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SMALL BUSINESS: Technology Special | Financing and
Insurance

Big Bucks Are Out There for the Little Guy

April 08, 1998|JUAN HOVEY | Juan Hovey is a freelance writer

Want proof that the supply of capital for investment in growing businesses increases every year?

Consider these numbers, compiled by the newsletter Private Equity Analyst, published in Wellesley, Mass., and quoted by Fred Krimm, a Los Angeles investment banker who raises debt and equity capital for small and middle-market businesses:

* In 1996, 194 private investment groups raised $36.1 billion in capital to invest in U.S. businesses big and little.

* In 1997, 233 groups raised $50.9 billion, an increase of nearly 41%.

Private investment groups get their capital from sources such as public and private pension funds, insurers, bank holding companies, endowment funds and wealthy individuals. The groups invest in start-ups and growth companies with revenue ranging from $10 million up in a wide variety of industries.

The good news here, of course, is not that you need only drop a hook in this sea of capital to get all the money you need to grow your business, Krimm says.

It is, rather, that if you do own a solid business, you stand a good chance of rounding up new capital--because investors see the opportunity to make their money grow by making your company grow.

To be sure, not every investment group funnels capital into small business. Many invest only in sophisticated debt and equity deals involving big businesses, and like most investment bankers, they invest only big chunks of money--$50 million or more.

But there remain many investors with capital to invest in small and middle-market businesses through investment bankers such as Krimm. The deals they put together involve the financing techniques regularly described in this space, including private placements, acquisition and buyout financing, mezzanine financing, and a host of other techniques routinely used by big companies but largely unknown to the owners of small and middle-market businesses.

Krimm runs Capital Markets Group in downtown Los Angeles, a small investment banking house targeting small and middle-market businesses with debt and equity deals worth more than $1 million. He founded Capital Markets Group two years ago after working with Big Six accounting firm Price Waterhouse and, before that, with investment banking house Bateman Eichler, Hill Richards.

"I saw the opportunity in this market," Krimm says. "I've been an investment banker for a long time, and it was obvious to me that the small and middle-market business is underserved. Because of their high overhead, the big investment banking houses don't get enthusiastic about the deal smaller than $10 million.

"That leaves a big void for those companies that don't need much more than $2 million to $5 million in financing."

Like other investment bankers targeting this market, Krimm does deals combining equity and debt financing, with most of the capital coming in as equity. In plain English, this means that the investors supply most of the capital you need for, say, an acquisition campaign by buying a minority interest in your company's stock--usually not more than 25%. They supply the rest in the form of a loan.

The investors earn capital gains on any increase in the value of the stock, plus interest on the loan.

"Most of my deals are equity-oriented because what most businesses need is equity, not debt," Krimm says. "When they have equity, they can go to the bank and leverage their borrowing power--because banks like to see equity sitting below them on the balance sheet, in case the business runs into any problems.

"Because of this, equity helps improve the cost of borrowing from standard commercial banks and from asset-based lenders. The more equity a bank has under it, the safer it feels when lending money--and when your banker feels comfortable, you can negotiate a better interest rate."

Few business owners realize that as many financing options exist for small and middle-market businesses as for big ones, Krimm says. The big investment banking houses chase the big deals, but many investment groups now target the small deal because they like the opportunities they see in this arena.

The difference, of course, is that the owner of a small or middle-market business must give up a bigger piece of the pie to make the deal attractive, Krimm says.

"If you're running a $100-million company, you may have seven people knocking on your door interested in your deal, and if you're running a $10-million company, you may get two or three," he says. "Your visibility isn't as high, and maybe your management team isn't as sophisticated.

"And because this makes your investors a little more nervous, you have to do a little more to calm their nerves."

Krimm doesn't downplay the work it takes for a business owner to put a financing deal together either, and he notes that investors don't exactly flood the marketplace with dollars for these deals.

But a great deal of capital is available and, given the need for it among small and middle-market businesses, he expects the supply to increase.

"There will be more investor entities coming into the marketplace to satisfy this need," Krimm says. "Whether the growth of the supply will keep up with the growth of small firms themselves, I can't say.

"But it's got to happen. Where there is a need in the marketplace, somebody shows up to fill it. That's a law of economics."

*

Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net

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