Saj­jad Hamid

?One of the big is­sues that own­ers of small- and medi­um-sized en­ter­pris­es (SMEs) face is get­ting fi­nanc­ing.

Ear­ly stage ven­tures tend to con­sume more cash that they gen­er­ate. They are some­times called cash sponges.

Lat­er stage en­ter­pris­es and post start­up phase firms, even though they are in a pos­i­tive cash po­si­tion, need cash to ex­pand the busi­ness. They need cash to in­tro­duce more prod­uct lines, ex­port, give cred­it, etc. So whether at ear­ly or growth stage, busi­ness­es need ac­cess to cap­i­tal that is eas­i­ly avail­able and at a rea­son­able cost. Some­thing that is quite chal­leng­ing to get.

There is an ad­di­tion­al prob­lem that is on­ly unique to the SME sec­tor. The cap­i­tal it needs tends to be risky and need­ed for the medi­um to long term. It's called growth cap­i­tal as op­posed to work­ing cap­i­tal. So en­tre­pre­neurs face a dilem­ma, how do they grow the busi­ness so they can com­pete against the big guys and at the same time at­tract cap­i­tal at at­trac­tive rates. This is the biggest sore for en­tre­pre­neurs.

Sources of cap­i­tal

Cap­i­tal can take two forms: debt and eq­ui­ty. Debt is es­sen­tial­ly a loan and it must be paid back with in­ter­est. Nor­mal­ly the lender asks for col­lat­er­al and, in de­fault, the bor­row­er can lose the as­set of­fered as a guar­an­tee.

The prob­lem with debt cap­i­tal is the ear­ly stage busi­ness own­er does not have busi­ness as­sets and there­fore can­not of­fer any. She will have to put up per­son­al as­sets or in­come to get a loan or ask for a guar­an­tor.

Com­mer­cial banks tend to avoid these risks as they are as­set-based lenders. So ear­ly stage ven­tures tend to strug­gle for lack of cap­i­tal or be de­pen­dent on the founder's in­vest­ment.

Eq­ui­ty fi­nanc­ing on the oth­er hand is con­tri­bu­tions by the share­hold­ers and are own­ers of the busi­ness un­like debt fi­nancers. Eq­ui­ty has the ad­van­tage in that con­trib­u­tors may not re­quire a div­i­dend un­til the lat­er stages of the busi­ness. This can give the busi­ness bet­ter cash flow as prof­its can be rein­vest­ed. Share­hold­ers at some point will ex­pect div­i­dends or the cap­i­tal back plus ap­pre­ci­a­tion. They look for big re­turns as the risk is greater; the law in fi­nance is the greater the risk the greater the re­turn on in­vest­ment.

Eq­ui­ty fi­nanc­ing can come from many sources for SMEs; founders, the 3 Fs (fam­i­ly, friends and fools), an­gels, ven­ture cap­i­tal and pri­vate eq­ui­ty funds.

Fi­nanc­ing chal­lenges

Un­like small busi­ness­es, large en­ter­pris­es have good cash flow and a large as­set base so they can bor­row from banks at prime rates (best rates) and ac­cess the stock mar­ket. Small ven­tures are stuck with be­ing con­strained by cash flow prob­lems and lack of in­ter­est by eq­ui­ty in­vestors.

Our en­tre­pre­neur­ial cul­ture is that busi­ness own­ers do not like out­side eq­ui­ty in­vestors as they (founders) will have to dis­close fi­nan­cial in­for­ma­tion.

We al­so do not like to share in the wealth (or be open to pub­lic scruti­ny) and this cul­ture has its draw­backs.

Have you ever no­ticed that some large en­ter­pris­es in T&T: Ma­touks, As­so­ci­at­ed Brands and SM Jaleel are not on the lo­cal stock mar­ket, even though they com­pete against com­pa­nies that have ac­cessed the cap­i­tal mar­kets. So when SM Jaleel go out to bor­row, they are prob­a­bly pay­ing a high­er cost of cap­i­tal than, say Co­ca Co­la, giv­ing them a big dis­ad­van­tage.

Busi­ness an­gels

Busi­ness an­gels, as the name im­plies, are in­di­vid­u­als who are al­lies in the busi­ness. They are peo­ple who are of­ten es­tab­lished en­tre­pre­neurs, who in­vest mon­ey and time in fledg­ing en­ter­pris­es at the pre-seed or start­up phase of the busi­ness life cy­cle and hope to get some fi­nan­cial gain. An­gel in­vestors tend to be mo­ti­vat­ed by their need to in­vest sur­plus cash in an ex­cit­ing ven­ture that they have some in­dus­try ex­pe­ri­ence.

Re­cent­ly, I was in­vit­ed to a work­shop ti­tled, "An­gel In­vestor En­gage­ment Train­ing For En­tre­pre­neurs" spon­sored by the Caribbean Ex­port De­vel­op­ment Agency (CE­DA) in Bar­ba­dos. The pre­sen­ter, Nel­son Gray, gave some ex­am­ples of suc­cess­ful an­gel fi­nanc­ing.

