Archive for September 2010
Equity Financing Exit Strategy
September 27th, 2010
“Equity Financing Considerations Are Similar To Marriage With Some Added Twists”
When business owners are looking to raise capital through equity financing, they are planning to sell off a portion of the ownership of their business to someone else in exchange for a cash payment. This sale of ownership can be of a controlling or non controlling nature, but unlike debt financing where you pay back the money borrowed, ownership can have very long term connotations.
That’s one of the reasons why many people equate equity investing to marriage in that you’ve got to plan whether you want to be in the relationship for an extended period of time and under what conditions.
And while marriage agreements can be made going into the relationship in the form of prenuptial agreements, business financing scenarios involving equity capital should go one step further and have both an entry and exit agreement in place.
Especially for small businesses, it makes very little sense to take on an equity partner with no clear exit strategy for either partner. Many businesses get trapped in a situation where either a owner wants to leave the ownership group or the owners can’t get along anymore and someone needs to buy out the other.
Without an upfront agreement as to how an owner can exit, the process can be grueling to complete and financially damaging to both parties, but particular to the trusting and naive that get taken advantage of by the remaining owner or owners.
While any equity investment will clearly outline what you get for the cash you’re paying, it also should have its own form of prenuptial agreement and states exactly how things ARE going to end. There is no misconception here that everyone’s in it until death do us part, and even if that was the case, what happens to the ownership shares on passing? Failure to plan out the end right at the beginning is a bad idea in virtually any situation I’ve come across.
But in the hast to secure financing and the excitement of getting going or getting things back on track, the exit strategy is many times over looked or over simplified.
And the exit strategy you’re prepared to consider will also better align you with sources of financing that are better fits for what you’re looking for. For instance, there are many equity investors out there that want to double their money in three to five years and then get all their money back along with the required gain. This speaks to a very specific exit strategy that has to work for both sides at the outset of discussing the deal.
For investors that want to ride the wave of opportunity there should still be an exit plan to really protect both sides as the longer the relationship goes on the more likely something is going to happen with respect to ownership and ownership objectives.
The other part to keep in mind is that the more sophisticated the investor or investor group, the more the exit plan is going to be stacked in their favor, taking advantage of the entrepreneurs financial ignorance or sheer desperation.
So, yes equity financing is very much like marriage, but with a contract going in and one going out with the divorce or funnel preplanned.
Click Here To Speak With Business Financing Specialist Brent Finlay
Business FinancingDebt Lender Requirements
September 24th, 2010
“Here Are The Three Debt Lender Requirements That Will Apply For Any Request For Business Financing”
I don’t want to over simply things as business financing applications can become fairly complex and involved, depending on the amount of funding a business owner is looking for and its application.
That being said, regardless of the level of complexity attached to not only getting an approval in place, but getting funds advanced, virtually all lenders are going to focus on these three main areas:
- Debt Servicing
- Loan Security
- Borrower Guarantees
Each category of lender is going to put different weights on each of these areas as well, but as one institutional lender who provides low cost financing put it to me the other day, “in the first 10 questions we ask, 9 are about debt service”.
So it goes without saying that if you’re in search of low cost financing, the proof and support for debt service are going to be the most important element being reviewed.
As the cost of financing goes up due to perceived higher risk, which is usually associated with less predictable or supportable debt service, the shift in attention moves to the other two areas as there is a greater possibility of a loan default which would require the lender to realize on securities and guarantees.
This is not to say that debt service is not going to be very important to the asset based lenders of the word. It just means that at least half of their top ten questions are going to be directed to security and guarantees pledged.
And when I speak of guarantees, this does not automatically include personal guarantees. If a business has accumulated enough retained earnings over time and non pledge asset value to provide the comfort the lender is looking for, then a business guarantee may be all that’s required. In situations where there are multiple business entities within a business group for tax purposes, its not unusual to see corporate guarantees from each entity to support a loan issued to one business in the group of companies.
These three areas are basically the 80/20 of business financing for most lenders. If the 500 page business plan or elaborate financial projections don’t adequately cover off these three areas in accordance to the lender category and risk category they are trying to get funding from, then the loan application is likely going to be a non starter.
Business FinancingSharing Business Financing Risk
September 19th, 2010
“Business Financing Risk Typically Needs To Be Shared”
Its not uncommon that business owners and managers in search of capital, especially those from businesses with sales under $1,000,000, seek a source of debt financing for their business that doesn’t require them to take any personal risk beyond their investment in the business.
While every business owner would prefer to minimize risk as much as possible, its unrealistic for new or developing businesses to expect lenders and sources of debt financing to take a disproportionate amount of the risk associated with a particular funding request.
In an attempt to avoid risk, owners can spend a lot of time looking for something that may not exist…that being debt financing without any form of a personal guarantee. And while personal guarantees are not always required, they will most likely will be for cheaper sources of debt financing.
