Venture merchant banking: financing 'sales' vs. 'assets'.

• Author: Ingrassia, Joseph

Banks have continued to change with the sophistication of the capital markets--arguably, U.S. capital markets are the most sophisticated in the world--but continue to fail small-to-medium-sized enterprises (SMEs) by not providing loans without a Small Business Administration (SBA) or U.S. Department of Agriculture loan guarantee.

Typical asset-based loans don't work for the majority of SMEs because the firms lack the current assets to leverage, as required by typical asset-based lenders. Most asset-based lenders and factoring companies are focused on current assets (otherwise known as accounts receivable) as the means to provide leverage to borrowers. However, with globalization and the direct extension of the supply chain to 150 to 180 days, conventional asset-based lenders and banks can no longer support SMEs' borrowing needs.

So, how does the typical SME that sources it products domestically or internationally purchase its pre-sold goods without having a surplus of accounts receivable?

Funding Growth, Not Current Assets

There are only two options. SMEs can attempt to raise equity--an uphill battle, at best. Unless the firm is a high-tech or biotech company, most equity investors will not be interested because most SMEs can't provide the return on equity that makes an equity investment possible.

The second option is to seek financing from a venture merchant banking firm. Merchant banks differ from traditional banks by assisting the SME with purchasing its pre-sold goods, as well as assisting in the management of company growth. Most companies are forced to borrow from Peter to pay Paul to finance their growth. This results in uneven growth, and in most cases, a loss of credibility with vendors who are promised payment--only to be disappointed after credit terms are extended and promises go unfulfilled.

Merchant banks typically support clients with purchase order, trade finance and factoring services. This vertical integration, as well as a staff that works with growing companies every day, is like a breath of fresh air to firms in need of funding. Once a client transfers from a bank or typical asset-based lender to a merchant bank, it's common that their business gains significant momentum. As a result of the financing, their backlog of orders is filled, their vendors are paid in a timely manner and their customers begin to depend on them more by placing larger orders with them.

The merchant banking model works well for most smaller...