Small business is extremely important for the economy. This is not just a US or UK issue, it is a global phenomenon. Small and medium-sized enterprises (SMEs) are the drivers of economic growth, job creation and thus wealth. Fostering an ecosystem that facilitates access to capital for SMEs is a policy imperative with a growing number of forward-thinking governments focusing policy on encouraging entrepreneurship with streamlined access to capital and incentives to investors in SMEs.
The most recent recession (or Great Recession as it has been labeled) exacerbated the challenges for SMEs to gain access to capital. Banks were pushed into a corner, either by choice or by regulatory over-reach, imperiling the most important sector of the global economy. But in crisis, opportunity and creativity rise. A new crop of Fintech innovators moved in to fill the growing void providing an element of relief and insight into the future of finance. From equity to debt, internet finance is the natural evolution of financial services propelled in part by the shortcomings of traditional financial firms.
Recently Crowdfund Insider spoke with Candace Klein, presently Chief Strategy Officer of DealStruck, an online lender for small business. While DealStruck may be her most recent posting, Candace has been engaged in early stage / SME finance for many years. She has founded several Fintech companies while being a leader in the equity crowdfunding space. Today she pairs her responsibilities at DealStruck by working with management teams of growing businesses to help manoeuvre the challenges of entrepreneurship including raising capital. There is a growing number of options to raise finance online for small business. In a discussion with Crowdfund Insider, Candace discussed the growing number of online financing options – including the pros and cons.
Crowdfund Insider: You have been involved in several startups. Why is access to equity capital so important for seed / early stage companies?
Candace Klein: I can only speak for myself and the companies I have started. When your business is very young, it may take some time to fully develop your product, find your ideal customer, and make meaningful revenue. If you are starting a business that is not selling a widget, but rather a technology or concept, it will take more time to generate revenue. Debt financing is great if you are selling widgets, if you can start to repay in a short period of time. But if you don’t see yourself generating revenue for 6-12 months or more, equity is really the only option that makes sense.
Candace Klein: The benefits are quite obvious to me. The traditional venture capital (VC) and angel community is looking for 10x returns, which is quite uncommon and unrealistic for most companies. And everyday people are often simply looking for better returns than they are seeing from their CDs or long-term investments. Most businesses are community-based, and have an immediate impact for those in their community, whether geographic or industry-based. Crowdfunding brings these companies together with the everyday investors in their communities. This new fundraising system opens up a new capital source for so many businesses that have fallen through the cracks because they weren’t a good fit for banks or VCs, and a new investment opportunity for many Americans looking to build wealth by investing in businesses or business owners they know.
Crowdfund Insider: What are your thoughts on Title II & Reg A+ (equity crowdfunding)?
Candace Klein: I have to be honest. I don’t have as much of a reaction to Title II and Reg A+ as I do to Title III, because Title III feels like the biggest change to the status quo.
Crowdfund Insider: What about convertibles (for early stage companies)?
Candace Klein: If you can get a convertible note as a founder, I strongly recommend it. This allows you to push off valuation until such time as you have built value into the company. Often, convertible notes will buy you one to two years, and the interest that investors accrue is far less expensive for the founder than getting an unnecessarily low valuation early in the company’s life cycle.
Candace Klein: Absolutely. Once your business is to a point where you are generating consistent monthly revenue and are able to pay your monthly expenses with revenue, debt becomes a much less expensive form of financing than equity. With debt, you maintain control of your business, and once your debt is repaid, you are no longer tied to your investor. Debt financing is also aligned more closely with your business goals, as the lender is looking for you to make monthly revenue to pay them back. Equity investors maintain far more control over you and your business for a much longer period of time, and are incentivized for a payout, which may push you to sell your business before you would have done so otherwise.
Crowdfund Insider: How easy is it to visit your local bank and take out a loan?
Candace Klein: It’s actually easier than you think. If you have an ongoing relationship with your local bank, your banker genuinely wants to help you find financing. They are going to look for comfort and confidence that you are able to repay a loan, so it may take a year or more of staying power to get approved, but I encourage every business owner to build that relationship with their banker early and often.
Crowdfund Insider: Karen Mills, former Head of the SBA, told us there exists a “credit gap” for small business. What has been your experience in regards to this gap?
Candace Klein: Since the credit crisis in 2008, we’ve seen increased regulation of lenders, and as a result, less capital available for the majority of small business owners. So, unless a business had been in operation for 2+ years and the owner had strong personal credit, there were limited financing options available. At the time, outside of traditional loans, the only options were very high cost, short-term alternatives.
Candace Klein: Sure. At Dealstruck, we launched specifically to serve this gap. We exist to finance what we call the mid-prime market- the small business owner who is not yet bankable, but who has built enough consistency in revenue to deserve financing that looks and feels more like bank financing. For these businesses, we offer term loans and lines of credit for up to $500,000, and our pricing is based upon APR and ranges in the mid-teens. We also have a stated goal to graduate our borrowers on a path to bankability, so our borrower will only be with us until such time as we are able to help them secure bank financing.
Crowdfund Insider: What are some of the options? IE factoring/receivables based. Secured / Unsecured. Pros / Cons?
Candace Klein: At Dealstruck, we offer financing based upon cash flow, outstanding receivables/invoices, and/or turning inventory. Our products are generally secured by a UCC-1 blanket lien on the business, and we do require a personal guarantee. We will generally advise our clients that, by offering a personal guarantee and UCC, you are providing the lender with more comfort in extending credit to you. If you’d prefer to not do so, you will end up paying the lender for that additional risk. The ultimate decision is yours.
Candace Klein: With the proliferation of new online lending options, it has become difficult for the typical business owner to 1) understand who the actual lender is and 2) how much they are paying for their financing. There are so many brokers online now who claim to be the lender, but who are not. It is important for a business owner to ask and get a clear answer, in writing, about who will ultimately be their lender. If it is anyone other than the person on the phone, it is likely a borrower will be able to find financing cheaper without the middle man. And when the financing offer comes, it is vital to ensure the annualized interest rate is spelled out clearly. This enables borrowers to compare apples to apples across different lending options. Many lenders have moved away from offering their pricing in this way, which has made it difficult for the borrower to shop for financing intelligently.
Crowdfund Insider: What can the online lending industry (MPL/Balance Sheet / P2P) do to improve the service offered to SMEs?
Candace Klein: Dealstruck has signed and participates in the Borrower’s Bill of Rights, and are proud to be in the company of several other lenders who have done the same. We encourage borrowers to understand their rights, and to select a lender who is aligned with their business growth goals.