Capital in the Capital: Two unconventional funding sources that are feeding entrepreneurs
From the pages of In Business magazine.
Six years after the Great Recession technically ended, Frank Staniszewski has noticed a much healthier appetite for risk among Dane County businesses. Staniszewski, president of Madison Development Corp., believes that appetite is back to prerecession levels and shows no signs of abating.
While financial institutions have regulatory considerations weighing on them, many banks have been very aggressive, and there is real momentum in emerging industries. “We’ve been making technology loans since the early days of Sonic Foundry and Mirus, and we’ve been working with the [university] research park,” Staniszewski noted, “but in the past three years, it’s just a different world than we’ve ever seen in 20 years of working with the technology community.
“It’s gone from just biotech to biotech and medical research, medical health records, to the IT-Internet, to mobile games and Internet games.”
The hunt for capital is no game, however, and not every small business qualifies for conventional bank lending. So in this look at business finance, IB profiles business resources that have emerged as alternative sources of capital — the community-based Madison Development Corp. and the statewide Wisconsin Business Development Finance Corp.
Madison Development Corp.
With an active loan portfolio of more than 80 loans totaling $6 million, the MDC, a nonprofit development company, helps hard-to-finance small businesses, whether they are growing or just starting up, with loans. The term “hard-to-finance” means they can’t fully meet the underwriting standards of private commercial lenders — lenders that often refer businesses to the MDC.
MDC’s lending programs are funded in part by the City of Madison’s Community Development Block Grant program. Under its business loan program, MDC can lend up to $200,000 to qualifying businesses for working capital, inventory, equipment, leasehold improvements, and real estate, but the average borrower receives about $50,000. It also has a venture debt program for emerging technology companies, from which it can lend higher amounts.
There are certain loan parameters for eligible borrowers. Businesses must be located in the City of Madison, and borrowers must increase employment by approximately one job for every $35,000 in loan funds received, a requirement that is tracked on an annual basis.
While MDC has its own cash-flow and collateral requirements, its credit standards allow for higher-risk financing than most private lenders, which are still under the watchful eye of federal bank regulators, can realistically engage in. The MDC charges fees (usually 2% of the principal amount) to cover costs of loan preparation and processing.
Whereas financial institutions might have hard and fast rules for lending, MDC has very few fixed rules, and where some might not even look at a prospective borrower’s credit score if he or she has had past credit issues, MDC will consider whether a prospective borrower has taken steps to correct those credit issues. “We look more at the total picture and some more subjective things like the person’s history, and what their experience is,” Staniszewski says.
One area where MDC sees growing demand is the local food sector. With the help of an MDC loan, Madison Sourdough Co. expanded its retail bakery operation, including adding a new pastry outlet, and purchased an old-fashioned stone mill from Austria that enables the company to make flour from locally produced grains.
Madison Sourdough offers a bakery, a café, and catering at its Willy Street location. With MDC financing, the company is increasing by 50% the space it occupies, and it has set up a rotisserie (a French-style dessert shop) as part of the project. In addition to the storefront bakery, it has an industrial bakery to serve a wholesale business that sells to restaurants and grocery stores, and that’s where the mill comes in.
Dave Lohrentz, co-owner of Madison Sourdough, noted the MDC loan was part of a financing package with Summit Credit Union. MDC’s $70,000 portion was for the flour mill, for working capital, and to refinance existing debt. The mill, with its old-school (19th century) design, could have sustainable implications outside of Madison Sourdough’s business interest because, as Lohrentz explained, “what we’re trying to do is develop a more robust market of local grain growers so that local grain is as ubiquitous as local milk and cheese.”
That means making every step of the grain production supply chain financially feasible, including the end stage. According to Lohrentz, the mill features horizontal millstones that can go slower, operate with less friction and less heat, and therefore retain more of the grain’s nutritional value and flavor. “We’re pretty excited about what it’s going to do for us,” he said. “It will allow us to work a lot closer with local farmers and help them figure out what kind of grain is going to work here in Wisconsin.”