And from a lender’s point of view, its not that they are necessarily gaining a great deal of additional security from a personal guarantee, but what they are gaining (at least in their mind) is 150% commitment from the business owner to do whatever it takes to make the business work, versus throwing in the towel when things get tough and letting the lender take a bath.
As businesses grow in size and increase their financial stability through the accumulation of retained earnings, there will be less of a need for personal guarantees to balance off the risk scale.
Personal guarantees or covenants are also closely linked to the type of lender you’re dealing with as well. When there is security pledged, lenders that are either good at liquidating assets or controlling them will be less concerned with personal guarantees compared with a lender taking an unsecured position or accepting security that they aren’t very adept or experienced at liquidating.
The key here is that the risk needs to be somewhat proportionate. If a business owner is asking a lender to take 80%+ of the risk, then it stands to reason that a personal guarantee is going to be required. In situations where there is more risk sharing between the business and the debt financing source then its more likely that a personal guarantee will not be required or at least a partial guarantee may be considered.
As I mentioned earlier, guarantees tend to be linked to the cheaper sources of money which relates to low risk positions for the lender. Higher lender risk will almost always mean a higher cost of financing to offset the risk if the lender is going to be interested in extending funding at all.
While the goal should always be to reduce risk wherever possible, you also have to realistic in terms of taking on a reasonable share of the lending and borrowing risk being entered into.
Click Here To Speak to Business Financing Specialist Brent Finlay
Business FinancingStrategies For Reducing Risk
September 17th, 2010
“Getting and Keeping Your Lenders and Investors Comfortable With Your Business Has a Lot To Do With Risk Management”
In the lending and investing world, the people providing the funds are always looking at how risk can be removed, reduced, or off loaded.
Most business financing requests, at least on the surface, propose a viable strategy that requires capital when applying for a business loan or approaching an investor. What separates 90% of all applications (or more) is the failure of the applicant to identify risk and find a way to remove, minimize, or neutralize it from the business.
In the standard “field of dreams” application where you give me the money, everyone will come from all over to buy stuff from me, and nothing will go wrong along the way, only tends to work in the movies.
But in the real world, all deals have risks and the better you are at proactively identifying them and doing something to mitigate their occurrence or impact, the more likely you are of always being able to secure the capital you require.
The larger, more established the business, the less intensive risk management overall needs to be as financial strength and equity in the business will provide the means to deal with things that can and do go wrong in most cases.
But when you’re smaller, or in a start up or growth mode, there can be many more things that can work against you that individually or collectively can put you out of business.
So lets get into more concrete examples to further make the point.
Anything that is new(er) and less established has more risk. The most obvious first area of concern is Sales. The sales orders, defined letters of intent, contracts, etc., that you can procure or show are available to you when seeking money, the more attention you’re going to receive.
The same holds true for collecting the money once the sale is made. If terms are required, is there a solid credit granting policy in place, does the business have any experience in collecting money, can the accounts receivable be insured or financed directly?
On the supplier side, is there well defined purchasing agreement for price and quantity? Can the price be hedged in some fashion? Is there more than one source of supply lined up? What is the stability of the local suppliers and do you need to go further a field for better pricing and more certainty of supply?
These are all risks. Established businesses get established because they have been able to figure out how to deal with all the relevant risks to them as they developed their business over time. In many cases they were lucky that lurking risks did not impact them and as they went along, systems and processes and expertise were either developed or put into place to make sure key risk areas were kept under control.
For developing businesses who haven’t got everything figured out, the standard position is to push forward and figure things out as they go. If that truly is the approach, then you’re going to need to have a fantastic opportunity in tow to offset risk, or enough of your own money to make things go as its highly unlikely that people with money are going to part with any for business proposals that are just as likely to lose it as pay the money back.
Click Here To Speak To Business Financing Specialist Brent Finlay
Business FinancingLeveraging Available Equity
September 14th, 2010
“How To Best Access The Capital Tied Up In Your Assets”
Business is and will always be about leverage. The ability to leverage both human and capital resources is the cornerstone to being able to grow and scale profitable business operations.
Yet the challenge with leverage is that its hard to stay on top of what balance sheet structure is best for your business at a given point in time. There is definitely a need to think ahead as what makes sense today may not work tomorrow.
For instance, if the business is going through a bit of a down turn and cash flow is or will be stretched, its far better to start working out how to leverage your available leverage early on even when its not completely clear as to how things will place out versus waiting until you have a problem.
Equity based financing under distress is not only going to be harder to come by, but its going to cost more as well. The worst part is that if you do hold good quality assets and the business does have a strong plan for improving financial performance, its easy to also overpay on equity financing due to the time constraints you could be under from leaving the process too long.
Even when everything is going well, the bank or institutional lender you’re working with today may not be interested in funding future growth which may come as a surprise when you least expect it.
