Financing Recycling Ventures

Access to capital is a significant barrier to the growth of new and expanding recycling enterprises. However, recycling companies are not unique in having difficulty finding the funds to expand. Indeed, improving capital formation was the top priority of small and entrepreneurial business participants in the recent series of White House Conference on Small Business meetings.

In the recycling industry, new companies may have special challenges in attracting capital. New technologies or processes, fluctuating commodity prices, uncertain materials supply, and fickle customers can combine to make these enterprises appear too risky to potential investors. Financial institutions like to compare potential financing deals with existing ventures. However, in many developing recycling sectors, such "comparables" are often hard to come by. Recycling entrepreneurs must be persistent and innovative in their search for the funding to make their business plans a reality.

In a recent survey of recycling enterprises in North Carolina, 38 percent of responding companies cited "limited access to capital" and 29 percent listed "cash flow problems" as their main obstacles to growth. Only "environmental regulations" were mentioned more frequently as a business obstacle, primarily by scrap metal processors.

These and other results reported below are from the "North Carolina Recycling Business Study" conducted by KirkWorks, Durham, N.C., for the Self-Help Credit Union and the N.C. Office of Waste Reduction. The study results were based on written and phone surveys and Employment Security Commission Data from nearly 500 recycling companies across the state.

The study documented that recycling businesses are an entrepreneurial and growing sector of the North Carolina’s economy, adding new jobs at six times the rate of all private industry in the last four years. Nearly 70 percent of recycling companies reported that their businesses were either starting up or growing. Four out of five surveyed firms were independent, locally owned small businesses, with annual revenues and total assets each averaging about $1.1 million per company.

Responding recycling companies seeking new financing needed about $356,000 dollars on average over the next three years. The most common financing need was in the hundreds of thousands of dollars, with more than 40 percent anticipating a demand for between $100,000 and $750,000.

Most N.C. recycling companies anticipated using additional financing to purchase fixed assets, with three quarters of the funds to be used for equipment, land or buildings. Less secured uses of funds – working capital, marketing, and research and development – were anticipated to claim only one quarter of funds.

The capital demands of North Carolina recycling companies are mirrored by those of firms in other states. As a greater amount and variety of materials are collected, processed and manufactured into value-added products, the investment needed for equipment, facilities, research and product development continues to grow.

Recycling innovators can take tips from other successful business sectors on capitalizing their businesses. Entrepreneurs, financiers, and government officials can all play a role.

The first step for the recycling business owner or manager is to put on paper what they know about their business and why it should succeed. The risks that potential investors and lenders are concerned about are real. The entrepreneur has to have both the industry experience and the background research to help assure potential partners that risks can be minimized and opportunities realized.

A business plan, written by the company founders, should address the company’s history, its products or services, target markets, competitors, and financial projections. Perhaps most importantly, the plan should provide information on the management team – explaining why these individuals have the unique strengths to make the enterprise a success. In addition to showing how the business will grow and repay investors and lenders if plan assumptions are realized, the plan should give a realistic assessment of the down sides and how risks can be mitigated.

One of the important conclusions of a well thought out business plan will be the amounts of money needed for specific uses during different stages of the business’s growth. The next step for attaining financing is to match each intended use of funds with the appropriate source of financing. Important characteristics about the investment needed include the amount, the use, the duration, the risk and the projected returns.

The most basic distinction between financing sources is between debt and equity. Debt financing is essentially borrowing money for a fee. Typically, regular payments are required and interest rates are charged based on the perceived risk to the lender. Usually the uses of the funds are for fixed assets which have a collateral value which can help the lender recoup losses if the business fails. Sources of debt can include commercial banks, credit unions, suppliers, customers, factor companies, leasing companies, credit card companies, and governmental loan funds.

Equity financing, on the other hand, involves selling partial ownership in the company for an investment of funds. Typically, company founders are the first equity investors through their own "sweat equity" and personal savings. Other equity sources can include friends and family, private individual investors, venture capital funds, corporate partners, employee stock ownership plans, or investment partnerships. Equity sources of funds are used for purposes which lenders will typically not finance in young companies – including research and development, marketing, working capital, and an equity share of fixed asset purchases.

