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.

Capstone then imports, ships, and stores the goods in U.S.-based warehouses it controls. The warehouse fulfills the orders based on an approved release request generated by Kosher Depot and signed off on by Capstone.

Finally, Kosher Depot bills the customer and assigns the invoices to Capstone, which collects the receivables.

During the process, Capstone charges the client set fees that total about 30 percent of the final profit. The balance goes to The Kosher Depot, which books the income as a sale. The difference between the gross income and the advance made by Capstone is recorded as “due from factor” until the receivables are paid. As the receivables come in, Capstone remits the balance from each factoring transaction to the Kosher Depot, which credits its books and zeros out the transaction.

While Kosher Depot focuses on selling, Capstone works the order-to-cash cycle, and together the partners aim to improve the system—including sourcing, logistics, and collections. But it’s a short-term relationship, mainly because the financing is expensive.

Once a healthy level of working capital is established and the company’s asset base grows, the business is able to tap in to cheaper financing. The gauge of whether a company is ready to abandon the venture merchant model is that it “should have increased its gross revenue and net profit significantly,” says Ingrassia.

As effective a springboard as the technique can represent to cash-strapped companies, it remains little known, however. Interestingly, Capstone’s CFO John Beasty says he wasn’t familiar with venture merchant finance until 1995. In that year, he was hired as a finance executive at Khepra Beauty Group LP to help restructure the bankrupt health and beauty products distributor.

As a fragrance-industry veteran, Beasty knew that the ailing distributor, which imported such coveted brands as Dolce and Gabbana, Adrienne Vittadini, and Moschino, would not have enough capital to stay afloat during the industry’s spring and summer seasons, when cash is scarce. After September, however, cash flows spike.

Khepra’s funding problem was a Catch-22. The distributor had millions of dollars worth of unfilled back orders. But it wasn’t generating any sales because it had no cash to buy inventory to fill the orders. At the same time, Khepra’s strong product lines, high margins, and backlog of orders made it a good candidate for a venture merchant deal, says Beasty.

Khepra called in Capstone in 1998, the financing deal was approved by the bankruptcy court, and within a year, the company was generating $17 million in sales. After the turnaround lured a takeover bid from Canada’s Riviera Concepts Inc., Khepra was sold to the Toronto-based distributor in a 1999 deal that created a $68 million company, notes Beasty.

That year, Beasty joined Capstone. The CFO’s contends that the straightforward, cash-on-the-barrelhead approach of traditional merchant banking is a “breath of fresh air” in a corporate finance world replete with off-balance-sheet financing and financial engineering.

The CFO’s view is not without self-interest, of course. But the technique’s direct approach and its mix of old and new financing tactics seem in tune with how small business owners like to operate. For some small companies that suffer 21st century growing pains, the 17th financing technique could indeed represent a Dutch treat.

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