Equity Financing Alternatives

Given the limited access to equity capital — and lower valuations if you can find investors — a variety of other possibilities are emerging as options for smaller and early-stage companies.  Among these are mezzanine loans, royalty financing, and a new breed of Community Development Financial Institutions (CDFIs).

Mezzanine financing becomes increasingly popular when valuations are low, and equity is expensive.  These investments are generally unsecured loans that, like equity capital, can be used for growth or recapitalization – often with a small equity position attached.  A recent article does a pretty decent job in laying out the fundamentals of mezzanine capital for entrepreneurs – with one catch: ignore the minimum EBITDA of $5M, for there are mezzanine funds out there loaning to companies with far lower EBITDA levels — one just has to know where to look.

But for many early-stage companies who have yet to reach profitability, any EBITDA requirement is a killer.  Among the other alternatives for entrepreneurs is royalty-based financing, which allows a company to borrow against a future revenue stream.  Similar to purchase order financing — but usually not constrained to a specific customer or order — royalty financing provides another alternative to growing companies, and can help weather the current equity markets.

Lastly, a number of small institutions — community banks, credit unions, and some nonprofit groups — are applying for CDFI status as an 859 lender (which provides access to federal money).  To do so, they must agree to direct a majority of their loans to low-income communities and individuals, which can be helpful for startups in either urban or rural locations. A WSJ article notes that CDFIs “have been increasingly active in lending to startups” since the credit crunch, and their numbers are growing.