The entrepreneur’s goal in securing financing should be to identify the appropriate mix of funds with the least cost to the business and the fewest restrictions on business operations. Founders usually seek to retain as large a share of ownership in the firm as possible, to realize returns on their investment and innovation and to maintain business control. Sometimes, however, it is important to realize that equity or debt investors can contribute much more to the business than money – including management expertise, contacts, marketing channels, and business partners.

Once the recycling entrepreneur has his or her business plan developed and a good idea of appropriate financing sources, it is time to start circulating. Many investors only consider potential deals that are brought to them by a respected intermediary. The recycling business planning significant growth should make sure to have good counsel. A law firm and an accounting firm, and perhaps an investment banking firm, can provide not only good counsel but important financing and business development contacts.

Such counsel can help the enterprise confirm the amount of capital needed, the preferred debt and equity instruments, and guidelines for identifying potential investors in compliance with state and federal securities laws. Operating within these guidelines, the entrepreneur should let every appropriate contact know about the investment opportunity with their venture.

Even after doing the homework on the business plan, getting strategic assets in place, structuring investment vehicles, and spreading the word, many recycling entrepreneurs are still left thousands or millions of dollars short of the capital they need.

One strategy is to tap into networks, associations, or events that have been developed to make the financing of entrepreneurial ventures more efficient. A second is to tap sources of governmental loans, grants or guaranteed loans.

Dozens of networks are active around the country in matching entrepreneurs with potential equity or subordinated debt investors. Typically, ventures pay a fee to list a business description with the networks. Subscribing investors receive the descriptions and can request more detailed information through the network or directly from the business.

Participating investors can include individual investors, venture capital firms, corporations, investment partnerships or other sources of financing. Some active networks that are particularly suited to recycling ventures include Technology Capital Network at MIT, Cambridge, Mass.; The Capital Network, Austin, Texas; Environmental Capital Network, Ann Arbor, Mich.; and Investors’ Circle, West Chicago, Ill.

Financial institutions and investors belong to a variety of associations. These associations can provide referrals to active members in a geographic area and information on the general investment criteria of their members. For example, the National Association of Small Business Investment Companies, Alexandria, Va., represents financial institutions which invest equity capital and long term debt in small, independent businesses.

The Social Investment Forum, Boston, is an organization of more than 1,000 organizations and individuals involved in socially and environmentally responsible investing. The National Venture Capital Association, Arlington, Va., represents venture capital firms. These firms typically invest equity capital in companies with high growth rates and the potential of eventually making a public offering of stock. Finally, the Community Development Financial Institution Coalition, Morrisville, Pa., represents more than 300 community development credit unions, loan funds, investors, and venture funds.

Another strategy for entrepreneurs seeking to find investors is to participate in investment forums or fairs. Many events have been organized around the country by entrepreneurial or venture capital associations to allow promising businesses to make presentations to audiences of interested financiers. The National Venture Capital Association maintains a list of investment fairs around the country.

A recent study concluded that investment forums focused on recycling ventures could help strengthen the capital markets for those companies.

The Recycling Venture Forum Study, available through The Northeast Recycling Council, Brattleboro, Vt., and the National Recycling Coalition, Washington, noted that although there are many individual investors, investment firms, finance companies, intermediaries, or other capital sources that are interested in financing strong recycling ventures, reaching these investors is a costly and difficult proposition.

Similarly, investors are looking for new ways to efficiently find new investment opportunities and accurate information on companies, to reduce their marketing and due diligence costs.

Two recycling venture forums are currently planned, based in part on the positive results of this study (see sidebar).

Whether identifying potential equity investors through networks, associations, forums or other methods, the entrepreneur needs to structure the investment offering with assistance from appropriate counsel. One option is to sell off company securities in a private placement complying with Securities and Exchange Commission’s small business exemption regulations to reduce expense and reporting requirements.

Public loan and loan guarantee programs offer a good complement private debt and equity financing sources. Federal, state, and local governments offer financing assistance to help promote small business, community development, rural employment, minority businesses and other goals.

The survey of North Carolina recycling businesses found that four out of five were independent small businesses, not subsidiaries of larger companies.

Their sales revenues averaged about $1 million per year and they employed about 12 workers per company. Recycling enterprises across the country that match this description are ideal candidates for SBA small business debt financing programs.

The SBA 7A Guaranteed Loan Program, for examples, guarantees loans through private lenders to businesses for up to $500,000 for a variety of uses.

The Market Development Directory published by NRC provides an excellent list of state and regional market development contacts.