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Raising Capital in an Economic Slowdown

The credit market is tight, but businesses with solid credentials can take advantage of lowered interest rates. Plus, other avenues to pursue

Raising capital is difficult under normal conditions, and a tight credit market and fears of an economic slowdown have made the challenge harder. Unproven early-stage companies could face a tough time finding funds from informal investors who are less willing to take risks in an unsteady economy. Firms looking for equity investments should expect to give up more ownership for less cash than during flusher times. For established businesses that are good credit risks, lower interest rates will make borrowing more attractive. Here's what you need to know.

Where should I look for capital if I have an existing business?

A good source might be a loan or credit line from your local independent bank (, 12/26/06), especially if you already have a business relationship there. Subprime mortgage defaults have hit banking giants (, 1/15/08) like Citigroup (C) hard, but most smaller banks don't face the same losses. "Community banks have very solid balance sheets and liquidity. They're not having to do the large writedowns for the subprime mess because they're traditionally more prudent lenders," says Paul Merski, chief economist at the Independent Community Bankers of America, a trade group. "They have money to lend."

Is now good time to take out a loan?

Yes, if you can get it. The Federal Reserve has dropped its rate target for overnight lending by 2.25 percentage points since the summer, to 3%, in an effort to ease the credit crunch. That means banks can offer borrowers lower rates and make the same profit. "If you have a good business and you have a good relationship with your lender and interest rates are coming down, it may be even less expensive to borrow," says Merski.

Will I face tighter credit standards?

Banks are still looking to lend to companies that have the ability to repay, according to Rebecca Macieira-Kaufmann, executive vice-president and head of Wells Fargo's (WFC) small business segment. "In any economic environment, we're going to want to look at a profitable business, an established business that has a history," she says. The same credit standards apply for business loans, but an economic downturn could make it harder for you to meet them. "What will happen in a stressed economic environment is you may have fewer receivables, your collateral may be worth less," Macieira-Kaufmann says.

Lenders are looking closely at the region and the sector that loan applicants are in, she says. You should demonstrate that your business is resilient enough to weather an industry slump. For example, businesses that thrived off new-home construction should show that they can shift to existing homes.

What if I my credit isn't good enough?

There are nonbank options available for businesses that can't land traditional loans. One new company in this space, On Deck Capital, offers loans of up to $100,000 to small firms based on their cash flow, rather than the owner's personal credit rating. "We focus on loans to small businesses who can't qualify for bank loans," says Mitch Jacobs, On Deck's CEO. "We've entered the market to fill the gap." Jacobs says interest rates are "in the ballpark" of traditional bank loans. Borrowers have to be in business for at least a year and show they have adequate cash flow of at least $3,000 a month in credit-card volume.

Jacobs says business owners should be wary of non-bank credit options that could come with brutal interest rates, like factoring receivables. You can also try to land a loan through social lending Web sites (, 12/21/07). In some cases, you may be able to get your suppliers to extend you credit as well, especially if you have long-standing relationships with them.

What about angel investors?

Angels may hesitate to invest their personal wealth because they're most likely seeing value shrink in their other assets, such as real estate and stocks, according to Tom Kinnear, an angel investor and head of the Zell Lurie Institute for Entrepreneurial Studies at the University of Michigan. "I think the angels are going to be a little more inclined to play it closer to the vest," he says.

Is venture capital available?

Venture firms raise money for their funds years before they invest in companies, so they still have money to commit, Kinnear says. But expect a lower valuation if you do get funded. "They will have the funds, but they will be more careful about valuations of businesses they invest in," Kinnear says. During a slowdown, VCs still want to make their target rate of return, so they'll be looking for greater shares of equity in their portfolio companies.

What about raising funds for expansion?

Companies in growth stages showing solid sales are better positioned to get both debt and equity financing in the current market. "If you're in a sweet spot of looking for growth capital or mezzanine funding, there's a whole lot out there," Kinnear says. "The closer you are to commercialization or have actual sales or, Lord willing, profits, the easier that is." The uncertainty in the market penalizes startups, but established and profitable companies can benefit from investors looking for payoffs with lower risks.

What is the government doing that could affect my business?

Tax incentives for small businesses might be worked into the Senate's version of the economic stimulus package (, 2/4/08). The plan would increase the amount companies can write off for investments from $125,000 to $250,000, giving an incentive to buy new equipment or other capital investments in the 2008 tax year.

A bill introduced on Jan. 24 by Senator John Kerry (D-Mass.) would also reduce fees on government-backed Small Business Administration loans. SBA loans, which normally increase when other types of credit are tighter, have dropped 5.7% in total volume from Oct. 1 to Jan. 25 compared with the same period in the last fiscal year, according to the National Association of Government Guaranteed Lenders. The group, which represents some 700 lenders, said members and borrowers cited high fees and other costs as top reason for the decline, according to the group's president, Tony Wilkinson. The bill would also increase money available for microloans.

Business Exchange related topics:

Global Recession

Recession Spending and Investing

Credit Crunch

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