Off-Roading Your Way to Financing

Despite significant easing of the credit constraints and continuing near-record interest rates in the post-financial crisis era, many midsize companies and startups are funding their growth and expansion through alternative-financing strategies. Among these novel, capital raising methods is crowdfunding—less so the Kickstarter “please donate” concept and more the newer debt and equity models similarly drawing in crowds of online investors. These newer platforms share some DNA with Kickstarter, but they provide an actual return on investments. The concept has also rapidly gained momentum as a funding method, reportedly growing between 60 and 80 percent in 2012.

By 2014, the crowdlending market is projected to be $6.7 billion, according to Lending Memo, which is the largest periodical on the crowdlending space. Other alternative-financing strategies like capital-equipment purchase and lease schemes and atypical debt and equity models also are thriving. Given the easy credit and low rates, the obvious question is, why bother with such alternatives?

The answer seems to be speed. Both startups and growing, midsize companies sense a rare opportunity that must be seized now.

“The companies that come to us are fed up with banks,” says Alex Tonelli, co-founder and managing director of Funding Circle, a crowdfunding marketplace. “The banks require so much documentation and have so many restrictions that literally months can slip by before any money is handed over.”

Many midsize businesses and startups also perceive draw- backs with traditional, private equity; chief among them is the concern of the firms’ sticking their noses where they don’t belong. “We sold our business to a private equity group and were quickly dissatisfied with the relationship,” says John “Jay” Ripley, co-founder and co-chairman of Sequel Youth and Family Services, a Round Hill, Virginia-based operator in 18 states of academic programs for young people experiencing behavioral problems. “We’d been in this business for 25 years, and they wanted to get in our shorts and run it themselves.” When Ripley had enough, he bought them out via a unique, alternative-financing concept. (See sidebar, “Four Paths to Unconventional Capital,” p. 39.)

Needing Money Now

Other companies like Mixt Greens, Ayla LLC, Sustain Condoms and Sonoma Cider were similarly fed up with traditional funding methods, and turned on the crowdfunding spigot instead. Had they not, they might still be waiting for investor interest and bank capital. Sonoma Cider is the brainchild of David Cordtz, co-founder and CEO of the Healdsburg, California-based maker of hard cider. Cordtz has worked in the beverage industry for more than 25 years and previously was the national sales manager for another hard cider manufacturer. In 2012, he happened to glance at the market growth for the beverage and nearly fell over. “The growth was ridiculous,” he says.

Indeed, the hard cider category had shot up from an annual 5 percent to 6 percent average growth rate over the past 25 years to more than 100 percent in 2012, the fastest growth rate for any beverage category. Even better, this rate was expected to rise further. Drinking-age millennials had apparently taken to hard cider like their great-great-grandpar- ents once enjoyed the drink. “Prior to Prohibition, hard cider was the leading alcoholic beverage in the U.S.,” says Cordtz. “Young people like that it’s a craft alcohol like some beers, but [it] is much lighter, organic and does not have any gluten in it. It hits the happy spot.”

Cordtz did the math and it added up to a $2 bil- lion market in four years. With his son Robert and longtime business associate Fred Einstein, Cordtz incorporated Sonoma Cider in December 2012. They successfully reached out to Novus—a small, private lending institution—for the startup money, as well as to a small group of angel investors, mostly friends and family. One of them mentioned CircleUp, an equity-based crowdfunding site.

CircleUp’s investors are comprised of hundreds of investment firms looking to park their money with companies in the consumer and retail spaces. The distinction between it and the typical private equity firm is that these investors are willing to write smaller checks. “A PE firm managing $500 million is not going to invest $500,000 in a startup or midsize company,” explains CircleUp founder and CEO Ryan Caldbeck.

CircleUp’s investors, who typically put their money into technology businesses, gain portfolio diversification and significant returns. “According to the Kaufman Foundation, the consumer and retail space averages a return of 3.5 times the investment in 4.5 years,” Caldbeck notes. Not too shabby at all.

For clients, the attraction is the speed of the investment. Caldbeck claims it takes 12 months for the average consumer or retail company to attract funding up to $10 million, the site’s cut-off point. “Our average is 61 days,” he says.

That swiftness was important to Cordtz, who wanted his cider business up and running in less than a year in order to take advantage of the market opportunity. “It seemed like the best way to reduce the time required to do this,” he says. “We took a nice chunk of investment capital from them to build our plant. We’re up and running now and on track to hit $4 million in sales our first year.”

Sustain Condoms also found an angel in CircleUp. Jeffrey Hollender, co-founder and CEO [of Hollender Sustainable Brands, which introduced Sustain Condoms], which he calls the “world’s first sustainable condom” (Not what you think; the product is made of fair-trade latex sourced from rubber trees), had previously launched the highly successful Seventh Generation line of environmentally safe household products, selling the company in 2010. He positioned Sustain Condoms the same green way, with a twist. “Only 19 percent of women use condoms as a form of birth control, and we wanted to dramatically increase this volume by marketing a condom specifically to them,” Hollender explains.

