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SMART ANSWERS
By Karen E. Klein

8.5.99  
When You're No Longer a Startup, Where Do You Go for Financing?
There are lots of options -- each has its costs and limits

Q: I have a Web design and programming business that I started with a low-documentation loan guaranteed by the U.S. Small Business Administration. Currently, I need to secure some funds for expansion. Should I take out another loan or seek venture capital? --R.S., New York

A: You've reached a critical time in your company's life cycle if you're seeking second-tier funding and getting ready to expand. No longer do you have to expend most of your energy just proving that your company is viable. You've probably attracted some good employees, respected clients, and established a presence in your market. It's a good time to be looking for cash. Interest rates are still quite low, and bankers are increasingly eager to tap the small-business market, though it can still be frustrating to get them to bet the larger amounts young companies need when it comes time to expand. Market conditions are also excellent for attracting venture capital. (See Business Week frontier Online's finance section for a library of detailed articles on capital conditions and funding sources for small businesses.)

First, update your business plan. You'll need that whether you approach lenders or VCs. From here, you need to show the right people that your company has the potential to get to the next level. "If you can prove that you've got some blue-chip clients -- companies that will grow with you -- and you're on your way to the $10 million or $20 million level, where you're likely to be acquired or go public, you can get some strong connections into private funding," says investment banker Peter Cowen, of Peter Cowen & Associates, in Westwood, Calif. "What you want to do now is lock in your vital assets -- like your best employees -- perhaps by giving them some ownership potential in your company rather than pay raises. Offer equity that vests one year from now so you can qualify people," he advises.

In your search for funding, don't lowball your request. Entrepreneurs often underestimate how much capital they need. You certainly don't want to go back for another infusion of cash six months from now.

You've got lots of options: If your capital needs still fall within SBA criteria -- loan sizes are generally limited by the $750,000 maximum the agency will guarantee for a lender -- you might call a financial specialist at your local SBA office and explore the possibilities there. There are some big lenders -- Heller Financial (www.hellerfin.com), Newcourt Financial (www.newcourt.com/content/guide/financial/divisions/divisions_c01_21.htm), and The Money Store (themoneystore.com) to name a few -- that specialize in SBA-guaranteed loans and financing small-business growth. (See Business Week frontier's Lender Profiles for more details.)

Venture capital might be available to you, depending on your size and whether you're doing work VCs see as hot and innovative. VCs are investing heavily in Internet and telecommunications infrastructure these days. They're looking for new products with big-time commercial potential. They have no interest in being the 18th variant on an E-commerce concept. If VCs think you have the potential to hit it big, they'll give you plenty of guidance and money to get your innovation to market fast -- not because they're nice but because they want a 25% to 35% annual return on their investments. For their pains, they exact a big chunk of equity.

If you lack collateral for a loan -- not unusual for Web companies -- this might be a good time to take on a partner or merge with another company similar to your own. "Someone else right around the corner from you may be trying to reach the same market you are. By joining forces now, you could take advantage of economies of scale and really make a big splash," says Bill Peterson, of Peterson Investment Banking in Chester, Md. He recommends professional help to boost you to the next level. "Get a small, independent investment banker who can give you personal support at reasonable cost," Peterson says.

If you can't afford to lay out cash for consultations right now, try to attract some seasoned businesspeople -- particularly those with experience in growing Internet companies -- who can act as informal advisers. "Look for experienced, smart, successful people who like to mentor," Cowen says. "Promise them equity in the company down the line, and let them know they will segue into a board of directors at some point. They will be likely to bring in more good people to strategize with you on their own."

At this stage of your company's development, investors and lenders are looking for evidence that you can handle the role of chief executive of a larger company. Not every entrepreneur can make the leap. Some of this is hard-core business strategy. You'll need to put together bigger deals with bigger clients. Appearances will matter, too, though. You'll want to start looking and acting like a more substantial company. That will probably mean a new marketing strategy and updated sales materials. Consider ramping up your profile by speaking at conferences and offering your views as an expert. Those experienced advisers can provide invaluable coaching to help you get to the next level, too.

Have a question about running your business? Ask our small-business experts. Send us an E-mail at editors@businessweekmail.com, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.

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