Lohrentz said MDC is easy to work with and occupies an important niche in local business financing. “What we’re doing in the restaurant and food business is not in the wheelhouse for a lot of conventional lenders, and MDC was very creative in making this happen,” he stated. “They found a way to say ‘yes’ when others said ‘no.’ They broke it apart into different components and made it happen, and that was important because we don’t have huge amounts of collateral on hand.”
Under MDC’s Venture Debt Fund, a revolving loan fund for technology businesses, debt is structured based on the company’s ability to reach the cash-flow break-even point, either with existing liquidity or with the borrowing company’s ability to raise additional equity capital. The fund is targeted to companies that have reached the revenue stage but are still in a negative cash-flow position, and it provides loans at rates from prime +3% to prime +8%.
Under this fund, MDC and private-sector partners like Madison Gas & Electric and 11 local banks have committed more than $12 million for emerging growth companies in Dane County. One recipient is Wellbe Inc., a health care software developer that received a $300,000 venture debt loan and levered it with private equity in order to hire salespeople and ramp up revenue.
With more of health care’s financial risk being shifted to providers, Wellbe’s cloud-based, software-as-a-service platform is designed to help hospitals and health systems manage those risks and control costs. It is attempting to do so by enabling providers to create content that explains care paths to patients who are facing surgery and to keep track of them through recuperation.
Abe Palmbach, president and COO of Wellbe, said that with loan terms, MDC is more flexible than banks can be, “which is the big service they provide to companies like ours.” In addition to providing debt financing that Wellbe otherwise would not have had, MDC was up front about the process and how it would play out, and it made a quick decision, getting back to him the same day he interviewed with the decision-makers.
While bankers are involved in MDC loan decisions, “to go directly to a bank and borrow money, at the stage we were at, would have been very difficult, but I think they [MDC] are looking at a little bit different risk profile,” Palmbach noted.
He also credited Staniszewski with helping Wellbe make progress with equity investors, as the MDC loan was coupled with $1.1 million in equity financing (the company has since raised another $2.4 million in private equity). “Frank knows so many people that he was instrumental in us finishing our financing round,” Palmbach noted. “We had gotten to a certain point with an angel group, but Frank got us to another, higher point. He brought other people to the table and helped close out our investment round.”
James Dias, founder and CEO of Wellbe, says his company has validated its value proposition, built its team, and is ready to begin scaling up. He credited MDC with developing a relationship with Wellbe management and understanding how the company was progressing as a business. “We worked with them for about a year and a half before they actually made the [loan] decision,” he noted. “We were already developing a relationship with them.”
MDC recently received $2 million combined from the Wisconsin Housing and Economic Development Authority (WHEDA) and MG&E for its Venture Debt Fund, which will allow it to keep the program going. Since it’s a revolving loan fund, the money is paid back and loaned out again, but since money is also lent with an initial interest-only payback period — typically six or nine months, before amortization begins — the fund was running dry. The problem MDC had was that borrowers kept coming back with requests for extensions of the interest-only period, and so the money wasn’t coming back very fast.
“So the ability for us to make new loans from money that was paid back was getting pretty tight,” Staniszewski said. “That new money helps us continue to do the program at about the level we’ve been doing the past few years.”
Pointing to the Wellbe experience, Dave Scholtens, vice president of lending for MDC, said the Venture Debt Fund complements equity-raising. “It’s so difficult for the businesses to raise the equity; so many times you hear the story, ‘Well, I’m going to raise $1 million, and I can do it in six months,’ and when we go to them nine months later, maybe they have half of it. They don’t realize that’s such a full-time job, and so we are able to fill that out and say, ‘Okay, if you raise $1 million, or if you raise $600,000, we’ll put $400,000 into debt.’”