He sought to raise at least $3 million to get the company to market as quickly as possible, but [he] had no stomach for debt, private equity or venture capital, preferring instead to reach out to individual angel investors. Several former investors ponied up and CircleUp rounded up the rest.

While he won’t divulge the percentage of capital these inves- tors represented, Hollender says he could not have funded the company without them. “One of them even joined my board,” he adds. “It was an efficient process that didn’t eat up any time, which was critical. Best of all, they got me to people who really understood both the value and the risks [of] what I was trying to do.” The product hits the market in June 2014.

Can You Spare a Few Million?

Mixt Greens is a multi-unit, quick-serve restaurant company with five locations in San Francisco and two in Los Angeles, making tossed-to-order salads and sandwiches. The six-year-old company also turned to crowdfunding for capital, but not in equity form, as the company’s owners did not want to dilute their ownership stakes.

Like Sequel Youth and Family Services, Mixt Greens previously was owned by private equity and reacquired by its founders (in early 2012). “We didn’t want to go the equity route again, and banks hate restaurants,” explains David Silverglide, CEO and co-founder of the San Francisco-based, casual dining chain. Despite promising unit economics and scalability, banks were unimpressed with Mixt Greens’ potential. “Even the banks with which we’d had longstanding relationships and did tens of millions of dollars a year in business with wanted so much paperwork that the whole process became too cumbersome to continue,” Silverglide says. “Valuable time kept slipping away.”

Silverglide had heard about Funding Circle from a friend and enquired about a $250,000 capital loan to build a new restaurant in San Francisco. Within weeks, the money was forthcoming. “It was a bit more expensive than what we would have had to pay a bank, but they at least understood our unit economics and profit,” he explains.

Funding Circle’s mission is to connect businesses needing up to $500,000 with an investor base that includes family offices, wealth advisors, high-net-worth individuals, fixed income funds and alternative-asset managers. “Our cash flow makes it easy for us to service the debt, and the timing alone makes up for the [loan rate] difference,” Silverglide says.

He points out that the biggest limiting factor in a restaurant chain’s growth is real estate. “When an opportunity beckons for a prime location, we now have the financial flexibility to seize it,” he says. Mixt Greens has since gone back two more times to Funding Circle to raise an additional $500,000 for two more restaurants, each opening in mid-2014.

Ayla LLC also went the Funding Circle route. The company sold high-end skin-care products like serums, cleansers and moisturizers online and wanted to branch out into its first brick and mortar store. “We were about to expand into makeup lines; and since most of our customers are women with challenging complexions and adult acne sensitivity, that’s a tough combination to market online,” says Dara Kennedy, founder and CEO of the San Francisco-based business.

Opening an actual store required more capital than she had, and Kennedy did not have a network of wealthy friends and family from which to draw. She visited her bank, but it imposed “too many restrictions,” she says. “They wanted to lend us hundreds of thousands of dollars when we only needed $50,000. I had built this business with as little money as possible, focusing on the bottom line, and that was not the route I wanted to go.”

Funding Circle provided the $50,000 and the store opened in October 2013. The week after, the San Francisco Chronicle featured Ayla in an article and customers swarmed the counter. Kennedy again is reaching out to Funding Circle to open two more outlets.

The Maddening Crowd

All this sounds too good to be true, of course. But, crowdfunding does have its drawbacks, chiefly higher loan rates and more attractive equity arrangements for investors than traditional capital sources. The concept also is so new that other downsides may eventually surface, says Daren Brabham, an assistant professor at the Annenberg School for Communications and Journalism, and author of the book Crowdsourcing. “I’m a big fan of crowdsourcing; but if you can get money from a bank, you should be doing that,” he counsels. “It may be great for startups; but for midsize companies, there are a
lot of gray areas here that will take time to become clearer.”

Among these gray areas is the JOBS (Jumpstart Our Business Startups) Act, easing some securities regulations and signed by President Obama in 2012. Certain provisions of the act have yet to be implemented. “It’s just not fully clear yet how the SEC (Securities and Exchange Commission) or FINRA (Financial Industry Regulatory Authority) will implement the remaining sections,” says James Walbom, CFO of Tiempo Development, a Tempe, Arizona-based software development company, who has similar reservations. “What if the way things are presented to investors now fail to go the way the investors’ expected? What implications might that have? To me, it’s casino stakes, a little too undefined for the moment. Consequently, we prefer more traditional means of capital financing.”

Among these means, of course, is the “go-it-yourself ” route—building a business without borrowing a dime or giving anyone a piece. That’s what Kim Overton did, launching Overton Enterprises with a single product, the Spibelt.

It’s the classic American business story, by way of Horatio Alger. A personal trainer at the time, Overton was jogging and saw other women running with their house keys secured in their bra tops or in a bulky belt pouch. “I thought, why not a one-inch wide slender pocket made of elastic like when a snake swallows a mouse,” she says. That day in early 2011, she sewed her first Spibelt (the first three letters stand for small personal item).

Today, Overton Enterprises sells Spibelts and related items directly and through intermediaries, its 15 employees sewing them in a 5,900 square foot warehouse. 2013 sales were $5.5 million. “I’m building this business on cash flow,” says Overton. “No way I’m sharing any of it with banks or investors.”