My Business Needs More Money!
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So you’ve managed to get your fashion business started, formed an entity, developed a business concept or product that has promise, established relationships with accountants, attorneys, suppliers, sales and PR contacts, and perhaps even lined up some customers. All very promising, but now your company needs to pay suppliers, as well as distribution and sales costs to get your product in the hands of customers. The real question then, particularly for an emerging fashion company, is how does your business plan to address its financing needs?
Determine Financing Needs
One of the best things an emerging fashion company can do is conduct a financial assessment of the company’s projected cash flow in so it can determine its financing needs. Additional working capital will likely be needed to smooth out periods of inconsistent cash flow, such as between the time of the initial cash outlay to produce product and the (typically much later) time when the company is actually paid for such product, as well as to meet growing demand and/or to “scale” its operational capacity to service a larger customer base.
The new company may also have specific financing needs other than working capital, such as developing (or re-developing) its website, adding e-commerce functionality, adding a new product line and paying for capital expenditures.
In a perfect world, the emerging fashion start-up would be so wildly successful that it could rely on sales from the “organic” growth of its business to address these needs; however, the practical reality is that most companies need to seriously consider how they plan to address their financing needs – particularly how much money is needed, over what period of time, and from what source – in order to make it to the next stage in its development.
Discover Financing Resources
There are a number of different types of sources of outside financing: venture capital investors, angel investors, “friends and family” investors, factors, and commercial bank lending.
Although not traditionally the core focus of venture capitalists, these investors recently have taken an interest in fashion companies with a strong technology or e-commerce component, such as those that have an innovative approach to “digital tailoring” or that provide social marketplaces for niche fashion items. Although far less often, the venture capital category may include strategic or corporate investments from large fashion houses, particularly for later stage companies.
Angel investors, which are usually successful entrepreneurs themselves, typically provide the mentoring and guidance that many young companies need. The benefits of “partnering” with a venture capital or angel investor, particularly one that has relevant industry experience and a strategic/business approach that meshes with that of the founders, can provide intangible benefits.
“Friends and family” investments typically involve several investors with which the founders have a pre-existing relationship that contribute relatively small amounts to the company. They typically want to support the business to achieve its goal of making the company a success and are also happy to get in on the ground floor as the business succeeds.
Factoring is not considered a loan and has traditionally been a common source of financing for fashion companies that generate invoices for orders for their products (such as those that sell apparel to retail stores). A factor will purchase such invoices (often on a season-by-season basis) at a discount to their total value – putting funds in the company’s hands quickly – and will assume the risk of collecting payment on such invoices.
A bank will loan the company funds in exchange for regular payments of principal and interest. The company must determine whether its projected cash flows will be sufficient to repay such regular loan payments, as well as whether the amount of loaned funds will be sufficient for the company’s immediate and longer-term needs. Banks are looking to be repaid based on the company’s credit profile/risk and are not sharing in the “upside” or entrepreneurial risk like an investor.
Select Financing for Your Needs
If you take on equity investors (i.e., investors that purchase ownership interests in your company) – be prepared to lose a certain percentage of the “upside” and, depending on the type of investor, a certain level of control of “high level” decision making and long-term business direction of the company. If “follow on” equity financing is required, the founder’s equity interests will be further diluted as a result, which could lead to the founders losing control over the company over time.
A venture capital investor’s ultimate goal (and, to a lesser degree, an angel investor) is to exit the “investment” and get a return – this can cause some divergence of goals down the line for a company that fails to understand this. Further, venture capital investors typically only invest in a small percentage of the companies they review – making for an involved (and costly) process with little assurances of being funded.
“Friends and family” investors tend to be less discerning, however, good old Uncle Joe may not be happy with you if the company doesn’t provide a return (which he won’t let you forget), not to mention he may pepper you with a variety of relevant and not so relevant inquiries regarding the company’s status and prospects, unnecessarily distracting you from your main focus on growing the business.
Using a factor will result in giving up a chunk of the company’s revenue to the factor and having less cash available to pay other expenses. In addition, factoring would not work for companies that primarily receive cash or credit card payments in full at the time of sale, such as from sales at the company’s own retail store(s) and/or through the e-commerce functionality on a company’s website.
If the company obtains a bank loan or line of credit, its cash flow will be noticeably affected. The company will pay regular loan payments to the lender and, as a result, will have that much less cash available to pay suppliers, operating costs and employees – requiring additional revenues or sound cost management (or a combination of both) to keep the business operating profitably.
In addition, having debt on the company’s balance sheet increases its risk of becoming insolvent or bankrupt. In the event the company defaults on the loan, the lender will likely seek to enforce a security interest in assets of the company which allows it to essentially sell the assets through a foreclosure process in order to repay the loan. Keep in mind that lenders will get repaid out of the assets of the company in priority before equity holders (including founders).
The type of financing source that is appropriate will depend on the particular facts and circumstances for your company, such as its growth prospects, as well as the size, nature and stage of development of the company.
For example, an early stage company with a strong management team and high growth potential that may require additional capital infusions upon reaching certain milestones in its development may be a candidate for venture capital or angel financing, particularly if such company has a significant technology component (such as a web-based fashion company).
On the other hand, an established company may be a better candidate for receiving a loan from a commercial bank compared to an early stage company that has little or no fixed assets (and who’s cash flow fluctuates more wildly).
A fashion company that primarily relies on accounts receivables/invoicing for its revenue may benefit from using a factor, given the ability to get funded quickly near the time an invoice is generated, while avoiding some of the more notable drawbacks of taking on equity investors or debt.
Establish Financing Early
Without considering how to address its financing needs, an emerging fashion company runs the risk of realizing the shortfalls too late – potentially losing key employees or not being able to fulfill customer orders as a result – or choosing a financing source that is inappropriate or misaligned with the founder’s ultimate goals for the company, greatly harming its long-term prospects. Given how challenging it is for most emerging companies to become successful and the ramifications for failing to adequately consider a company’s financing needs, founders should be sure to address this critical aspect of business planning early on and often.
About Christopher J. Kula
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Chris is the co-author of many Phillips Nizer-published legal alerts in his areas of practice, and serves on the New York State Bar Association Business Law Section’s Technology and Venture Law Committee, as well as the American Bar Association Business Law Section’s Private Equity and Venture Capital Committee. He is a Hofstra University School of Law graduate and, prior to law school, attended Villanova University.
About Phillips Nizer
Phillips Nizer LLP has been engaged in a wide-ranging practice of domestic and international law for over 85 years. Established in 1926 by Louis Phillips, former Assistant General Counsel to Paramount Motion Pictures, and Louis Nizer, considered one of the most outstanding trial lawyers of the twentieth century, the firm consists of lawyers who are well-respected leaders in their fields. The firm’s bond with the fashion and apparel industries began in the 1940s, a relationship that continues to this day almost 60 years later. Phillips Nizer’s principal office is in New York City, with additional offices in Garden City, East Hampton, and Hackensack, New Jersey. For more information, please visit: http://www.phillipsnizer.com/
