Archive for November, 2009

Business Financing Sources Can Be Hard To Pin Down

Most things you try to acquire have some type of regular and predictable supply. Some products and services are readily available while others may require lead time to order or restock. And even if someone goes out of business, there is typically another vendor to work with.

Furthermore, process for acquiring a product or service, the terms and conditions of use and so on, also tend to be easy to locate.

If it was only so easy when it comes to securing capital for your business.

While the vendors may be easy to recognize, the process for acquisition and the determination of availability may be very difficult to figure out.

Lets looking into the key reasons why.

1. Sources of Business Financing get the majority of their capital for lending or investing from other sources of financing, which can be further leveraged down the line. If the “up line” sources reduce supply or increase the costs, there is a trickle down effect that is very hard to predict at a local borrower level. Sometimes retail lenders are shut down completely because of a major source no longer extending supply.

2. Capital providers manage a portfolio of placed accounts. Portfolios are continuously adjusted based on the economic outlook for different sectors. If a particular sector is becoming too large a part of the overall portfolio to create “risk imbalance”, then the capital source will stop providing new funding for that sector and may even call in loans or sell off what would normally be considered a well performing asset to reduce concentration.

As an example say that a business owner or manager requests construction industry financing in January from a preferred lender and that financing is approved and disbursed. If the exact same request was made 6 months later, there is no guarantee that an approval would be forth coming, which could be based on the industry, overall portfolio risk, and so on. Supply is not going to be constant.

The rules aren’t constant either. Perhaps the same request 6 months later can still get approved, but more security is required or a smaller percentage can be approved, or tighter terms and conditions accompany the approval, or rates are higher to reflect a higher perceived risk.

Total moving target.

3. Humans are involved. While financial companies providing capital have policies and criteria to follow, the decision making process is managed by individuals. When the individuals involved change, the decision outcome can change… even though nothing else may appear to change from one deal to the next. Even if personnel doesn’t change, many lending organizations operate with a rotating desk of underwriters who are assigned applications at random. All things being equal, different underwriters can come up with different lending or investing decisions on the same file.

4. Economic outlook. At the time of writing, we are near the end of 2009 and still in the middle of the current recession. Many business financing sources continue to build their cash reserves to protect themselves against any potential losses that may occur in their portfolio from recessionary impacts. This is quite ironic in that their exact action of building cash ends up shrinking the money supply and creating the exact effects they are trying so hard to guard against. In these situations, supply of capital is not the issue … willingness to supply is.

5. Time Of Year. A financial organization that provides capital for loans or investments operates as a business within an annual business cycle like any other business. At the beginning of a fiscal period, lending criteria tend to be quite tight as organizations see if they can acquire lower risk assets. If by the second quarter, the “placement numbers” are off, the criteria can get loosened up to help meet targets. As the end of the fiscal period draws near, nothing but low risk loans or investments will be considered if the company has already achieved its budget. The opposite would take place if the budget still had to be made.

So when you’re looking to secure business financing, regardless of your previous experiences, remember that your success will always hinge on how all of the above comes together at any point in time. Put things off a couple of months and the rubics cube could look totally different.

Technorati Tags: Business Financing, business financing sources, capital providers, financing companies, investors, lenders

How have Equipment Leasing And Financing Sources Been Impacted By The Recession?

As we move towards the end of the year, equipment leasing and financing companies are still dealing with the financial impacts of the current recession.

Like any type of lender, a leasing company requires a source of capital which is made up of a composition of equity that is debt leveraged to the max to achieve the largest potential money supply at the lowest possible cost.

In 2009, the cost of capital for many lease companies went up as many of their related funding sources added greater risk premiums into their cost of borrowing for leasing products.  Add to this the increased number of business failures and resulting lease facility losses from delinquent accounts and the result has been less lease companies with more conservative lending policies and higher rates.

The more conservative lending policies are largely driven by two things.  First, the unpredictable nature of recessionary impacts makes it harder for lenders and financiers to assess the credit worthiness of any particular applicant.  So current approvals are targeted to low to medium debt leveraged companies who have some ability to withstand and manage through any reductions or anomalies in their respective cash flow.

