essentially mini case studies.  In fact we added a venture debt transaction recently where the stated cost to the customer (interest rate) was just over 10.5%, however, by our calculations the effective cost was over 18% (we had a lot to say about that deal)!  If you are shopping interest rates 10.5% may look attract to a biotech company, but in the context of the whole, focusing and comparing alternatives solely on rate would be very misleading.  We'll profile that transaction, and others, once we go live.

I ran across a blog post by a Venture Capitalist that I found interesting on a number of levels.  The post was written in response to a question posed by a college student after the VC had delivered a lecture on entrepreneurship.  The question was: "So, now I know more about how you decide on which startups to back.  But, more generally, what do you do?  What does a typical day or week look like?"  I took away four things that I thought I'd share with you ...

While we finish-up pre-VFHUB launch activities (thus the slow blogging activity!), I thought I'd share with you some of the more interesting and maybe helpful web links that I've traversed recently.  One is an interview with Paul English, a co-founder of Kayak.com, the online travel site.  While he is a high tech guy, the subject matter is relevant for all businesses, tech or not.  Plus I think it's always interesting to hear the entrepreneurial back stories, especially from someone who has been very successful.  You can listen to the audio or read the transcript here.

According to the Center for Venture Research, total angel investor funding in 2009 was $17.6 billion, which was roughly an 8% decrease from 2009.  That $17.6 billion in funding was spread across over 57,000 entrepreneurial ventures (a slight increase over 2008) spread across multiple sectors including, most prominently:  healthcare services/ medical devices, industrial / energy (driven by trends in green technologies), retail and biotech.  The level of angel funding was virtually equal to total Venture Capital funding in 2009 ($17.7 billion), but spread across 20 times the number of companies!    

How do you manage the world of risk identification and insurance at your company?  How do you track trends and pricing, compensate your broker, select and evaluate your broker?  The VFHUB community can help. While much of the focus at VFHUB is on debt and equity funding, our database also includes information on insurance brokers and insurance companies.  If you haven't already rated your broker and insurer, please do that now!

As you may have seen over the past week, there are some encouraging signs that the funding environment is gradually improving.  The trend, as you might expect, is starting with the largest, most creditworthy companies, where accessing capital has significantly improved.  Smaller and medium sized firms, unfortunately, are still largely finding it rough going.  The Economist.com points out that one of the underlying reasons for the slow thaw is that many of the non-bank finance companies have had difficulty getting funding - i.e. their fuel to lend. 

We’ve all seen commercials and advertisements pitching our ability to lease the latest model car for an incredibly low monthly payment.   It’s commonplace today and I’m very sure that it has put millions of people into BMW’s, Lexus’s and other luxury cars based on the “lure of the monthly payment”.  Similar tactics are commonplace in commercial markets but, unfortunately, businesses don’t enjoy the same legal financial cost disclosure requirements as consumers.  Do you also look at cost and not simply monthly payments?

I always find vacation to be a chance to be a little reflective.  An opportunity to put work on mute for a while and take a big step back to gain perspective on life and career.  This year I am in Marco Island, Florida enjoying some warmth and, especially, time with my family.  I see plenty of people with cell phones pressed to their ears and serious looks on their faces ... who knows, maybe they are talking to an old friend or reserving a jet ski?  I hope you'll agree that regular perspective checks are a good thing both in business and in life.  VFHUB was established to give business executives a unique chance to find broad, unbiased perspective on financial services markets.  Are you getting that vantage point? 

By all accounts venture capital activity in 2009 was the lowest in many years.  The 2009 MoneyTree Report compiled by PricewaterhouseCoopers and the National Venture Capital Association reported that venture capital investments in the U.S. totaled $17.7 billion in 2009.  This represented funding across almost 2,800 transactions.  According to the report, this was the lowest level since 1997.  By comparison the funding amount was a full 37% less than 2008.  Further, the NVCA reported that fundraising by venture capital firms themselves, the "fuel" for investing, in 2009 totaled approximately $15.2 billion (vs. $28.6 billion in 2008), the lowest level since 2003.  We're now nearing the end of the first quarter ... how is 2010 shaping up?

The interest rate is the largest cost in almost all debt transactions.  For that reason it is usually the key focus for any company looking for financing.  It should not be the only factorin evaluating a transaction (we'll discuss these in later posts), but we'll discuss here some of the factors influencing the setting of interest rates by finance sources as well as how to compare, or "benchmark", interest rates using VFHUB.  This knowledge can be powerful in negotiations and also provide you with peace of mind!

The array of funding options can be confusing, particularly to businesses that only access capital markets sporadically.  Terminology used in the marketplace can also add to the confusion.  I thought it might be helpful to put the various funding options into some perspective for our Members.  I ran across a matrix that I developed in mid-2007 that summarizes the main product types.  While today's markets are chaotic, the categories shown below should help you see the bigger picture.  I include brief definitions, common collateral required, typical structural elements and expected returns for the finance source.  Again, remember the return expectations are from 2007.

Earlier this year several large national and regional banks announced their intention to actively lend billions of dollars to U.S. small businesses in 2010.  This includes firms like J.P. Morgan Chase, Wells Fargo and Huntington Bancshares among others.  The question is – is that happening?