WMO
Withrow, McQuade & Olsen, LLP
Attorneys at Law
Copyright © 2006 Withrow, McQuade & Olsen, LLP. All rights reserved.
3379 Peachtree Rd NE
Ste 970
Atlanta, GA  30326
Couseling the Small Business Client in Georgia:
How to Finance the Small Business


National Business Institute
Atlanta, Georgia
May 5, 1999

Scott C. Withrow, Esq.
Withrow, McQuade & Olsen, LLP
3379 Peachtree Road, Suite 970
Atlanta, Georgia 30326
404-814-0200

Copyright 1999 Scott C. Withrow

HOW TO FINANCE THE SMALL BUSINESS

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Strategic Alliances

The strategic alliance has rapidly developed into a major structural alternative to joint ventures and a major financing alternative to traditional debt and equity offerings. While the strategic alliance can take a variety of forms, this paper will focus on the prototype in which an early stage, small business with some entrepreneurial technology or service capabilities establishes an alliance with a larger corporation with established marketing resources and contacts. The small business gains access to great marketing resources and the large entity gets entrepreneurial ideas which it may have difficulty developing within its corporate culture.

I have represented entrepreneurial clients in several very successful strategic alliances with larger entities, in one case with a Big 5 accounting firm and in another case with a major long distance phone company. Companies such as IBM and Microsoft are actively seeking to form strategic alliances which complement their existing products and services. The growth of the strategic alliance is largely due to the value of and dependence on technology in the current economy.

Simple Structure. As a legal structure, the strategic alliance is generally a simple sharing arrangement without the extensive negotiations over capital contributions, control and ownership normally associated with a joint venture, partnership or venture capital investment. A basic form of Strategic Alliance Agreement is attached as Appendix B. The first observation to make, particularly for those of you with "page-counting" clients like me, is that the agreement is only six pages long. Simplicity is a major benefit of the strategic alliance.

The members of the alliance may contract with clients jointly, separately, or as contractor and subcontractor. Article I of Appendix B contemplates separate billing by each alliance member with an option for Large Corp. to assume the prime contractor role. The relationship may exist for a specified term or simply on a project-by-project basis. Article II of Appendix B states a five year term, but the agreement can be terminated early for any reason by either member upon 60 days notice.

Proprietary Property. The small company typically is sharing some of its proprietary property or information in the strategic alliance relationship. The main function of the agreement with respect to the small company is to protect this proprietary property or information from appropriation by the larger corporation. Article IV of Appendix B establishes confidentiality obligations between the parties and refers to a separate exhibit for the Non-Disclosure Agreement. The Non-Disclosure Agreement should, in turn, fill in the specifics concerning the proprietary property or information, particularly that of the small business. The contractual non-disclosure agreement will provide back-up protection to the extent the proprietary property or information is not already covered by patent, copyright, trademark, trade secret or other legal protection of intellectual property. In addition to non-disclosure, the small business may request an affirmative agreement by the larger corporation not to attempt to replicate its proprietary property or information.

No Partnership. Article V of Appendix B states that the members of the alliance are not partners or joint venturers for tax, property or liability purposes. This structure avoids the sticky tax issues arising in forming a partnership or joint venture, particularly between capital and service partners.

Indemnification. Notwithstanding the structural attempt to separate liability, Article VII of Appendix B provides a standard, mutual indemnity, excluding negligence and wrongful acts by the other party. The provision requires prompt written notice, the right of the indemnifying party to defend and select counsel, and the obligation of the indemnified party to cooperate in the defense.

Nonsolicitation of Employees. A concern in strategic alliance relationships is that one party will end up hiring the employees of the other. Article VIII provides a mutual non-solicitation of employees for six months following termination of the strategic alliance.

Nonsolicitation of Clients/Non-Compete. The form in Appendix B does not include provisions for nonsolicitation of clients or noncompetition that may be requested by the larger corporation with the marketing contacts. The decision to give such covenants, and the scope of such covenants, if given, must be carefully considered by the small business on a case-by-case basis.

Other Considerations. One drawback of the strategic alliance structure is that the small business may become dependent on the marketing resources of the larger corporation without any rights of control. Ideally, small business should be developing its own marketing resources while it enjoys the benefits of the strategic alliance so it can survive on its own when the strategic alliance terminates.

During the actual management of the strategic alliance, the relationship between the parties is very important. The written agreement provides little in the way of management structure to govern the alliance. Commitment, chemistry and trust must exist and be maintained for a successful relationship. The development of such a relationship requires significant time and effort that must be considered in the pricing arrangements of the alliance. When the parties realize the importance of relationship issues and manage them appropriately, the strategic alliance can be a win-win situation for both sides.

Overall, the strategic alliance largely preserves the strategic advantages of the small business, and actually leverages these advantages with the marketing resources of a large enterprise. Entrepreneurial nature is maintained with a minimum of additional procedure. For technologically oriented businesses, the strategic alliance should be seriously considered as an alternative to traditional debt and equity financing.