Second, equipment leasing can be largely based on the ability of the lessor to predictably be able to liquidate an asset if necessary in terms of the the time it takes, the costs incurred, and the net proceeds they can expect to receive.  During recessionary periods where business failures occur, the market can see significant increases in supply for used equipment.  This can result in lender or lessor losses as forced liquidation values drop.

While these financing conditions exist for all types of lenders, equipment finance companies as a whole are significantly impacted due to their smaller relative size which does not provide them with a large margin of error.

For the business owners, the noticeable changes when seeking equipment financing are that overall rates for leasing products are higher than they were a year ago.  All things being equal, an approved equipment loan tends to come at a cheaper cost of financing than a comparable equipment lease.  This typically is only relevant for “A” credit deals, as there aren’t many equipment loan products available for lower credit applications.

For lease financing, The “A” credit risk lenders are looking for A+ deals, the B Lenders are looking for A to A- deals, and the C Lenders are looking for B deals.

There is credit to be had, but it can be hard to locate if your application is a mid to higher level risk.  And the rules change constantly as lease companies monitor their portfolios and their liquidation pathways in the market.

While lending policies and rates have loosened up a bit over the last few months, expect equipment leasing options to continue with higher rates and tighter terms for the foreseeable future.

Technorati Tags: Business Financing, equipment financing, equipment leasing, finance, lease

Construction Loans Can Come In A Number Of Forms

Construction loans are typically a second mortgage registered against the property where the construction is taking place. If there isn’t sufficient value in the underlying property to secure construction financing, then other security would also have to be provided to the lender.

The basic premise of a construction loan is that money will be advanced to complete a predefined stage of work. Once the stage is completed and inspected, the property will have increased in value, providing additional security value for draws or advances for future stages of building.

Construction loan amounts as a percentage of the overall project cost can vary considerably depending on the lender and the specific project. For instance, some construction financing programs are capable of funding 100% of the building costs, where others require the borrower to provide an equity investment at the beginning or end of the project.

The equity portion can also vary considerably among lenders. For lower risk, lower cost construction financing, the equity portion required by the borrower will be higher and range from 50% of the total project costs up to 75%. In many cases, the key risk element that can separate lower cost lenders from higher costs lenders is the amount of equity the borrower has available to invest in the project.

Keep in mind also that the borrower will also need to cover off inspection, appraisal, legal, and administrative costs as well as any taxes associated with the construction project, which are all costs above and beyond the actual project costs considered for financing.

Construction capital products can also be quite specialized among residential home and commercial building applications. Larger, more complex commercial projects tend to have a smaller lender population that can be more international in nature as the related funding sources primarily focus on the same types of large projects over and over again.

Construction related capital may also be connected or disconnected from the longer term mortgage instrument. A connected construction financing facility will provide advances for construction and once the project is completed, the total advances will be immediately rolled into a long term mortgage.

A disconnected construction loan would be totally independent from the longer term mortgage and would likely involve two separate lenders, one for the construction portion, and one for the long term mortgage.

Because of the risks associated with any construction project, there is much greater lender interest in financing a completed building than one under construction, so its not uncommon for the construction financing piece to be stand alone capital that needs to be paid out by a separate lender.

Regardless of the size of construction loans, accurate estimates and solid project management are the keys to getting the projects completed within in the funding approved. Cost overruns and delays can result in capital shortfalls that may not be easily covered off.

Technorati Tags: construction financing, construction loan, construction loans

Cash Flow Management Actions To Consider

When news breaks about a recession coming or present, perception becomes reality as consumers and business owners start to change their spending habits and prepare for what may lie ahead. In effect, the recession becomes a more prolonged reality because we make it one through our actions.

The primary action by consumers taken is lowering on expenditures, especially on non essential purchases or on larger items that can be put off for awhile.

Ok, so this is nothing earth shattering.

But as a business owner or manager, how do you choose to react to what is unfolding? Its hard to know how the collective recessionary impacts will ripple through an industry or sector with respect to timely and collective magnitude. So how do you decide what actions to take and what to prepare for?

Unless, you have little or no debt and have some sort of cash reserve at your disposal, I suggest considering some or all of the following.

Quoting Intel’s Andrew Grove, “Only the paranoid survive”. And from one of my former type AAA colleges, “in life, you can be homicidal or suicidal, I choose the former.” Point here is that its better to prepare for the coming storm, expect it will reach you directly, and take all necessary measures available to you to survive the impact.

