You Made a Great Product. Now, Don’t Make This Common Financing Mistake

Imagine for a moment that you make and distribute a killer BBQ sauce.

Your friends love it. Their friends love it. A Top Chef winner posted about it on Instagram. Then a wholesaler representing the biggest grocery store in your area calls – they want to order thousands of cases and see how it sells to their customers. Huge deal. Big.

Until you have to make it happen.

You’re going to need materials – all that stuff that’s going in your sauce. A co-packer, or contract packer, to put the sauce into bottles. Oh yeah, the bottles cost money too. Shipping, to get your sauce from the co-packer to a distributor’s warehouse. The distributor gets a cut, maybe 15%. And that’s all before it makes it to the store, where they’ll add extra margin to their cost from you, and hopefully, at the end of all of that, someone will buy it and put it on their smoked chicken.

You’ve gotta pay for it all somehow, and since that invoice you gave the wholesaler won’t get paid until 30 to 45 days after the product gets delivered, you’re going to need capital.

The most common financing choice: raising money through equity

You might be tempted to go find investors. For a percentage of your company, they’ll happily give you the financing; after all, you have a proven product.

But there is no reason to give up a large percentage of your company just to solve a working capital problem. I once personally heard John Mackey, Whole Foods, Inc. CEO, describe venture capitalists as, “hitchhikers with credit cards.”

Remember, you don’t just have a product — you have more valued assets at your disposal: your accounts receivables, your inventory and your purchase orders.

Solving the timing problem

Most of our clients come to us with a timing problem. They need something core to their operations — employees, product, work space, raw materials – you name it – and the cash they need to pay for those things won’t come in until later, 30 days if you’re lucky, 90 days if not. In the case of packaged goods, this is particularly important as inventory and cost of goods must be paid for quickly, and in some cases it must be prepaid.

It’s not just soda and cereal, either. Take the story of Daniella Helayel, fashion designer and owner of an independent label named Issa. In 2010, Prince William and Kate Middleton stepped out to announce their engagement, and Kate, who’d worn Issa designs many times in the past, was clad in a royal-blue Issa dress. Millions of photographs and days of television coverage later, Issa’s phone was ringing off the hook, everyone wanted the dress — and other Issa products — and Daniella, who didn’t have the capital to get more blue dresses produced, searched desperately for investment.

“I didn’t have the money to finance production on that scale,” she said. “The bank refused to give me credit and the factory was screaming for me to pay its bills. I needed an investor.”

Traditional banks often don’t offer purchase order financing. So Daniella eventually turned to a royally-connected one: Camilla Al-Fayed, half sister of the late Dodi Fayed, who died in a car crash with Kate’s new fiancé’s mother. Camilla bought equity in the business, negotiated to buy 51% of the company, and eventually used her ownership stake to install a new CEO. More troubles continued, as the princess wore Issa less frequently. Daniella left her company two years later, frustrated with losing control of the brand she’d founded. This does not have to happen to you.

Purchase-order financing (or inventory finance and accounts receivable financing) is a better solution for working capital needs

It’s impossible to anticipate when a princess will wear your clothes, or when that call will come from the grocery store you’ve been dying to work with. But that doesn’t mean you should be short of the cash you need to make it happen — or that you should sell your equity to do so.

We make bets on great companies like this all the time. You’ll find, if you come to us, that we start first by understanding you, and your product — why the BBQ sauce you make is going to be so successful. Then we look at your financials. But all the numbers are secondary to that first part: you. You’re the one that makes the sauce, literally and figuratively.

Enough with the fictitious sauce. Are you hungry now too? Find another example of purchase-order lending with our client Blue Ribbon. As a seasonal business, we helped them smooth out their revenue year-round to make cash and workflow much easier. Can’t promise you won’t want their cookies, though.

Just remember: don’t use equity to cover your working capital. (That’s not to say that you shouldn’t take on investors — just use their capital strategically to maximize your equity position and for things that will grow your company, like great marketing.) In case you need more convincing, here I am a few years ago, with a few less gray hairs, making the case:

Thanks for listening — and don’t forget: princesses have fickle tastes in clothes.

Cole Harmonson is the CEO of Far West Capital, a company that funds the goals of high-growth entrepreneurs. Know a great company in need of capital to unleash their potential? Send them here and we’ll give them a call.

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