Shoring Up Your Finances Is A Capital Idea

Coffers are flush--but maybe not for long. Here's how to enter a downturn in good shape

Chand K. Akkineni, president of Capricorn Systems Inc., an eight-year-old information technology company, reads the papers just as everyone else does--and he sees storm clouds ahead. But unlike many of his small-business brethren, he's taking steps to protect himself. Thanks to the company's performance in the past few years, Akkineni had no trouble arranging both nonbank and bank financing in addition to the more expensive receivables-based financing he already had. "Next year is going to be tough, but we want to keep growing," he says. "Now, I have other options."

So will other small-business owners, if they're wise. It's a great time to reevaluate your company's finances with an eye to shoring up the foundation. At the moment, banks, finance companies, and venture capitalists are still relatively flush. Only 5.7% of 54 banks surveyed by the Federal Reserve in September, for example, tightened standards for small-business loan applicants, and about the same percentage eased standards.

Many analysts agree that a recession is a possibility next year--and in that case, credit conditions could get worse. Thanks to some changes in the banking industry, it's not likely to be as bad as the steep recession of the early '90s. Still, experts say the best time to take preventive steps is when you don't actually need them. "While times are good, you have an opportunity to get your financial house in order," says Sandy Maltby, head of small business services for KeyCorp, a Cleveland bank.

Start by reviewing your credit structure, with an eye toward conservatism. Consider how much your profits might decline in a downturn, for example, and see whether you would have the cash to cover interest payments. If you would not, you should be looking for ways to pay down that debt now; if you're covered, you still might want to take out a long-term loan at today's low rates, just to give yourself an extra bit of cushion.

The time is ripe because, at this point, small businesses have few worries about arranging financing. KeyCorp and Wells Fargo & Co., with large portfolios of small-business loans, say they have no plans to cut back. "I've not seen any tightening of credit in the last six months," says Michael R. James, executive vice-president in charge of small-business banking at Wells. Both banks say that they have not imposed more stringent lending conditions or increased their rates to compensate for any perceived increase in risk.

Granted, caution is rising. Some banks have cut their exposure to small companies doing business overseas. And Wells Fargo's James says he expects some overly aggressive lenders to pull back. But even if there is a recession, the effect on the banking sector may be less severe than the 1990-91 experience. Last time, the slowdown was accompanied by new loan review standards stemming from the savings and loan crisis and increased capital requirements for business loans. Since then, the loan review standards have been modified to allow banks to increase their small business lending. Besides, in a recession, the Small Business Administration would increase its guarantees on loans, as it did the last time around. In fiscal 1992, SBA-guaranteed loans grew some 34%, to $5.93 billion.

Overall, says Jere W. Glover, chief counsel for advocacy at the SBA, small businesses should face fairly accommodative conditions until the bitter end of a recession. That's because banks are competing more vigorously in this market segment--especially for the smallest loans. "The banks have found this to be a very profitable area to do business," he says.

COLLAPSE. When bank loans don't offer enough, nonbanks, including commercial finance companies, equipment and real estate lenders, and financial-services giants such as American Express Co. and Merrill Lynch & Co., offer alternatives. Nonbank lenders gained share in small-business lending in the last recession and now account for some 7% of all lines of credit, 67% of equipment leasing transactions, and 61% of business credit-card loans, according to Financial Institutions Consulting in New York. They are sure to grab even more market share in the next downturn. "Commercial finance companies tend to do well when banks become risk-averse and pull back," says Samuel L. Eichenfield, CEO of Finova Group Inc. in Phoenix.

Of course, entrepreneurs in the unfortunate position of just starting out as the world economy collapses are probably already experiencing financing difficulties. It will be harder for entrepreneurs to get financing from family members who have suffered stock market losses, for instance. "The friends-and-family money is going to be somewhat less," says David Wiesen, a New Jersey consultant. Around 30% of small businesses rely on this source for at least some startup funding.

Similarly, angel investors--individual venture capitalists--are likely to be less available if they are nursing wounded stock portfolios. Marci Zaroff, president of Under the Canopy, a one-year-old catalog distributor marketing upscale, environmentally responsible merchandise, recently lost financing from an angel after having used up $500,000 of personal savings and available credit-card financing. A business owner himself, the angel backed out from a planned $2 million stake in the Randolph (N.J.) company when "his own stock crashed," says Zaroff. She's talking to a factoring company about financing her receivables, but continues to look for a long-term investor.

Venture-capital firms, meanwhile, have more dollars than ever to invest. In the first half of this year, venture partnerships raised some $8.2 billion, a record amount, according to Venture Economics in Newark, N.J.--adding to the uninvested assets raised previously.

DEFERRED IPOs. The funds are putting their money to work as fast as they can, investing at least an estimated $10 billion in the first nine months of '98, on the way to surpassing last year's record, says Pricewaterhouse Coopers. They are expected to continue to do so even if the economy stumbles. "There's just too much money in this industry to sit on," says Fred Beste, managing partner of Mid-Atlantic Venture Funds in Bethlehem, Pa. Before the last recession, available funds were much skimpier and practically dried up.

For companies seeking venture financing, however, the terms will change. Valuations will drop to reflect the lower stock market, since so many venture capitalists cash out by taking their companies public. And entrepreneurs will have to give up more equity than they would have a few months ago for the same investment.

Of course, those companies that had their hearts set on going public will have to wait. Icarus Corp., a Rockville (Md.) software developer, is a prime candidate for an initial public offering. The 29-year-old company has been profitable for years, has more than $9 million in annual revenues, is a growth business, and carries no debt. Last July, it planned to issue 2 million shares at around $8 apiece. But as the market for small-cap stocks sputtered, co-underwriters Laidlaw Global Securities Inc. and Hoak Breedlove & Wesneski & Co. pulled the offering. CEO Herbert G. Blecker prefers curbing growth to adding debt or diluting equity.

Companies unable to fulfill IPOs can turn to bank lines of credit or private equity investors--or, as a last resort, merge with a competitor. "We are sitting down with every one of our clients to consider how much capital they need and their financing alternatives," says Michael J. Kollender, an investment banker at Josephthal & Co. in New York. Sounds like a good idea for every business owner.

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