This may seem a bit dark and paranoid (and it is). And there is a chance that a recession does not have a material impact on your business. But what if it does? Will you have time to react effectively?

The goal is to protect the life blood of your business …cash flow. Here are some actions to consider.

Being homicidal with respect to cash flow entails a number of things. First, the working assumption during recession is that sales, on average, will go down…that less money will be spent. So, in order to protect cash flow, you would protect inflows by offering sales and discounts on a regular basis and typically ahead of seasonal offers so that you get the cash first. Yes, you will make less margin, but you’re keeping cash coming in to pay the bills.

Second, on the outflow side, you should consider reducing inventories. The focus is on making sales early, not trying to maximize on sales late in a sales cycle or seasonal period.

Third, reduce fixed costs through layoffs and delay of major purchases. If you have to cut back on marketing, do so on the branding side, not on the direct response side that’s going to bring in sales. There is going to be strong competition for less spending dollars, so make sure you offers are well communicated to get your share.

Fourth, start to extend your terms of payment as much as possible. From a cash flow management process, always allocate resources to cover labor and fixed costs and manage any cash flow gaps with suppliers as much as possible. Cash Flow Management can be very stressful with many sides looking for money, but you must always plan out how to make payroll or you’re out of business. Many times, when cash comes in from accounts, its quickly paid out to bring things up to date with suppliers without enough being held back to assure payroll gets made in the coming weeks. As recessionary impacts ripple through supply chains, its typically the businesses that understand their cash flow leverage points and plan out contingencies that get through the period with less cash flow problems.

Fifth, bring your financing profile up to date, and develop a solid understanding of how you can obtain money if there is a shortfall. Business Financing can take some time to secure and will be harder to locate during a recession so being prepared can be half the battle. Refinancing term loans and mortgages before problems exist can provide cash flow relief on a money basis that will cost you some additional interest over time, but basically serves as insurance against potential future cash flow problems.

Sixth, proactively determine what, if any, personal funds you are prepared to lend to the business. Use personal funds only as short term bridge loans that can come in and out in predictable fashion. If the business goes south, you want to have your personal resources available to you for future living expenses.

These are some basic steps you can take with your cash flow during times of recession. This is not an exhaustive list by any means, but more so a list to get you thinking about how to make sure your business gets to see better days after the recessionary period ends.

Technorati Tags: Business Financing, Cash Flow Management, cashflow

Non Notification Versus Notification Factoring

As a quick overview, Factoring is a form of Business Financing whereby a finance company purchases your outstanding accounts receivable at a discount and provides you with an immediate advance against the outstanding invoices in order to increase business cash flow.

Factoring is more commonly used when traditional bank working capital facilities cannot provide sufficient leverage against good quality accounts receivable.

What I would call traditional factoring was based on a customer notification model and was very controlling on the part of the factor. With notification, the financing company or factor would basically take over the contact and collection process with your customer.

The factor would essentially inform your customer that certain invoices outstanding with the customer were sold to the factor. The factor would invoice the customer for payment, collect payment, and provide any residual balance after deduction of fees back to you.

For many companies that qualified for factoring, the notification and customer control process left them uneasy and in many cases resulted in businesses taking a pass on what otherwise would have been a great form of working capital financing for their business.

Business owners did not want their customers to get the wrong impression about the financial health of their business when all of a sudden a financing company gets directly involved in the collection process, nor did they want to risk customer service issues to a forced third party interface.

To better serve the market, Factors are now offering Non Notification financing to more and more of their clients.

Under Non Notification Factoring, the financing company does not contact your customer and lets you remain in control of the transaction including the collection process. Your customer would still issue payment to your business and you would in turn forward the check to the Factor to be cashed in a joint bank account with both yourself and the factor named on the account. Wire transfers would go directly into the joint account.

In this manner, the factor is controlling much of their risk at the end of the process with the cashing of checks or receipt of wire transfers.

A business still has to qualify for non notification financing with respective accounts receivable financing companies. There may be cases where some Factors only feel comfortable offering Notification financing based on the risk assessment for a given account.

