Trends in Financing & Transactions for Small and Mid-Sized Businesses

From 2003 through 2007 small and mid-sized companies (revenues from startup to several hundred million dollars) had a good chance of raising capital if they had a decent business in a stable or growing industry. As the financial markets stalled in 2008 and plummeted in 2009, many companies found themselves with limited capital and shrinking income and profits. While not much better in 2010, the markets are very slowly beginning to thaw-¦.it will likely be several years until financing levels and availability returns to any semblance of normalcy.

Money raised by venture capitalists is at a low, and it is expected that the number of venture funds in the next several years will shrink significantly as those with poor performance and short track records fail to replenish their coffers. We are experiencing a “right sizing” of the venture capital industry to more sustainable long-term levels. While there are many high net worth investors and angels, there is still a reluctance to invest until businesses can make credible revenue and cash flow forecasts. Though there is a guarded sense of optimism in the business community, hoping for a better 2010 …we must not be lulled into a sense of false security as the markets and economy recalibrate.

The banks have significantly increased reserves, and in general have a policy mandate to lend to small companies. A disconnect exists between the policies of the banks, the current administration’s directive and the regulators’ actions. In listening to commercial bankers, many claim their hands are tied by the regulators with increased scrutiny and pressure to be risk adverse. In many instances this has led to a stalemate between the mission to regulate and the desire to lend.

So where do Small and Mid-Sized Businesses (SMB) find capital? The most likely sources of financing for companies can be segmented into four broad groups based on the stage, need and current company performance:

1. Asset based lenders – these firms make loans against accounts receivables, inventory and sometimes purchase orders; they fund working capital.

2. Growth equity funds – these investors provide capital for well managed privately held businesses that can demonstrate the ability to excel in their particular market niche -¦and that require permanent capital to capture market share or move to the next level. Sometimes these investors will facilitate a recapitalization or partner buyout.

3. Mezzanine funds – these are hybrid lenders/investors that provide subordinated debt for expansion and recapitalizations. They are also a good source of financing to fund acquisitions.

4. Key partners – this source of funding involves engaging suppliers and customers -¦focus on those that have the most to gain from your company’s success.

Another dimension to the funding challenge, and related topic, is that of available buyers for shareholders or owners seeking liquidity. Keep in mind that the difference between a buyer and an investor is the percentage ownership of the business. In today’s market there appears to be buyers for well run market leading companies -¦let us call these the “A” players. The “C” and “D” players are most likely going to shutter. Those in the middle, i.e., the “B” companies (which make up most of the market) must intentionally take action to become an “A” player or likely find themselves headed backwards. For those “B” players that have solid product lines and well positioned products or services, but find themselves with a problem balance sheet, there is likely a solution -¦possibly a large strategic buyer with cash looking for opportunities to increase revenues and bolter earnings.

With the threat of a double-dip recession, increased taxes and unpredictable future health care costs, leaders of small and mid-sized companies must act to secure their future by taking bold and decisive steps to become an “A” player!

Kenneth H. Marks is the managing partner of High Rock Partners, providing growth-transition leadership, advisory and investment. He is the lead author of the “Handbook of Financing Growth” published by John Wiley & Sons. You can reach him at [email protected].