Banks

Banks are financial institutions that accept deposits and make loans. They fall into several categories, such as savings and loans, thrift institutions and commercial banks. Knowing the category in which they include themselves can tell you a lot about the kinds of loans these banks are interested in making. Savings banks are more experienced in dealing with consumer loans, such as home mortgages and automobile loans. Commercial banks have more experience and interest in business loans. Probably the most important point to keep in mind when dealing with a bank is that bankers don't like risk. Their primary concern is always the safety of their funds, which can be in conflict with the need to assume risk in an entrepreneurial venture.

Banks come in all shapes and sizes and there are some real differences among them. Small community banks with two or three branches may operate quite differently from large commercial banks with hundreds of loan offices. A commercial bank may be more experienced and familiar with a business loan request, but a community bank may know the small business personally and have more confidence in its ability to repay the debt.

Commercial Finance Companies

The primary purpose of a commercial finance company is to provide loans to purchase inventory and equipment. Loans from such companies can be useful for manufacturers or wholesalers. Commercial finance companies generally charge higher rates of interest than banks. They also may be more willing than banks to approve a small business request. Commercial finance companies will require that the debt be fully collateralized.

Factoring

A factor company can be a useful source of funds for small businesses with substantial assets in accounts receivable. Factor companies purchase accounts receivable of the small business at a discount, thereby freeing cash for the small business sooner than if it had to collect the money itself. The factor company takes title to the accounts receivable in exchange for a cash payment.

Factor companies provide two types of financing alternatives: recourse factoring and nonrecourse factoring. In recourse factoring, the small business and its individual principals retain part of the risk for ultimately collecting the accounts receivable. If the customers do not pay, the factor company has recourse against the small business and its principals for the bad receivables. In nonrecourse factoring, the factor company has no recourse against the small business or its principals for bad receivables. Neither commercial finance companies nor factor companies are appropriate as a means of seed capital to start a business because of the need for collateral or accounts receivable to sell.

Leasing Companies

A leasing company is a business that rents various types of equipment to businesses and individuals. By renting rather than buying, the small business may obtain needed equipment without a large, front-end capital expenditure. Many leasing companies do require a down payment or several months' prepaid rent. The small amount of cash needed to secure the use of equipment for your business makes leasing very attractive to many business owners. Leasing may help the small business to avoid the expense of purchasing quickly outdated equipment if the industry experiences rapid changes in technology.

However, since the small business does not actually own the equipment, the leasing company may repossess it upon a default in payment.

Small Business Administration Loans - Lender of Last Resort?

SBA loans are a major source of financing for small businesses, providing over $10 billion in 1997, both direct and guaranteed. Paperwork on SBA loans can be excruciating, although the recently adopted "low-doc" programs are an improvement. Typically SBA loans require fixed assets as collateral and guaranties of the principal owners and their spouses. SBA loans work well for "mom and pop" businesses and traditional industries. Another advantage of an SBA loan is that the entrepreneurial nature of the business is generally maintained as long as the monthly loan payments are made. SBA lenders do not require the control concessions that venture capitalists do.

SBA loans do not work well for technology oriented businesses with little fixed assets or for pure start-ups. Entrepreneurs with good credit may find it easier to obtain a straight commercial loan rather than SBA loan. Commercial bankers, like venture capitalists, are now aggressively pursuing small and even start-up businesses with good credit.

The SBA offers financing through the programs listed below.

7(a) Loan Guaranty Program. As the SBA's primary lending program, the 7(a) Loan Guaranty Program was designed to meet the majority of the small business lending community's financing needs. In addition to general financing, the 7(a) program also encompasses a number of specialized loan programs:

Low Doc. This program is designed to increase the availability of funds under $100,000 and streamline or expedite the loan review process.

CAPLines. An umbrella program to help small businesses meet their short-term and cyclical working-capital needs with five separate programs.

International Trade. A program for a business which is preparing to engage in or is already engaged in international trade, or is adversely affected by competition from imports.

DELTA. Defense Loan and Technical Assistance is a joint SBA and Department of Defense effort to provide financial and technical assistance to defense-dependent small firms adversely affected by cutbacks in defense.

Microloan Program. This program works through intermediaries to provide small loans from as little as $100 up to $25,000.

Certified Development Company (504 Loan) Program. This program, commonly referred to as the 504 program, makes long term loans available for purchasing land, buildings, machinery and equipment, and for building, modernizing or renovating existing facilities and sites.

Small Business Investment Company Program. Small Business Investment Companies (SBICs), which the SBA licenses and regulates, are privately-owned and managed investment firms that provide venture capital and start-up financing to small businesses.

Summary

Appendix C summarizes the various financing options available to small business and their relative impacts on the control and tax structure of the small business.

RESOURCES ON THE INTERNET


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© 1999 Scott C. Withrow. All rights reserved.

NOTE: This site includes a summary of certain legal issues facing small businesses today. This site does not, and is not intended to, give legal advice. Reference should be made to full text of the statutes and regulations for complete analysis. Consultation with competent counsel is strongly recommended.