Investing in a clothing line 2

Posted by Kathleen Fasanella on Jun 18, 2008 at 1:38 pm / Newbies, Operations, Small Business / Trackback

I don’t get many valid questions about getting financing for a clothing line. Most inquiries are how to find investors (consisting of one paragraph explaining how talented and creative they are) or the occasional stray query from someone who wants to sell their designs to a manufacturer or even, how they can use their design sketches as collateral for a loan from investors or a bank. Really. The question on loans I got the other day wasn’t bad and gives me an opening for a type of financing that may work out well depending on the goals of each party.

This question comes from an attorney who had a sideline (hobby as he describes it) selling small runs of tees, hoodies and hats which he sold to NYC boutiques. He sold all the goods but says he “sorta just broke even”. Now he’s interested in making a higher end product complete with pattern making and production rather than using blanks. This is where the loan comes in.

A friend of mine said ‘Look, make samples, and get orders. Once you get the orders, I will fund you.” Is this a good idea? What sort of ROI or profit split is typical in this scenario? I’m not looking to make money off the bat, I know it will be better to get our name out there, and worry about bigger ticket items, outerwear, etc in a few years. Is there any advice you can give me?


In my opinion, if you want to retain equity and management control in your company, you’re better off considering loans in the context of purchase order financing (pg.184). You borrow a fixed amount based on the costs of production to include materials and labor for a fixed period of time. Probably the best source for these loans are banks, assuming you’re a good credit risk. Some people describe PO financing as factoring but it’s really not the same thing (related links at close). Anything else amounts to a partnership of some kind which is a mixed bag. For example, this related anecdote is structured as a loan but amounts to a partnership and ownership in the venture:

We have some friends, an older couple, that are pretty wealthy. We never asked them to invest in our clothing line, but they wanted to. Unfortunately, their terms weren’t agreeable to us. They wanted to give us $50,000 to start which is wayyyyy more than we need, so I would NOT have agreed to that to begin with. In return they wanted 15% of gross sales for our new line, and another 10% of our current business. “Forever” is a long time, and under their terms there was no point at which they would stop getting a return on their investment. It was to be permanent for as long as the company exists, or as long as they’re both living. Valerie told me there’s an industry standard for investors and she gave us a break down on what their return on their investment should be. It wasn’t nearly as much as they wanted. We offered that amount to them and they weren’t interested. Said it would take too long to get a return on their investment. They are both in their sixties, so I certainly can understand.

Valerie (my evil twin) basically said it depends on what you have to work with. If you’re penniless and an angel investor wants a piece, it’ll be up to 51% (I know someone who got a venture capitalist and had to sign over 70%). If you have something to work with, meaning you have the money to produce your samples and take orders, then you’re better off securing a loan just for production. For longer term loans, she said there’s no fixed standard but that it is more typical to assign a payback of 25%-30% of sales until the principal of the loan is paid off. Then, the investor realizes their profit based on a sliding scale, a decreasing percentage of monthly net sales. Valerie is the one to talk to if you’re interested in attracting big money; she’ll get you prepared for that step.

Personally, I don’t like debt; the longer you owe someone money, the longer they own a piece of you. In the case of the attorney I opened with, I can only say what I would do. I would borrow the money for a fixed rate of interest, for a set period of time and pay it off in chunks as soon as I received payment from my accounts (at delivery). I would structure each minimum payment (presumably weekly till it was paid off) to be based on the production costs of that lot plus interest. I wouldn’t carry the debt into the next season. The next season I’d do it all over again, securing a loan if I had to. I’d prefer to pull the profit from the first season and plow it into the second to avoid a loan or were a loan unavoidable, use the first season’s profit to offset the cost of the next year’s production, reducing the amount of money I’d need to borrow. Obviously, I’d be starting small and increasing incrementally but the way I look at it is, mistakes will be made. Smaller lots = smaller liability. I wouldn’t be able to absorb a large mistake on a large lot at the outset. That’s just me. I don’t like risk.

Of course there’s more to it but these related links will provide more detail.

Related entries:
Don’t borrow money to start a clothing line
How to find investors for a clothing line pt.1
Investing in a clothing line
Partnerships
Why contractors won’t partner with you
Factoring invoices: Financing a fashion line
ADHD dump: factoring
ADHD dump: factoring 2

6 Responses to “Investing in a clothing line 2”

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Mike C
June 18th, 2008
5:04 PM

Giving someone 15% of gross sales forever makes it really, really, hard to have a successful business. Turning that down was wise.

I agree with Kathleen in that I would look for debt financing rather than equity. I’ve raised money through both mechanisms in the past and there is far less headache with debt.

I’m probably not a rigid as her on the repayment schedule. I like cash more than I fear debt. Especially in today’s environment where it’s not uncommon for lenders to be reducing open lines of credit, I prefer the marginal increase in expenses that the debt load carries if it allows me to hoard some cash.

I know I can spend cash, I don’t know that I’ll always be able to access open lines of credit.

What I do keep an eye on is that the total debt as a percentage of sales drops over time and that the balance sheet looks healthy.

We’re a bit further along than a startup though, but my outlook on it hasn’t changed much since Amy was sewing everything in an upstairs bedroom.

