Natural Foods Merchandiser

Funding sources depend on aspirations

Sure, the marketplace for naturals and organics keeps getting more competitive, with a steady flow of new players and the big players getting bigger.

That has an upside for independents. The more consumers spend to support businesses that promote health, the environment, sustainable agriculture, local farms and fair trade—the more investors are taking notice of companies in the Lifestyles of Health and Sustainability sector.

"In a lot of cases, demand is exceeding supply for a lot of these things," said David Link, co-founder of Denver-based Greenmont Capital Partners, a $20 million private equity fund dedicated to LOHAS businesses. "That's an attractive set of circumstances for venture capital."

Still, he and other investors attracted to natural and organic food businesses say most entrepreneurs will need to use their own money and borrow from friends and family to get their businesses off the ground.

Greenmont has yet to finance a retail concept, though Link is open to the idea. Returns are typically smaller and slower in retail than for certain new whiz-bang products that promise explosive growth, such as Boulder, Colo.-based Izze Beverage Co., one of Greenmont's investments.

No matter how much good a company may do for the world, if it doesn't pass muster on business and growth plans, forget it, Link said. "Growth is key for any business. You shouldn't lower the standard for returns because [a business] sells granola."

Traditionally, venture capitalists want to at least double their money in three to five years, then have the option to liquidate the investment, which requires an exit strategy—such as selling a product or the company to a larger company, or going public. Most retailers grow too slowly to assure a timely exit, said Douglas Collier, executive director of the Boulder Innovation Center, a public/private business incubator in Colorado.

However, Elizabeth U of Investors' Circle Foundation in San Francisco said many investors are willing to accept smaller monetary returns where they see greater social returns or environmental returns. Investors' Circle is a nonprofit that connects individuals, angel investors and venture capitalists with young companies in the LOHAS arena.

"You can make your money and invest in ways that are aligned with your values," U said. One such business is Seattle-based Organic to Go, launched last year with a niche focus—high-quality catering for corporate meetings and events. In a year's time, Organic to Go has opened 12 stores in Washington and California that sell grab-and-go meals. But owner Jason Brown, an industry veteran, said he's used a lot of his own money to help fund the business.

The type and amount of funding a retailer can access depends on a variety of factors, including credit history, business plan, profitability, revenue, the owner's experience, how long the business has been operating and other funding sources. Some types of funding are best for early-stage companies, while others are better for expansion or capital improvements.

"Banks don't loan money on anything but assets or personal guarantees," said Brown. "I think in the early stages of development the only way to fund a business is through self-funding or angel investing," he adds. "Once you have some traction and you have kind of turned a corner and you have several million in revenue, if you can show a path to profitability … and a path to a liquidity event," you're more attractive to venture capitalists and large angel investors.

Banks and local economic development groups may also be more interested at that point, and have a variety of loan options, including Small Business Administration loans.

Once a business can show the growth and profits to attract larger investors, its owners have a new challenge—picking the right investors, said Brown, himself an investor in LOHAS businesses.

Do the investors support the entrepreneur's goals? How committed are they? Do they want to be involved in guiding the business?

"If you're a new entrepreneur or a seasoned entrepreneur, the best thing you can do is surround yourself with a board of directors or advisers that you can trust and you believe in [and] who have industry experience," Brown said.

Directors can help the entrepreneur "see the forest for the trees" and guide funding decisions.

"For me personally, I invest in people and the clarity of their vision because no matter what anyone does, there are going to be surprises," Brown said.

Consider tradeoffs
Entrepreneurs also should consider how much control they're willing to exchange for investment. It isn't uncommon for equity owners to replace a company founder with a new chief executive—a blessing or a nightmare depending on the founder's goal.

Seven years ago, Mike Cianciarulo was that outside guy venture capitalists introduced to Earth Fare, a 30-year-old independent store in Asheville, N.C., that had recently relocated and modernized.

"I think [venture capitalists] saw opportunity in the Southeast, [with] one store doing a lot of volume in the Asheville area," said Cianciarulo, who came from an 18-store conventional chain in Florida that posted $300 million in annual revenue. "The company was at a crossroads in their growth. I think [the venture capitalists] were looking for anything with an upside."

In Cianciarulo's first few years with Earth Fare, the company's founder personally guaranteed some bank loans to help fund growth—a risky move. Cianciarulo helped improve Earth Fare's profitability and the loans were repaid.

Within a few years, Earth Fare secured a traditional line of credit with a local bank. Since 2000, Earth Fare has opened 11 new stores across the Southeast, using that credit and cash flow, Cianciarulo said.

The bank loan "feels like a bargain" compared with venture capital, because the interest rates are so low, he said.

Having a good relationship with the bank is key, said Cianciarulo and Brown.

For its part, Earth Fare has kept the bank up to speed on its moves. And that can be helpful to the retailer as well, Cianciarulo said. "[Bankers] can really help you grow because they keep you in line, (help you) maintain ratios … manage your business."

Co-op concerns
Food cooperatives have a different challenge when it comes to funding. With multiple owners, typically one person won't sign for a bank loan. There's no promise of huge profit either, since co-ops reinvest net income into the business or send it to members, said Tim Wingate, finance manager for 33-year-old Hunger Mountain Co-op in Montpelier, Vt. On the flip side, co-ops are a big draw for investors wanting to improve their communities.

In the mid-1990s, Hunger Mountain moved to a new location, tripling its size. The costs of moving, new equipment, the mortgage and working capital totaled several hundred thousand dollars. Cooperative Fund of New England—one of several funds in the United States devoted to co-ops—helped Hunger Mountain put together a financing package that included its support and that of a local community fund and a local bank, which offered a program that backed certain loans with a U.S. Department of Agriculture guarantee. Money also came from individual Hunger Mountain members.

The co-op has since paid all its debts (except the bank loan, which has a 20-year payoff) and it now invests in other co-ops through CFNE.

Co-ops like Hunger Mountain make up 4 percent of CFNE's investors. The fund's biggest contributors are religious organizations and individuals, said Executive Director Rebecca Dunn. Other sources include banks, trusts, foundations and nonprofits.

While most lenders look at a loan applicant's character, collateral and credit—the three Cs—said Dunn, who has an MBA in finance and started her career as a banker, "We also look at … I call it the fourth C. It's not a C—karma," she said. "We try to get to 'yes.' … We say, 'What do we have to do to make this happen?'"

For instance, CFNE may suggest ways a retailer could better manage its inventory or keep its books. In 30 years, CFNE has made about 380 loans totaling $12 million.

Kelly Pate Dwyer is a freelance writer in Denver.

Click here to order a copy of Market Overview 2005.

Natural Foods Merchandiser volume XXVII/number 6/p. 30, 32

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