But for those that do qualify, Non Notification Factoring can be a powerful financing tool for a growing business.

Technorati Tags: accounts receivable financing, Business Financing, factoring, Non notification, notification

How To Know When To Cash Out

Every business will change ownership someday.  Some will have internal family succession plans while others will just decide one day to place the business up for sale.

But when is the best time to sell a business?

If you follow some of the investment bankers and business brokerage firms, they will speak to the M&A cycle, and where its at, at any point in time.

The basis of the M&A cycle is that over a period of time, buyers are more actively interested in acquiring businesses and business assets than at other times.  Factors that feed into the formation of an actual cycle are available capital, the economic landscape, market potential in different industries and so on.

While there is definitely a pattern to overall M&A activity, it also becomes a selling tool for M&A firms, brokers, and consultants, all  in the business of making money from buy/sell transactions.

The is also the more traditional approach to simply building your business year over year until you reach retirement age and then, at that point, if there is no internal or family succession, then sell your business interest in the open market.

Personally, I subscribe to a third approach…

Sell your business when someone wants to buy it for a fair or inflated price.

Under this approach, your business is always for sale whether you’ve been operating for 20 months or 20 years. By being open to this possibility, there may be more opportunities to consider over time than you may have thought possible.

The rationale for always being ready to sell is quite simple.  It takes a buyer with access to capital to complete a sale and without buyers that have the desire and means to take action, there is no market.

And you never know when you have created something of value for someone else.  Take a look at websites like YouTube.com and more recently Mint.com where young entrepreneurs were offered small fortunes to acquire their business models, only a few years after start up.  Perhaps you would view these as extreme cases, but the point here is when opportunity comes knocking, what will you do?

When a motivated buyer is interested in what you have it typically doesn’t hurt to at least listen.  And the motivation for buying could be all over the map… You own a property with a location of interest, you’ve developed a new technology or have a strong product brand, and so on.

The other side to this coin is what happens if you don’t take advantage of a great offer from an impatient buyer?  You could end up better off over time, but that most certainly is not guaranteed … a bird in the hand …

If the buyer is a competitor with money, then the competitor will likely take another approach to gain market share and end up becoming a stronger competitor in the future.

Another scenario to consider is when a small company hits the market right and starts growing like crazy, attracting buyer interest in the process.  If a larger company steps forward to buy you out because they have the infrastructure and resources to take advantage of your business offering, will you be able to scale the business yourself if you turn them down?

People can look back in the rear view mirror and say so and so business was foolish to sell out to XYZ company because of the profits generated from XYZ over time.  But there is absolutely no guarantee that the buyer would have been able to achieve the same level of success and in fact could have ended up failing badly and cashed out for nothing.

Too often, sellers establish their own time line for exit with the hope that there will be a fair market when the time comes to put the business up for sale.  And when you view your exit strategy decades into the future, this becomes a form of long term horizon gambling.

I’m not saying you should sell anytime someone shows an interest in a business you own, I’m merely saying you should consider it.

The best time to sell may be sooner than you think.

Technorati Tags: buyer, exit, exit strategy, Sell A Business, seller

In Almost All Cases, Risk and Cost Of Capital Are Closely Related

If you have ever studied the theory of finance (and managed to stay awake through it), you will have been exposed to yield curves, CAPM , risk free rate, weighted average cost of capital, term structure of interest rates, and so on.

Basically, the more risk that’s present in an application of capital, the higher the related cost of capital.

Yet, I continually see business owners that are trying to change the equation while searching for low cost capital with a high associated level of risk.

The lowest interest rates are reserved for opportunities where the lender is well secured, there is well established cash flow, excellent credit, and a reasonable amount of total debt load.

Rates for both debt and equity capital will go up as these investment characteristics become less excellent.

This is pretty straight forward stuff that most people would understand and agree with.

However, the context of society’s basic understanding on the cost of capital is based more on mortgage rates and car loans than anything else.

Business Financing can be a whole different ball game due to the higher levels of inherent risk and when we speak of risk, its risk of lender or investor loss.

From a lender or investor point of view, risk has everything to do with the liquidation pathway which stated in different terms means “how do I get my money back if things go south”.

For residential mortgages, the lender puts the house up for sale and gets the funds back in 3 to 6 months, depending on the market and the  foreclosure procedures in play.