In 1999, Ram Shri­ram pro­vides US$100,000 & US$200,000 to Lar­ry Page and Sergey Brin–founders of Google–to help its start­up. He owned about five mil­lion shares (at the IPO stage) in the com­pa­ny worth about US$580 per share to­day. You do the math, but his re­turn at the IPO stage (he has since sold some shares) was in ex­cess of 10,000 times his ini­tial in­vest­ment.

An­oth­er ex­am­ple was the case of David Berkus, who was asked by a for­mer em­ploy­ee to in­vest US$100,000 in a start­up known as Ama­zon.com. He did not. If he had, his ini­tial in­vest­ment would have been worth US$42 mil­lion at the IPO.

So the up­side is high re­turns for in­vestors if they can in­deed spot a fu­ture win­ner.

How­ev­er, not all ear­ly stage com­pa­nies can be­come the fu­ture Google or Face­book. These gazelles are the ones that can more than com­pen­sate for the firms that un­der per­form or go bust. An­gel in­vest­ing is not for the faint heart­ed. It is for the in­vestor who will spend the time look­ing through a large num­ber of prospects to find po­ten­tial gazelles.

In­vestor at­trac­tion

Ac­cord­ing to Gray (CE­DA) busi­ness an­gels are look­ing for the fol­low­ing qual­i­ties in start­up com­pa­nies:

�2 Be will­ing to give up some con­trol of their com­pa­ny

�2 Have po­ten­tial for high growth

�2 Plan an "EX­IT" with­in five to sev­en years

�2 Have a team: an­gels in­vest in teams (not in­di­vid­u­als)

�2 Have time: It's eas­i­er to raise funds when you don't need them

If these cri­te­ria are not met, an­gels tend to look for the next best can­di­date. So if you are on the search for an­gel fi­nanc­ing, make sure you get those tips right.

Crowd­fund­ing

Crowd­fund­ing or crowd­sourc­ing is a new con­cept to raise aware­ness, feed­back or to gain sup­port (fi­nan­cial or oth­er­wise) for your idea, prod­uct or com­pa­ny and it nor­mal­ly us­es the In­ter­net.

A few weeks ago, the Caribbean Cen­tre for Com­pet­i­tive­ness (CCC), host­ed a ses­sion on crowd­fund­ing. Pre­sen­ters An­drew Far­quhar­son and Lyn Bara­nowsk spoke on "In­no­va­tions in Fi­nanc­ing: Con­cept to Com­mer­cial­i­sa­tion: SMEs/Start-Ups" They iden­ti­fied four types of crowd­fund­ing mod­els: eq­ui­ty, do­na­tion, debt and work­ing cap­i­tal.

The eq­ui­ty mod­el is where the firm own­ers can raise cash from bid­ders and in­vestors get a share of the com­pa­ny. Some ex­am­ples in­clude Ven­ture­Health and Poli­wogg. Re­cent­ly, some sites have start­ed to serve spe­cif­ic in­dus­tries or niche mar­kets.

The do­na­tion or pre-sell­ing mod­el is ei­ther ask­ing you for a do­na­tion to sup­port them or some­times the com­pa­ny is ask­ing you to pay mon­ey up­front for a prod­uct un­der de­vel­op­ment. So the sell­er gets valu­able cash to fur­ther de­vel­op it and you get a chance to get the first one. The most fa­mous sites are Kick­starter and In­dieGoGo.

The debt mod­el is where lenders re­ceive prin­ci­pal and in­ter­est. An ex­am­ple would be Lenders Club. Mar­ket In­voice would be an ex­am­ple of work­ing cap­i­tal mod­el and they sup­ply cred­it to cov­er ac­counts re­ceiv­able, a crit­i­cal is­sue at start­up.

Good and the bad news

The good news for en­tre­pre­neurs seek­ing to raise cap­i­tal is that there are more op­tions to­day. Tra­di­tion­al­ly, it was just the 3 Fs and fi­nan­cial in­sti­tu­tions. Now you have an­gels, crowds and pos­si­bly ven­ture cap­i­tal. How­ev­er, these in­no­va­tions have not gained ac­cep­tance as yet in T&T. There is need to de­vel­op a mar­ket for an­gel fi­nanc­ing lo­cal­ly, which might ex­ist in a small and in an in­for­mal way. The crowd­fund­ing mod­el on­ly works if you can ac­cess to a for­eign Web site. There are no lo­cal ver­sions here. But some­thing tells me, giv­en the ben­e­fits of these two in­no­v­a­tive forms of fi­nanc­ing, lo­cal fi­nan­cial en­tre­pre­neurs might be plan­ning to en­ter the mar­ket soon.

Saj­jad Hamid is an SME con­sul­tant. He can reached at en­tre­pre­neurt­nt@gmail.com; en­tre­pre­neurt­nt.com