Dr. P.V. Viswanath
For Small Firms Like Emrise Corp., New Hurdles
to Borrowing Are Emerging
Six months ago, Carmine Oliva embarked on what he expected to be a straightforward effort to raise $18 million to $20 million.
Based on his experience, the chief executive of a small California communications-systems company figured he would send out a few pages of financial statistics to half a dozen banks and have his money by Labor Day.
Instead, he wound up approaching at least 20 potential lenders and putting in months of effort. He finally signed his loan agreement Nov. 30. Unable to find a bank to lend him all he needed, he paid a higher price to borrow from a private investment fund -- one that invests Asian money in the U.S.
Mr. Oliva's company, Emrise Corp., is the kind of small, struggling company that benefited from the easy-money lending environment of the past five years. Emrise posted losses in 2006 and most of last year, in part because of a scrape with the Securities and Exchange Commission that forced it to restate earnings. The maker of communications parts for aircraft and offices survived in its business in part because it could raise money without too much trouble -- until the credit crunch hit this summer.
With credit markets in turmoil, many companies are finding it harder to get the money they need to fuel their businesses. Small companies with less-than-perfect financial histories -- the majority of American companies -- are being hit especially hard. Even small companies far removed from the world of housing and crumbling bonds, such as Emrise, are finding it tougher and more expensive to borrow.
Citing "considerable evidence that banks have become more restrictive in their lending to firms and households," Federal Reserve Chairman Ben Bernanke said this month in a Washington speech: "More-expensive and less-available credit seems likely to impose a measure of financial restraint on economic growth."
Mr. Oliva puts it more simply: "In the old days, you could cold-call lenders and you would get nine of 10 to respond. Now, nine of 10 say they aren't interested."
Reignmaker Communications Inc. of Atlanta, a closely held provider of Internet-based telecom networks for small businesses, was looking for money over the summer to fund acquisitions and new distribution networks.
"We talked to many, many traditional banks in Atlanta," including the company's longtime banker, Wachovia Corp., and went through a long process with SunTrust Banks Inc. before being turned down, said Reignmaker CEO Steve Smithwick. "Because of the market as a whole, they were unable to do anything for us."
In September, the 12-year-old company raised $11.5 million by issuing preferred shares to two investment banks -- Stanford Group Co. of Houston and Jones, Byrd & Attkisson Inc. of Atlanta. The banks received warrants to buy additional preferred shares and will get an 8% dividend on their preferred shares, payable in cash or common shares.
Mr. Smithwick would have preferred a bank loan. "You are not just paying a premium from an interest perspective, you're diluting the existing shareholders" by issuing the shares, he says. Reignmaker has annual sales of about $3.5 million and 30 employees.
In Lewiston, Idaho, Greg Follett, general manager of family-owned Follett's Furniture & Mattress Center, says he is seeing tighter credit terms in his daily business. Suppliers "used to be a lot more laid back" about how quickly he paid, he says. "If I had a 30-day invoice and didn't send it in 30 days, they might call a week later. Now, it is exactly 30 days, and they call and say, 'Where is the money?' "
Emrise, of Rancho Cucamonga, Calif., needed money for what normally would be viewed as sound reasons: It was getting an influx of orders and needed funds to build inventories so it could ship products quickly. It also wanted to make an acquisition to boost sales.
The company was far from a perfect credit risk. It had to restate 2004 and 2005 earnings to account for a sale recorded in one year that should have been recorded in the other. Its stock last year fell below $1 a share on the New York Stock Exchange's electronic trading platform.
But after losses in 2006 and part of 2007, due partly to the cost of hiring new accountants to re-audit the company, it told potential lenders it expected a return to profitability in the fourth quarter, excluding one-time charges. The special audit had found only one misreported sale, the one that provoked the audit. Emrise has big customers, including AT&T Inc. and Boeing Co.
Until summer, Emrise had little difficulty raising cash. After one banking arm of Wells Fargo & Co. called a $1.5 million loan late in 2006 due to the restated profits, another Wells Fargo arm provided a fresh $5 million credit line. Emrise had strong banking relationships in Britain, France and Japan, and arranging loans usually took a month or two.
By July, when the vice president for finance was contacting potential lenders, he found credit markets were stiffening and bank willingness to lend to Emrise was eroding.
Emrise got in touch with 20 to 25 banks world-wide, because the company has operations in Europe and Japan and wanted to use world-wide assets as collateral. Initially, there was no response. As Mr. Oliva and his finance chief went back to the banks, the rejections began. Bankers reported they were having trouble getting loans approved by their credit committees.
"When you start getting all these rejections, you say, 'My God, will all 25 say no?' " Mr. Oliva recalled.
By August, he was downright anxious. Orders were coming in for products to be delivered in the fourth quarter, and he had engaged an investment bank to help find an acquisition. He was down to $2 million in cash. What would he do if he didn't have enough working capital to ship products on time, or if his investment bank found a target company he didn't have the money to buy?
Finally, about 10 lenders expressed some interest, and received financial packages from Emrise. In the past, Mr. Oliva said, lenders would review the materials and perhaps come to headquarters for a visit. Now, they wanted to visit factories and see actual goods being produced.
In the end, just two banks and two investment firms made offers, and one of the banks, a subsidiary of an Austrian bank, later withdrew. Lloyds TSB Group PLC, a bank in Britain, was willing to lend money just for working capital. Emrise finally chose Private Equity Management Group, an Irvine, Calif., firm that says it oversees about $4 billion world-wide. PEM offered both working capital and acquisition money, for a total package of $23 million.
There was a catch. If Emrise wanted acquisition financing from PEM, it would have to borrow the working capital from PEM as well, and PEM would charge a lot more than a bank. It gave Emrise a week to decide. With credit markets deteriorating, PEM told Emrise, it would have to charge more after that.
Mr. Oliva accepted PEM's offer and then spent weeks responding to its detailed requests for documentation and proof of collateral. Emrise is paying 1.25 percentage points above the prime lending rate, with a minimum rate of 9.5%, for a $7 million revolving loan secured by its assets, and 4.25 points above prime, with a minimum of 12.5%, for the remainder. It also is providing PEM warrants to purchase 2.9 million Emrise common shares over the next seven years.
When Emrise got its money in December, senior executives celebrated. They finally could fully fund their operations and ship goods without delays, and the acquisition hunt could get serious.