For a commercial mortgage, the same applies, but the market can be a lot thinner in terms of buyers, and the time period for sale could turn into years which will require payment of property taxes, maintenance, utilities, etc, which all reduce the proceeds and increase the chance of loss.

Higher risk equals a higher cost of captial.

When you look at unsecured loans based on stated income and credit, the risk is again higher.  For in the event of a failure to pay, what’s the likely hood of the lender getting any money back?

Equity capital is significantly higher than debt capital in most cases due to higher risk of loss by the investor.  Equity investors will demand a wide range of returns, but the range can be as broad as 15% to 30% or even broader … depending on the risk.

Yet I’m still amazed when medium to high risk ventures are convinced they should be able to secure low risk capital.

Unproven business models and business start ups for example are not prime plus type risks.

Many times start ups and unproven ventures get upset with me when I propose relevant business financing solutions that they view to be high or even extortive.   I have had many discussions with entrepreneurs seeking 8% to 12% money for a 18% to 25% risk.  They have nothing to offer in terms of security except the future cash flow projections of their business idea or project.

I then provide the best analogy I have to try and bring them back to earth which is as follows.

A private investor will place second mortgages for 12% to 14%, fully secured by residential properly, providing a higher than normal rate of return due usually to the bad credit of the borrower.  Their relative risk is small, although they will have to be prepared to deal with some foreclosures, but the profit margin is still very good.

So if these guys can get 12% to 14% all day long secured by real estate, why would they ever invest in a venture looking for even a lower rate of interest and not offering any real security except the promise of future profits?

Some times I get through, but most times I don’t.

I guess hope does spring eternal.

Technorati Tags: Business Financing, cost of captial, debt, equity, investors, lenders

There’s Nothing More Impressive Than First Hand Knowledge

Have you ever had a conversation with someone where they just knew everything relevant about a subject?  What ever question you through at them, they instantly came up with a factual, accurate, no fluff answer that left you impressed?

That type of focused and detailed knowledge can also be the making of a great first impression if used properly.

Too often when business owners or managers apply for business financing, they are not completely up to date on the details and specifics of their own business.  Yes, they can answer questions at a strategic level, but when lenders or investors start to drill down into the specifics,  they don’t have much to offer or have to overly rely on reports and notes or even their  employees to answer the questions posed.

Outside of the underlying business opportunity, there is nothing that impresses a lender or investor more than a business person who they can grill in all directions but can still consistently come up with a solid and specific answer.

Why?

Because this type of demonstration of knowledge is hard to fake with some last minute cramming.  It tends to speak to someone who is on top of the key metrics of their business, pays close and regular attention to the things that matter, and has thought about things enough to have a strong opinion if required to provide it.

The key though is in the delivery.  Being a “know it all” can totally destroy the potential good Karma created.  No, the better approach is to let them come to you.  Let them ask the questions and expand further on your answers.  All you have to do is provide the answers and let the interview flow.

I mean, if you had some extra capital and wanted to lend it out or invest, who would you be more willing to trust with your money… a business person with general knowledge or someone who gives you all kinds of warm fuzzies when they blow you away with their depth of knowledge and attention to detail when describing something to you.

It’s not a hard answer for me.

Too often potential Business Financing opportunities go up in smoke when the business owner or manager either lays an egg or basically does not impress when they get their opportunity to close or advance the deal.

Technorati Tags: Business Financing, investor, lender

Return On Investment Versus Cost of Capital

The common challenge faced by business owners and entrepreneurs is how to take advantage of short opportunities that require capital.

A typical scenario would be entering a contract to deliver a good and service that you have access to but the buyer does not.

Lets make up some numbers to better illustrate.

Say you have an opportunity to supply 100 widgets to a company you’ve never done business with before for $10,000 each for a total sale price of $1,000,000.  Your cost to supply before financing costs is $600,000 so there is a potential $400,000 margin in the deal.

You have the access and ability to complete the deal and all that is required is capital.

Like most deals, there is some time requirement to deliver.  In this case, lets say its 3 months.

So all that’s missing is capital to make this highly profitable deal go and with 3 months to work with, you should have plenty of time, right?

Potentially.