It will be interesting to see how the current turmoil in the credit markets has affected the market for business loans. When we installed our first TSS line, it was “easy” to find financing.

We’re planning on installing a second line this winter as well as some automated cutting equipment. Hopefully, it will be equally easy this time around.

Kathleen
June 18th, 2008
6:13 PM

I’m kicking myself for forgetting to talk to Mike before posting this. When we were in Houston, he had some pretty interesting things to say about debt.

The other thing I didn’t mention but should have is how your financing needs depend on your production model. Again, Mike and Amy are a perfect example. They will never need an infusion of cash tied to market dates and scheduled lot production because they sell year round, consumer direct, made to order. Their capital needs are tied to company infrastructure and assets (that lean cell and apparently, another one coming soon -congrats Mike!) rather than big batch production.

The last thing is, Mike is very financially astute, this is his milieu. As such, he has a good sense for where he stands at any given point. I’m not good with money so the way I stay out of trouble is just not to owe any. Also, some of my advice is conservative because I see people really pushing the limits of what they should be doing, like taking out sizable second mortgages and what not. So, if I say to only get PO financing, they’ll still get more than that but maybe not as much as if I gave them my blessing on carte blanche.

Valerie told me over the phone that if you can manage debt and have good credit, that it’d probably be okay to finance up to $30,000 in start up costs (iow, beyond PO financing) provided you could get it at 10% or so. She says some people have 10% credit cards. Eric says his credit union credit card is 6.9%, I didn’t realize they were so low these days. Still, Valerie doesn’t like debt either. I’m not allowed to quote exactly what she has to say about it :). I think the difference is, we’ve seen a lot of people go broke. It’s one thing to have to close up shop because you’re can’t do better than break even. Quite another thing is if you have to continue to service a lot of debt associated with the failed enterprise. Rather like insult to injury.

Mike C
June 19th, 2008
9:05 AM

They will never need an infusion of cash tied to market dates and scheduled lot production because they sell year round, consumer direct, made to order. Their capital needs are tied to company infrastructure and assets (that lean cell and apparently, another one coming soon -congrats Mike!) rather than big batch production.

That’s true, though its not uncommon for us to need lines of credit for working capital during the summer months. Our slowest month is about half our busiest month – but our expenses don’t drop by nearly that much.

For new ventures, I recommend that people choose very modest goals. Your goal should be to find out whether you’ve got products that you can sell and whether you could make money if you sold a reasonable amount of them. If the answer to either of those questions is “no” then you need to go back to the drawing board. If you’ve in debt too your eyeballs, it may be too late.

I’m evaluating an acquisition opportunity right now for a company that’s up for sale. They used a traditional wholesale model and took on debt to fund it. I’m trying to decide whether Fit Couture could buy it, move their production in-house, and switch their sales model to our own.

I’m not sure that I could even offer enough to cover their debt though. That’s a tough position for them to be in.

It’s also tough because I really can’t offer a lot of cash for acquisitions. Anything I would do would be on some sort of owner financing or earn out. Unless I seek out equity partners, we don’t have the cash on hand to buy companies outright. (For the first time, I’m pondering the wisdom of finding equity investors for just that reason. We’ve gotten pretty good at our model, and I think we could pick up moribund apparel companies in specific niches and make them work. You really need cash to do that though.)

Also, some of my advice is conservative because I see people really pushing the limits of what they should be doing, like taking out sizable second mortgages and what not. So, if I say to only get PO financing, they’ll still get more than that but maybe not as much as if I gave them my blessing on carte blanche.

Definitely agree.

Our banker is always calling us to leverage our house for business credit. No way. Not going to happen. Same with our retirement accounts.

Esther
June 19th, 2008
6:28 PM

Yikes, using retirement accounts for collateral is scary!

Thomas Cunningham
June 19th, 2008
11:01 PM

for a new company, asset-based financing (i.e. purchase order financing and then receivables financing) are the only prudent type of debt to take on. Anyone who takes on debt for a start-up, prior to having orders in hand is asking for trouble — and anyone who lends money to a start-up with no sales (unless they have other security) is a fool. If you don’t have a business with positive cash flow, you will be absolutely taken by any equity investors who will require a huge share of the business to compensate them for taking a huge risk on a money-losing operation. The right way to start a company is with your own equity until you develop revenue, then go to asset-based financing, which is relatively easy to obtain if you have orders from credit-worthy customers. Oh, you may also be able to get your customers to finance your business by asking for deposits at the time the order is taken, usually in return for a discount. Don’t laugh, there are people in this business that ask for, and get, such deposits. Overall, it’s generally expensive money, though, when you factor in the cost of the discount.

Briendy Katz
June 23rd, 2008
2:59 PM

After a 15 year career in corporate America, with six of them spent in the fashion industry, I have decided to launch my own line together with my BFF. We are starting with a fragrance, as that is my forte. What advice can you give us for the official launch. Is it best to go to mass retailers, online, small kiosks.. and what is the simplest, most economical way to introduce the line.

Thanks for your excellent blog- it is chockful of useful info. for all of us– the newbies.

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