Small Business Labs

Discover Small Business Watch Survey -Small Business Cash Flow Concerns Growing

The Discover Small Business Watch is "a monthly index measuring the relative economic confidence of US small business owners who employ less than 5 employees."  Discover has been doing this for over a year now, and in addition to recurring questions about small business confidence, they also ask other questions from both small business owners and consumers in general.

I was fortunate enough to have the opportunity to talk with the Director of Discover's small business card unit, Sastry Rachakonda, about their most recent survey.  I was curious if their surveys were detecting any impact of the sub-prime mortgage loan problems on small businesses liquidity and cash flow.  Sastry pointed out that 46% of the September survey respondents said they had experienced cash flow issues over the last 90 days - a substantial increase over August's 41% and July's 35% . 

Their September survey also found that one third of the respondents said they extend credit to their customers, and 64% of those extending credit said their customers whoe use credit had delayed payments or had ask to delay a payment in the past three months. 

While just one set of data, it does indicate that small businesses may be feeling the impacts of sub-prime mortgage sector.

Thanks Sastry for taking the time to talk.

Home Equity Loans, Credit Cards and Small Businesses Financing

Several interesting data points on small business sources of financing.  The Discover Small Business Watch group sent me details of their recent survey which showed that 30% of the respondents said they had used a home equity loan at some point in time to finance their business.  Discover surveys businesses with 5 or fewer employees. 

Earlier this year the National Small Business Association released survey results that show that credit cards are an important financing source for small businesses.  Their survey includes a wider range of business sizes, but 89% of the respondents come from businesses with less than 20 employees.  The survey showed that:

• 44% of small businesses use credit cards to finance their business.
• 71% of small businesses that use credit cards carry a monthly balance

Credit card usage by small business has increased since 2000, when 64% of small businesses carried a monthly credit card balance.

Search Funds Gaining Popularity

Knowledge @ Wharton has an article and podcast on the growth of search funds.  These are specialized private equity investment vechicles that are used to find and acquire an existing small business.  While there are no hard and fast rules about search funds, generally speaking the process is:

• an individual entrepreneur or an investment fund raises money to fund the process of searching for and finding viable acquisition candidates.  The Wharton article is an interview with a person from Gordian Capital, which is a private equity firm specializing in search funds.
• After finding an acquisition candidate, the search fund goes back to their investors and invites them to invest in the acquisition.  Investors who participated in the search fund get preferential deal terms in the acquisition.
• The company is acquired and run by a new management team and/or the search fund entrepreneur.  Exit strategies vary, but in most cases the exit is to sell the acquired company after a few years or to generate a long term stream of income for the investors.
• Search funds tend to focus on established businesses with positive cash flows.

Targets are usually successful small businesses that have succession planning issues.  Acqusition by a search fund offers the small business owner an exit strategy, and often the owner works with the new manager for a transition period to teach them the business.  The entrepreneur acquires a working business, and does not have to build a business from scratch.  The investors, hopefully, get above market rate returns for their investment. 

Search funds used to be fairly rare, but seem be gaining in popularity.  After not hearing much about them for the last 5 years or so, I've seen several references and have met with several entrepreneur led search funds over the last couple of months.  This new popularity is likely driven by the general growth of private equity, and the number of large private equity deals that have happened over the last couple of year. 

For more information on search funds Stanford has a good description on their web site.