You’d probably be surprised to see how many of these deals never happen or have to survive a mad scramble at the end to make them work.

Operational issues aside, the main reason for failure or distress is from the inability to secure capital for deal.  And in many cases, this failure to Secure Capital comes down to the mind set of the business person (or none business person in charge).

The starting assumptions of most people is that 1) money won’t be hard to find, and 2) it will come at a reasonable cost.  For these high value, unproven transactions, these assumptions are almost always wrong.

Especially when its your first time through with a transaction like this to a new customer, the goal is to get it done and make some money in the process versus trying to maximize the return.  If the deal gets done, there will potentially be future deals with the customer and potentially other customer now that there is a track record established.  If the deal doesn’t get done, it was all a waste of time as well as a liability issue if breach of contract occurred.

The capital that tends to be available for these types of transactions is opportunistic in nature and come with a high cost of use.

I’ve seen cases where the source of capital required the borrower to split the margin with them.  I’ve seen cases where the capital source wanted 3%+ for the use of the funds and a large fee on completion.

When business owner and managers hear these types of numbers, they scream foul and walk away in disgust if they’re new to this game.  And instead of getting the deal done and making some money, they tend to spend and waste their time looking for cheaper money that will save them money on the deal.

Look,  I’m all for saving money and maximizing my return on a deal.  And as far as high cost sources of financing go, I don’t like or dislike them.  This is not about what someone thinks is far or unfair.  This is what all business financing scenarios are about, and that in one word is RELEVANCE.

Business Financing is always about finding the source of capital that is relevant to your specific needs and situation at a given point of time. And what is relevant is what is available to complete the transaction in the time period required.

Too many times business people shoot themselves in the foot by holding out for a better deal, for a cheaper source of capital.  If you can find one, great.  But if time is ticking and the next best option will get the deal done but grossly cut into your profits, what do you do?

I say get the deal done, make some money, and build off of your successful transaction so that the next time around you have a chance at a greater return.

But that’s just me.

How To Do You Locate A Suitable Source Of Business Financing?

Until you’ve actually tried to Secure Capital for a business, you may not completely be able to relate to my answer to this question.  Securing business capital can be complex, frustrating, and difficult at times for the following reasons:  1) borrowers needs don’t fit closely enough to a lender or investor program; 2) lender or investor criteria and/or application of criteria can change suddenly as their portfolio changes; 3) secondary elements like appraisals, environmental assessments, recourse agreements, and other third party requirements can increase cost and time to close.

Taking into consideration the above statement, there are basically three ways to access Business Financing.

You can contact lenders and investors directly, work through a broker, or work with a financing specialist (basically a value added broker).

If you plan to manage the process yourself, make sure you have sufficient time to devote to the cause.  If there is a rule to go by, the smaller the dollar amount, and the simpler the application of capital, the more likely that you can self manage the process yourself.

As deal size goes up, so does complexity due mainly to higher risk assessment and lender requirements.

Depending on what you’re trying to secure capital for, some sources of financing can only be accessed through a broker, so a self administered approach can also result in a smaller market and potentially sub optimal alternatives.

The broker versus financing specialist distinction is a personal characterization of the market.   Many business owners and managers start out seeking business financing on their own.  If they are unsuccessful, they will try to find an intermediary to assist them.

And like most industries where brokerage is involved, there is the good and bad, the high value added and the no value added.  Most brokers (my opinion) do not have the ability or knowledge to work in your best interest and are mostly focused on collecting as much information as they can from you and getting it in front of as many sources of capital as possible in the hope that one of them gives you money.

While its important to qualify a lender or investor to make sure you are focusing your efforts with relevant lenders, the same holds true for brokers and financing consultants.

A capable broker or financing consultant has the ability to determine what sources of capital are relevant to your needs at a specific point in time, has the ability to access said sources, and can assist you in properly applying and closing the deal so you get funded.

If you can project manage the process yourself, by all means do so as it will likely be a very rich learning experience that can benefit you in the long run.

If you get bogged down or realistically don’t have the time to manage the process of securing business financing to completion, then take the time you have and qualify those individuals offering their services to assist you.  The right financing specialist can more than save you what they may end up costing you both in terms of dollars and time.

Technorati Tags: Business Financing, financing consultants, Secure Capital