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.

Despite its long history, few small-business owners have heard of venture merchant financing and fewer still are using it. During the 17th century, groups of investors would pool their money and bankroll the merchant voyages of Dutch ship captains. The investors, and the trading posts they set up and ran, were precursors to modern-day shareholders and corporations.

Although the upfront costs of the voyages were hefty, the captains and investors could count on a steady stream of buyers willing to pay a premium for exotic and hard-to-get goods.

Venture merchant deals are rooted in this process. Merchant bankers raise funds and act as temporary chief financial officers, running their client’s trade and taking control of the order-to-cash cycle for a period of about 18 months to three years.

For their efforts, merchant bankers take about a third of their client’s profits, which includes a growing percentage of the accounts receivable they collect as the receivables age. (The banker’s cut of the receivables usually starts at about 2 percent.) In such factoring arrangements, a merchant banker or other intermediary typically buys a company’s receivables at a discount, providing the company with immediate cash.

Venture merchant financing is, however, costly in comparison to other forms of small business capital. For instance, Small Business Administration loans carry interest rates pegged to the prime rate (about 5.5 percent currently) plus a premium, while personal credit cards carry 18 percent to 21 percent interest rates.

Nevertheless, venture merchant deals can be well suited to help small companies expand because they provide immediate capital that otherwise might not be available, contends Joseph Ingrassia, a managing member of Capstone. Further, since the deals don’t involve any actual borrowing, they don’t burden small-company balance sheets with debt.

By providing enough cash, venture merchant financing helped The Kosher Depot to buy enough inventory to enable the company to grow. Before his factoring company introduced him to Capstone a few months ago, Lederman, like many of the merchant bank’s clients, had never borrowed money directly or used any kind of third-party financing.

The hurdles to garner Capstone funding are high, however. The merchant banker vets businesses to make sure that: their finances are in order; management has a proven track record in a niche business; there’s a strong demand for the company’s products; customers are creditworthy; and the business’s gross profit margins are between 25 percent and 30 percent.

Six weeks ago, Capstone accepted The Kosher Depot as a partner, and the two companies inked a two-year, $3.3 million venture merchant deal. Capstone agreed to advance cash to the Kosher Depot against customer invoices so the food distributor could buy more inventory. Based on current sales volume, and taking the infusion of capital from Capstone into consideration, Lederman projected that his revenues will climb to between $3 million and $5 million by year’s end.

The deal works like this: The Kosher Depot assigns its purchase orders to Capstone. Next, Capstone buys the pre-sold goods from manufacturers using part of the $3.3 million it had allocated to The Kosher Depot.

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