How to decide financing options in the current market environment

Much of the country is still recovering from the recession, making it difficult for companies to secure financing. Northern California, however, is an exception.

“It’s definitely a bifurcated market right now. The environment for financing is very robust here in Silicon Valley and other tech hubs,” says Kelly Cook, senior vice president and market manager at Bridge Bank. “If you read the Wall Street Journal or the Economist, they say banks are still not really lending. That’s not the case here.”

Smart Business spoke with Cook about the financing environment and methods available for companies to get funding.

Why is the financing environment good locally? Is it the market or the technology industry that’s here?

In the Bay Area, the unemployment rate is low, even for nontech companies. There’s a ripple effect — a lot of nontech companies service the tech industry.

There is a large amount of new capital available from all different investment sources from corporate venture arms, to traditional venture capitalists, to the angel groups that are forming, as well as private equity and hedge funds getting back into the tech financing market. All of that is rippling through the local economy and job market.

When does equity financing make sense?

Equity financing is readily available for entrepreneurs and management teams that have a good track record and offer a new technology or new way to address a big problem in a big market. In the earliest stages of a company, equity financing is the way to go. The decision is about what type of equity to raise.

Options include sweat equity — using the founder’s money and/or knowledge, raising money from friends and family, or angel investors. If you are far enough along in terms of product and initial customers, you may attract institutional equity financing.

There are various theories/approaches on how much ownership stake to give up for that equity. Savvy entrepreneurs know how to raise just enough to reach the next value-creating milestone. Once a company generates annual revenues approaching several million dollars, more choices will open up on the debt financing side.

Do you have to show consistent profitability before banks will offer debt financing?

A lot of entrepreneurs, CEOs and CFOs don’t think they can raise bank debt financing when the company is still cash-flow negative, but that’s not the case. A true technology-focused lending group has a number of solutions including working capital lines of credit, which are underwritten based on the strength of a company’s accounts receivable. There also are invoice-specific financing structures, asset-based lines, and traditional, revolving, borrowing-based lines of credit.

How do you determine what form of debt financing is right for your business?

That’s a consultative discussion among a company and its finance partners. If a company has revenue and cash tied up in the accounts receivable cycle, it should consider a working capital line of credit such as a line tied to specific invoices or a collection of invoices. With regards to a more permanent source of debt financing, a potential lender will look at your business plan and determine whether it can support typical financial covenants and a term debt structure. If so, then typically that’s the least expensive form of term debt financing.

But if a company’s forecast won’t support covenants, or you don’t want to be burdened by managing covenants because there’s too much uncertainty, then a venture debt structure makes the most sense.

Banks also can be used in conjunction with other financing partners. Banks are regulated entities, and are limited in terms of providing venture debt. But they can participate with a venture debt provider and combine that with a working capital line of credit from the bank. That combination can be a powerful solution because it gives short-term financing at a low cost and flexible term debt that extends cash runway to allow a company to execute its business plan.

There are flexible, customized solutions for each company, but it takes some digging into the plan, market and financial history. A good lender will conduct a diligent underwriting process to determine pricing and structure that meets a client’s needs.

Kelly Cook is a senior vice president and market manager at Bridge Bank. Reach him at (650) 462-8513 or [email protected].

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