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Finding the right fit: Financing options

Published February 6, 2012

By Nicole Formosa

TORRANCE, CA—Similar to many small startups, Niner Bikes co-founder Chris Sugai squeezed everything he had to get his new company off the ground in 2005. Through personal capital, investments from friends and family, and two minority investors he concocted a recipe that carried him through the initial growth phases.
But as the 29er movement caught on and sales took off, it became clear he would need more cash to mature.

“Growing from a tiny business to a small to medium-sized business, and growing rapidly, takes quite a bit of capital. It’s no secret the banking markets have tightened up,” he said. For a company that’s growing but only marginally profitable, options are limited.

Sugai spent a considerable amount of time and resources exploring alternative routes. Ultimately, his answer came through mezzanine debt and a hard-money lender. Both financing options typically carry higher interest rates than standard bank loans and can involve more risk, but the solution allowed Sugai to avoid private equity funding and the pressures that come with it.

“There’s no set formula,” Sugai said of figuring out financing for small businesses. “We’re in a good position now. We’ve reached profitability. We struck a new deal with a regular commercial bank to reorganize our debt and obtain a lower financing rate.”

Sugai’s deliberation over how to finance his company’s growth is a story to which many in the industry can relate. In recent months, such companies as Eddy Merckx Holdings and Storck Bicycle have turned to outside investors to access capital to finance future growth and remain competitive. With plans to launch a BMX bike and sneaker collection, Merckx’s primary owner sold 20 percent of its shares to Diepensteyn, parent company of Belgium’s Palm Brewing, while Storck brought on French sports retailer Décathlon.

Dave Loughran, owner of online brands Planet X, On-One and Titus, penned a recent blog post about his trip to London to meet with venture capitalists, one of his initial explorations into outside funding. Loughran is the sole owner of his Sheffield-based company, which has grown fourfold in the past three years. In one year alone, Planet X ballooned from 3 million pounds ($4.9 million) in annual revenue to 10 million pounds ($16.4 million).

With those kinds of numbers, Planet X has caught the eye of potential investors. A high-stress period of tight cash flow prompted Loughran to respond to an inquiry about raising capital.

“Since Wiggle was sold there was significant interest in that we are one of a small number of growing online companies at the same turnover level that Wiggle was pre-acquisition. There is also quite a large amount of wealth floating round where there are actually very few places to put it. Property is dead. Banks? Plus there are very big tax advantages in the U.K. for high-net-worth individuals to back growing companies,” said Loughran, who has not yet decided whether to move forward with outside investment but adjusted his inventory levels to improve cash flow.

U.S. markets are loosening a bit and there is interest in the cycling and outdoor industries among investors, but it’s still difficult and competitive to secure financing through institutional lenders or venture capital firms. And as it gets more challenging to do business as a small company, the $5 million to $10 million players have to ask themselves: “Can I really do this? Can I really survive without some kind of strategic deal being done?” said Laurence Levi, president of VO2 Partners, a New York-based investment firm focused on $10 million to $50 million companies in the active and healthy living sector.

To be competitive with the big boys in the industry, in most cases, a company needs to be at $15 million in annual revenue to afford a national sales manager, compete on distribution and employ a strong, differentiated voice to tell the market about the product, according to Gregg Bagni, director of White Road Investments, a fund started by Clif Bar founder Gary Erickson to provide capital to $500,000 to $15 million healthy and active lifestyle companies. If not, a brand must offer something unique or find a niche to own.

“If you’re a smaller brand and you don’t really have anything to hang your hat on, I’d be a little worried right now,” said Bagni, who recently helped White Road obtain a minority investment in Public Bikes, the consumer-direct urban brand started in San Francisco by Design Within Reach founder Rob Forbes. White Road also owns a stake in Santa Cruz Bicycles.

Planet X’s Loughran put it bluntly: “Traditional midsized brands, I think, are now pretty screwed—that is, unless they adapt and evolve. The big power of the likes of Specialized, Trek, Giant, they are going to dominate retailers. And small to midsize brands realistically, unless they have a fantastic demand, are the walking dead. There will be no sympathy from the big boys, just the odd extinction and the odd absorption as the mid players struggle for daylight.”

As Loughran points out, the great strengths of the bigger brands pulling in $700 million to $800 million in revenue annually are also their great weaknesses. Smaller companies can be nimble, fast, own niches and try things bigger companies shrug off.

That formula has worked for entrepreneurs like Loughran—who has built a booming carbon fiber wheel business—and Sugai, who traded in a 25-year career in construction to try his hand at big-wheel mountain bikes, a bike still being laughed off some trails when Niner launched, and now one threatening to make 26-inch bikes extinct.

“It’s been an adventure,” Sugai said. “When I first decided to get into this industry I had a number of people tell me if you want to make $1 million in the mountain bike industry bring 2 [million]. It’s sage advice to anybody out there.”

Topics associated with this article: Earnings/Financial Reports

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