Company.com talked to Mitch Jacobs, founder and CEO of On Deck Capital, Inc., a New York based company providing loans that work for small business-not the other way around. Mitch founded On Deck Capital in 2006 and, to date, has provided more than $41 million in loans to small businesses when traditional bank loans were not an option.
Company.com: Let's talk about the problems associated with debt-funding for a start-up compared to equity-funding—where does that conversation start?
Mitch Jacobs: Obviously there's vastly different approach if you're starting a technology company that you expect to scale to maybe a hundred employees and a very pervasive presence on the web, versus a local business. Each in their own right is equally admirable pursuit, but very different approaches depending on what your objective is.
CC: In terms of the kinds of funding a company would look at, is there a difference between a traditional “mom and pop” shop, and a technology company that is maybe looking to grow quickly?
MJ: When you're starting the search for capital it begins with an assessment of your own venture, and understanding what kind of business you are passionate about pursuing. That's the first factor in determining which path would be best for you in terms of sources of capital to pursue that opportunity. So if, in that self-assessment, you see yourself as a high tech startup where you are going to invest in building a technology platform that has enormous scale potential, then you are going to move in the direction of sources of capital that understand the dynamics of those companies that they tend to burn capital or they tend to work from non-financial metrics in their growth--meaning that the metrics might be number of registered users, impressions, deployments of software before the metrics become revenue and net income. There is a series of sources of capital that are the natural sources for a business like that. If you're heading in a direction where you plan to start something that is more of a main street small business, then you're going down a different path, and that opens you up to different sources of financing. Those sources of financing are going to be more interested in understanding what you plan to invest relative to what other similar businesses who launched that same type of operation have invested in the past, and what your plan is in terms of what's going to attract customers and what's going to differentiate you and what your competitive environment might be like in the local community. That first step of a self assessment is really going to be your first step in understanding which sources of capital are available to you.
CC: Is capital harder to get for the technology company with a great idea, or the individual who just purchased a dry-cleaning franchise?
MJ: There are millions of existing small businesses in various stages of development that are scratching their heads with various levels of intensity, figuring out how to urgently get access to capital. There are an equal number of millions of Americans who are, for the first time, maybe because of some kind of disruption to their employment, thinking about starting a small business. So they are also scratching their heads asking where is the right place to start and what is the right source of capital for my business. I think that there are challenges in the venture-backed startups and starting up a main street small business in terms of access to capital, but the number of people seeking capital for the latter exceeds the former by many many millions, so I think it makes sense for us to focus on the main street small business. There's a big question in the United States now, and it's how to provide financing for main street small businesses. The Obama administration and many traditional assistance providers like the SBA [www.sba.gov] and programs like SCORE [www.score.org] are all working very hard right now to try to figure out the answer, and in many ways that can only make the challenge for the current or future small business owners that much more difficult to navigate their way through the headlines and get down to how to get their business started, or their existing business financed further.
CC: How should a new small business owner think about funding their new business?
MJ: I think for someone just starting in business you have two principal sources of capital--one is equity for a small business and the equity in a small business typically comes from savings, friends and family, and it comes from, ideally, from some customers in the form of generating cash-flow as early in the cycle as possible. You may be able to go to certain programs--there are programs for minorities and low to moderate income areas where programs like Accion [www.accionusa.org] and CDFIs [www.cdfifund.gov] can play a role in investing in a pure startup by using long term debt capital, but very rarely will a lender step in to provide financing for a pure startup. So if I were advising a new main street small business, I would encourage the business owner to identify a plan that requires the least amount of start up capital to get to a point where they're generating cash flow, and then look to their savings, their own friends and family and local sources of investors that can help them get money in place for that additional investment capital. The challenge with that last category of local investors is that most small businesses don't provide an equity return. It's hard for the investor to envision when they would get that exit liquidity where they get their cash out, plus some significant return. So anyone launching a small business needs to be aware that there may be defined sources of capital that aren't going to expect that big return, like friends and family, or any cash they've managed to set aside for that purpose. The one thing that can make the cash more available is designing a program where you can say to your investor, "I plan to pay you back in year three, and I'm going to pay you back with an attractive return, and I'm going to pay it back over a long period of time" so that you're setting a realistic objective where you'll be able to provide your friends and family or local investor with a return in the future. So that creates what I would call "debtquity" that can free up capital for the launch of a small business.
CC: If you sell a piece of your business the investor may want some control, which kind of funding is a bigger constraint for business owners?
MJ: My advice is to stop worrying about control. Having investors, whether it's equity or debt, is going to be a part of any startup or growing business. Worrying about control is the wrong place to focus your energy. THe right place to put your energy is--number one--get into a business that you are best suited to run. You have a basis of experience that others don't have, a talent or a passion , and you also have some experience as a business owner or a good group of advisors who can help you get up that experience ladder very quickly. If you, by putting your self in a position where you will be a successful leader, you will then be in a position to do the second thing, which you have to do whether it's debt or equity, which is manage your investors. Keep them informed, provide them with an opportunity to provide input, explain to them what your strategies are. Not only your long range strategy, but what your plans are for the next six months to a year and keep them apprised of your progress.
CC: So the management of investors is more important that the idea of control?
MJ: If someone is investing in a business they have a right to expect a certain amount of input, but they also should be smart enough as an investor to know that they've backed the entrepreneur, and if they go beyond a certain point in terms of their input or their expectations of control they will undermine their own return. One of the things you can do to help yourself early on is work with experienced investors.
CC: What kind of covenants do you typical see a lender put into a debt financing package?
MJ: You're going to deal with a few different categories of covenants--first off expect to have a lien on the entire business. A lender is likely to name specific assets that they will also have a lien on and that becomes the backing for their loan. They'll expect you to maintain certain financial covenants, there'll be income levels, net income levels, revenue levels. There might be certain balance sheet covenants like the book value of the business. All of which you really need to sit down with an accountant and understand, and to forecast the future of your business so you're not going to trip any financial covenants. This is a few-hour exercise, it should not discourage someone, and it sounds more intimidating than it is.
You then need to be aware that there might be certain types of eligible investments. The money might be general money you can use for anything but more likely there'll be some structure that you need to create about how you're going to use this money and what its intended purpose is. There is commonly a requirement called a cross default that says you won't default on any other credit or loans or debt that you have, and if you did you'd also be defaulting on the loan that you're taking from the bank or from the lender.
CC: How do you prepare yourself as a business owner in order to attract investment capital?
MJ: A great way to prepare yourself is--first off--to be realistic about your plan. I think that quite often business owners confuse their passion and their certainty that they can be a success with the rate or the speed at which they will do it. The best mindset to put yourself in as a business owner is that you are going to be successful. Consumers love going and making purchases at businesses where the business owner is passionate--way more passionate than they as a consumer could ever be about a particular good or service that is being provided to them. That's what creates the value for a consumer, that they're working with a business that is so passionate about the good or service that they are providing. Built into the product is the value of all that passion. But as a business owner, what you need to do is allow yourself to dream and to build a big plan, but actually have your tactical plan to get there be very conservative, and really work from the bottom up in how many customers you need to come through the door and what price you're going to charge for the product and what kind of revenue will result and what the costs of the product are--and you subtract that and that leaves you with the money left over to cover the overheads. Go through a detailed process of really envisioning what that business will look like week after week as you build it up and recognize that it will take a little more time than you think, and the revenue's going to come in slower than you think. Build that into your plan so you're out raising a realistic amount of money.
I think that the best thing you can do is build a conservative plan toward a really big dream.