A Small Business Loan from a Hedge Fund?

It's hard to get traditional loans these days. But as banks tighten their purse strings, hedge funds are offering asset-based loans to small companies

In early 2008, Jim Gee hit an impasse. Over the previous five years, Gee had been expanding Trinity Communications, a small cable-TV company in Marion County, Tenn., that he founded in 2003. With startup costs of nearly $3 million, Gee had used personal funds to get the business rolling, laying fiber optic cables across two rural towns and attracting new subscribers. By 2008 he had 600 customers and 6 employees, but Gee couldn't find additional funds to service new towns and sign new subscribers.

"Local lending was just not available," says Gee. After he exhausted possibilities at traditional lenders, his attorney recommended that he reach out to a hedge fund that had recently started providing asset-based loans to small companies. So Gee met with Genesis Merchant Partners, a fund launched by the $145 million, Connecticut-based hedge fund Sands Brothers Asset Management. Within two weeks of the meeting, Gee had secured a 15-month, $500,000 loan from Genesis, carrying an interest rate of over 14% after fees, with a 10% penalty if he were to pay it off early. Trinity has nearly tripled its subscriber base since it secured the loan, says Gee. His company is now taking out a second loan for a similar amount from Genesis to continue its growth plan. He doesn't consider the terms particularly onerous: "I was open to go as high as 15%."

It's clearly not easy for small companies to get traditional bank loans these days. Major financial institutions have written down over $400 billion in bad investments over the past year and banks are scrambling to raise depleted coffers. That usually hurts small companies more than their larger counterparts. "It's not like a big company that can just sit on its hands for three years and wait the cycle out," says David Grin, co-founder and portfolio manager at the $1.8 billion fund Laurus Valens in New York. "There are a significant amount of companies out there with virtually nowhere to go."

With a new cadre of hedge funds (BusinessWeek.com, 10/31/05) and alternative lenders looking to fill that void, small companies, public and private, are competing for available funds. "Our members' phones are ringing off the hook, says Andrej Suskavcevic, CEO of the Commercial Finance Assn., a trade association of roughly 300 asset-based lenders. The calls started pouring in during the fourth quarter of last year, says Suskavcevic, when companies started realizing they'd have to turn to new lending sources to survive.

"More Due Diligence"

So called asset-backed loans are commercial loans backed by company assets—anything from a company's inventories to its accounts receivable. These loans differ from traditional commercial bank loans because they cost more, require lenders to scrutinize assets more thoroughly, and sometimes require physical inspections that most banks wouldn't conduct, says the CFA's Suskavcevic. "There's more due diligence to verify it," he says. While established lenders like Citigroup (C) and Bank of America (BAC) have had asset-backed lending arms for years, more hedge funds have recently jumped into the business. According to a 2007 report from the Commercial Finance Association, there were $545 billion in outstanding asset-backed loans in 2007, up 11% from 2006. Suskavcevic expects that number to grow in 2008.

Hedge fund loan rates vary across the board, but are usually considerably more than traditional banks', which are 200 or 300 basis points (2 to 3 percentage points) higher than the prime rate, says Laurus Valens' Grin. That's why companies should consider traditional lending sources first, says Stratton Nicolaides, CEO of Numerex Corp ( 2 Next Page

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