Business development, Wisconsin-style
The Wisconsin Business Development Finance Corp. is a not-for-profit certified development company, or CDC, that facilitates Small Business Administration 504 loans. In addition, the WBD provides consulting and loan packaging services to banks and borrowers, which allows lenders access to other government-sponsored lending programs without having to make an investment in training, and it disperses financing under the federal New Markets Tax Credits program to larger businesses willing to invest in underserved areas.
WBD has approved more than 300 deals in Dane County and is now one of the largest producers out of the 255 CDCs in the United States. The organization works on loans via several programs, but its bread and butter is the SBA’s 504 program. It basically serves as an SBA lending facilitator, handling applications and cutting through the red tape for borrowers.
The funding source for the 504 loan program is the sale of unsecured bonds (debentures), which are purchased monthly by large institutional investors. The proceeds go to banks, which lend the money through the SBA to small businesses that essentially tap into a market they could never access on their own. To get an SBA 504 loan, a business has to partner with a CDC like Wisconsin Business Development. The fees charged by the program cover any losses, so taxpayers are basically off the hook.
To be eligible, a business and its affiliates cannot have a net worth exceeding $15 million, and its net profit after taxes cannot exceed $5 million. The maximum amount WBD can loan eligible borrowers is $5 million — though it can lend $5.5 million to a manufacturer or for an energy-efficiency project. Since WBD can finance up to 40% of a deal, the overall size of a loan it participates in can be much higher. “If we represent 40% of a project, it could be a $12-plus million project,” noted President and COO Dan Schneider. “Typically, we don’t go below $300,000 in total loan needs.”
Banks are more willing to make 504 loans because so much of the risk is spread elsewhere, and borrowers like the long-term commitment at fixed rates. Nevertheless, Vice President Diane Pasley says the WBD is constantly educating bankers and others about its mission. “Bankers don’t always educate the borrowers about us, so we’re trying to reach out to either commercial Realtors, contractors, or business owners directly.”
Among the businesspeople who have secured multiple WBD loans is hotel owner Kevin Wilson, whose company, KGW Management, owns three local hotels: a Super 8 hotel, a Sleep Inn & Suites hotel, and the AmericInn Hotel & Suites in Monona. When he was ready to purchase his first hotel, the Super 8, Wilson was introduced to Pasley by a friend in banking.
With the WBD’s help, he secured loans to acquire a Super 8 on the Beltline (via Oak Bank) from his previous employer for $4 million, to build the Sleep Inn & Suites at Hwy. 51 and the Beltline (through Monona State Bank) for $5 million, and to acquire the AmericInn at Broadway and Monona Drive (via Settlers Bank) for $3.5 million. His collaboration with the WBD has thus far spanned his first loan in August 2005 through the third loan in March 2012.
Not only did Wisconsin Business Development help Wilson get through the red tape of the SBA, it also helped him obtain the other financing. “I don’t know if I would have personally been able to jump through the SBA hoops,” he stated. “WBD is very good at servicing and underwriting the whole thing before it even gets to the SBA.”
The SBA loans are repaid on a 20-year amortization, with what Wilson called very favorable rates that are locked in for 20 years. KGW Management was able to put 15% down on each loan. “The payment can never go up for the whole 20 years,” Wilson said, adding that the loan for the Super 8 is already paid off. “I think it’s 5.25% for the Sleep Inn and a little less for the AmericInn. The SBA bundles these and sells these on the debenture market. What it sells for defines what the rate is going to be, so in the AmericInn’s case the rate was less than 2%, but with fees added in, it was closer to 5%.
“It’s a good deal, especially for someone like myself who was starting out. Coming up with the least amount of down payment was pretty important.”
While alternative lenders might have different standards than traditional lending institutions, one thing they have in common is the requirement for quality management. Without it, it’s harder to justify a loan under any underwriting standard. “It really comes down to who is running the show,” says Scholtens, “and who are you lending it to?”
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