Capital Ideas: A Little Cash’ll Do Ya

Facing narrowing funding options, some successful small businesses hit an inventory-financing wall when they're about to grow. One new-old solution: venture merchant financing.

Growth is hard on small companies, particularly when it comes to financing inventory. “When I first started,” recounts Jordan Lederman, “I would wait for my first customer to pay before I could buy products to sell to my second customer.”

Lederman is president and chief executive officer of The Kosher Depot, a $1.3-million specialty-food distributor in Westbury, N.Y. Like many small-business owners, he finds that growth spurts can involve some pain. For instance, Lederman says, he nearly crippled his business last year when he bought $40,000 worth of kosher artichokes from Spain.

To be sure, The Kosher Depot is a thriving business, selling exotic kosher foods to restaurants, supermarkets, caterers, universities, and such celebrity chefs as Jeffrey Nathan. Lederman had enough purchase orders in hand to cover the artichoke order. But the Spanish suppliers wanted cash in advance of shipment, and the bulk purchase consumed every bit of cash he could scrape together. The result was that the company was drained of its working capital.

The food distributor had fallen prey to his own success. He had hit a wall in terms of amassing enough excess cash to buy the additional inventory needed to boost sales. Growing his business beyond its current revenue ceiling seemed a daunting, if not impossible, task.

Help, however, was on the way in the form of 400-year-old solution that hasn’t reached the radar screens of most small-business executives: venture merchant financing. By entering into such a deal with merchant bank Capstone Business Credit LLC, The Kosher Depot received a cash infusion big enough to get the company past its growth dilemma.

Before the solution presented itself, though, Lederman’s company was in a far from unique situation. With significant sources of financing for small-business growth drying up over the last few years, inventory-funding crises seem to be growing more common. For one thing, bigger banks focusing on large corporate customers have gobbled up local and regional banks once friendly to small companies. The larger banks have reportedly been tightening lending criteria for smaller clients.

Globalization compounds the problem. The modernization of manufacturing facilities in China, India, and other Asian nations has increased the chances that finished goods are imported and not manufactured domestically. Foreign suppliers often insist that small companies pay upfront, before shipments leave factories and warehouses. Such payment terms leave small-business owners with little operating flexibility, forcing them to either cobble together cash quickly or cancel orders.

Further, funding sources for small businesses—
those with under $50 million in sales, say—are intrinsically limited. The private entities among them are shut out of the capital markets, for instance. Often, they don’t generate enough investment return to attract private capital. Rarely do they have the balance-sheet strength or asset base needed to secure commercial loans or letters of credit.

The erosion of other capital sources makes venture merchant financing particularly alluring. Besides being a more available than other funding sources, it can serve as a financial proving ground for small business by enabling them to grow big enough to take part in more traditional capital raising.

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