Seth Godin, one of the most prolific bloggers and inspirational marketers, has an interesting post on his blog titled “Debt, equity and a third thing that might work better.” He’s spot on that banks aren’t in the market to take on risk, and thus will only lend against collateral that’s already in place. Another point, which isn’t mentioned in the article, is that equity financing is even more “expensive” now than a couple years ago because of that point about the banks. Only now, it is much worse.
What I mean is that previously, banks were more apt to lend against capital purchases like new equipment or an acquisition with a smaller amount of money down. At one point is was possible to get up to 12x leverage on money, so a $1,000,000 piece of equipment could be purchased for $80,000 assuming good free cash flow or profits to service the debt. Well, as banks have gotten even more risk-averse, they are requiring 20 – 30% down, if not more.
This has made it much harder for businesses to finance projects. In turn, the difficulty to get bank deals done has resulted in more high quality businesses looking to raise equity to fulfill contracts or to expand. This has provided investors and VCs more established, less risky investment options with which to choose from, creating even more of a gap in the market for capital for more risky, early stage deals.
I do think some more dialog on alternative funding and business building strategies is warranted.