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How Have You Financed Growth?

“How Have You Financed Growth?”

CEOs reveal what worked and why.

After the terrorist attacks of 9/11, imports from Afghanistan and Pakistan became less reliable, and consumers bought fewer luxury items — including hand-woven rugs. That posed problems for Rug World Oriental Rugs of Brentwood, Mo. Bob Shallenberger, an equity partner with Rug World, asked customers with deep pockets for loans, an idea that helped his 11-year-old company hurdle the rough terrain and finance long-term growth.

When the United States was bombing Afghanistan, banks didn’t warm to the idea of loaning money to a business with Afghani suppliers. So I chose an alternative means to get cash.

I approached loyal customers with this proposition: Loan Rug World $50,000 now, and you can purchase $50,000 worth of rugs later at only 10% over margin. What qualified as "later" was negotiated individually with customers. Multiple customers agreed. The cash injections propelled us through the choppy waters of 2001 and 2002. What’s more, it established a deeper relationship between the store and regular customers. It nourished their loyalty.

We also approached our handful of foreign suppliers and said, "Look, if we don’t sell, you don’t sell. We need a break right now. So instead of paying up front for a rug, let us pay when we sell it." They agreed.

We’re continuing both tactics until the economy stabilizes. Rug World’s annual sales are now between $1 million and $5 million.

4 investors and a market shift

In May 2000 Susan Bird paid $1.5 million for EPL Bio-Analytical Services, a 13-year-old laboratory in Harristown, Ill., which focused on pesticide analysis. Three months later, EPL lost its primary client: a government-funded research study that had been slated to continue through 2002. Bird suddenly found her two-year cushion gone.

I immediately searched for other markets. We tested dog food for potential contaminants and chicken for preservatives — anything corollary — to make payroll. Once we landed those accounts, we turned our attention to financing growth.

EPL could no longer rely on government studies. We asked employees, "What are you best at?" Their answers pointed toward agricultural studies, so we queried major seed producers nationwide about their current and future needs. One agreed to come on board if we could develop a series of tests for genetically modified corn. The problem was that we needed to fund 13 months of research before this company officially became a client.

To finance that period, two investors, industry associates of my husband’s, bought 10% of the company; a third investor, a former EPL employee, bought 5%. (We had cut the staff from 18 to 10, which caused some resentment, so soliciting an investor from the employee pool had to be done delicately.) We also established a relationship with a fourth investor, who agreed to pitch in and help make payroll when ends didn’t quite meet. Finally, a state-sponsored program granted us a low-interest loan. Altogether EPL raised more than $1 million.

Though we temporarily shifted markets and sold part of the company to investors, we desperately needed the cash and would take the same route again. Since then, we’ve experienced tremendous growth.

From May 2000 to May 2001, our revenues were only $684,000, down 75% from when I bought the company. In 2002 revenues were $1.2 million, and we expect $6 million by the end of this fiscal year. We’re currently hiring and investing profits to fuel additional growth; investors are now knocking on our door.

Customers and vendors assuage risk

Founded in 1996, Speck Product Design Inc. of Palo Alto, Calif., manufactures computer devices and consults for large tech firms such as Dell. Tony Lillios, a partner at the $4 million company, tapped clients and vendors to fund certain tooling processes, which enabled Speck to build the infrastructure for new products without footing the bill.

Customers often maintain separate funds for tooling, which we can take advantage of. Vendor financing works similarly: To help foot the bill for a prototype’s development and the infrastructure needed to produce it, vendors who will profit from the product are asked to help finance its tooling.

If tooling doesn’t work, Speck will spin off a prototype and develop a licensing agreement. Then an investor or other company has the option of assuming the risk of developing the product for which we have a patent. We receive income from these licensing agreements; it provides stability to counterbalance the risk of developing other prototypes.

We plan to continue using tooling — either through vendors or customers — and licensing agreements to finance growth. Last year we were down to $3 million in revenues, but now we’re back to $4 million, and we plan to grow between 25% and 50% annually.

Detour develops funds, credibility

Peter Abraham, executive producer of Fusion Films in Santa Monica, Calif., financed a documentary by producing short, commercial-like videos for large companies such as BMW and MTV.

I wanted control over my vision. I used to produce commercials, but that became unfulfilling, so I went out on my own, producing commercial shorts that were later sold as videos. They took off. I used that money (about $500,000) to create "I Am Trying to Break Your Heart," a documentary about an alternative band, which has established Fusion as a serious production company. In 2002 our revenues were $6 million.

Now I’m interested in producing commercials again, but our reputation — and the level of work we’ll be producing — has improved in quality and quantity. Creating the short films for commercial clients helped Fusion acquire new perspective, clout and credibility.

Buy now, pay later

Michael Brey, founder and president of Hobby Works Inc., a $6 million chain of craft stores based in Laurel, Md., uses a mixed bag of financing.

Say a landlord agrees to help pay for renovating of one of our locations. Instead of hiring a general contractor to do the work, I’ll take the money, do it myself and fold the money back into my business. I’ve raised $10,000-$35,000 per store this way, and I’ll do it again when we open our fourth retail outlet this year.

Vendor financing can be risky. I buy a large quantity of goods, but don’t pay for them for 90 days. I can then sell the products and use the cash to fund other initiatives, but it only works if the product is a "churner" and sells quickly — like small pots of paint that hobbyists buy with abandon.

Hobby Works now has secured Small Business Administration (SBA) loans. SBA loans are expensive; after the first loan, I said I would not get one again. But now I’ve become acclimated to the idea of debt.

Tip: Even though nearly every bank says it processes SBA loans, only some banks are experts. Save yourself some hassles and investigate to find the experts.

This combination of financing and SBA loans has helped Hobby Works grow its revenues to $3.5 million in 2002, up from $2.4 million in 2001.

Less is more

Michael Goldstein, president, Magazine-of-the-Month Inc., a $1 million company based in Washington, D.C., first solicited venture capitalists (VCs) for funding. But uncomfortable with accepting a large chunk of money, Goldstein instead secured growth capital by asking large clients for a 50% down payment on work provided by his company.

Venture capitalists were only interested in giving Magazine-of-the-Month upwards of $1.5 million. I didn’t need that large of an infusion, nor did I agree with their strategy of burning through money. So I took my own route: slower growth built on large accounts.

The key was asking for half our money up front. (I basically made up that number. I just knew I needed a sizeable amount to get a program started and to pay the bills. It worked.)

I assembled an amazing board of directors with good contacts. Their advice really helped me avoid the temptation to get more money than I needed and grow at a VC-directed pace. Yes, we’re growing quickly — 300% last year — but that’s slower than the VCs planned. We plan to continue the down-payment strategy with large accounts, which generally have a sales cycle of one to two months.