The point here is that optimal financial leverage needs to be an endless pursuit on the part of the business owner and/or business manager. And leverage is always going to be based on the amount of debt financing you can secure against some combination of the paid in and market value of the equity in the business.
The second point is that regardless if your in a survival mode or a growth mode, its easy to pay too much for business financing due to a lack of time available to conduct the process.
And the third point is that today’s lender is not necessarily going to be tomorrows lender so you always have to be cultivating what will be the next best fit for the business as the business changes and the overall economy changes around it.
Click Here To Speak Directly To Business Financing Specialist Brent Finlay
Business FinancingBusiness Financing Can Require Lots of Patience
September 10th, 2010
“Any Attempt To Secure Business Financing Needs To Be Tempered With Patience”
Recently I was working on two different business financing deals. The first one was for a well established business with great cash flow, great credit, and a strong business model. The second financing scenario was refinancing a business that was struggling to cash flow growth and was trying to overcome many of the challenges that come with a start up business.
While on the surface they couldn’t be much different, the one thing they had in common was the amount of time it was taking to get the financing they needed into place.
And it wasn’t necessarily hard in either case to identify the potential source of business capital that could satisfy their needs. The challenges in both cases came from getting a final commitment in place and getting the funding advanced.
This is a very common occurrence these days post 2008 thru 2010 recession (which for many is still not over).
The lending process and related bureaucracy can be totally maddening to any business owner and manager who is used to taking charge of a situation and getting everything covered off that is required, within a certain time frame.
When it comes to business financing, the process can only be followed, not forced. As soon as you put pressure on a lender or a provider of capital, it will also inevitably lead to a no or decline of an application for funding that may have otherwise gone in your favor.
This is where patience comes in.
Once you have a source of financing lined up that you are comfortable with, its time to gear down and start moving at the speed of the lending process, which can be delayed or slowed down for any number of reasons, most of which you have no control over.
And when you start running out of time on a deal or funding requirement and the financing is still not either approved or available for funding, the tension and pressure of the moment can push you over the edge.
But if you want the options you’re working on to remain options, you’re going to have to create whatever contingency plans are necessary to get you through to the other side of the process where the money is.
Remember that the more people that are involved in getting everything covered off for a lending approval and disbursement (appraisers, accountants, lawyers, consultants, credit committees, customers, suppliers, etc.), the higher the probability that the process will take more time than less.
Sure, everything can come together quickly and be in place ahead of your expectation. But most of the time it won’t, and without a healthy dose of patience, good options can quickly be destroyed, putting you right back at square one.
Click Here To Speak With Business Financing Specialist Brent Finlay
Business FinancingEquity Financing Considerations
September 5th, 2010
“There Are Many Things To Consider When Looking Into Equity Financing Options”
When seeking equity financing for an existing or future business, its important to make sure you have a clear understanding of what you’re getting into.
Many times business owners are either in too much of a rush or pressed against a wall to consider the pros and cons of any equity financing options they are considering, being more inclined to take what they can get. Even if there is more time available to consider the “goodness of fit” of a potential investor into the business operation, the key issues and considerations can still be easily overlooked or glossed over.
The primary thing to remember is that taking on an investor is like marriage. You could be involved with this new person or person for a long time, and breaking up the relationship at a future point in time may not be very easy or even possible to accomplish under terms you can live with.
That being said, one of the first tenants when considering taking on an equity investor is start with the end in mind.
The reality is that anyone who gives you their money is going to want it back, so it only makes sense that the ending of any proposed investor marriage is clearly lined out from the outset in a manner that is acceptable for both parties.
From the business owners point of view, the goal may be to be able to buyout the investor at a specific point in time for a clear dollar amount, or at least for a dollar amount that is calculated by an acceptable formula.
This creates a structure where both sides can size up the value to each other of getting involved in a transaction in the first place as well as providing some level of protection to both parties.
Selling off part of your company without doing this is dangerous to say the least. Everything can seem nice and light at the start of the business relationship, but things can change radically in a very short period of time.
And regardless if the business is ahead or behind on its financial projections created at the time equity financing was secured, there is a defined process for either party to deal with any changes in circumstances or expectations.
Once the honeymoon is over, its hard to predict where the relationship will go so it only makes sense to provide both sides with a way out that doesn’t potentially kill the business in the process.
Click Here to Speak to Business Financing Specialist Brent Finlay
Business FinancingAsset Based Financing is Bridge Financing
September 1st, 2010
“With Some Exceptions, Asset Based Financing Is Only A Temporary Source of Business Loans”
Unless you’re a fairly large company with substantial profitability and assets, its unlikely that an asset based lending solution is going to be a long term or even a medium term funding solution.
The reasoning is fairly simple. The cost of most asset based lending will either not be affordable long term or will substantially eat away at your profits.
The focus of an asset based lender is to finance assets that either they can control directly or that they can easily set up a clear liquidation pathway to get their money back from the liquidation of the assets.
This specialized form of lending charges a premium for the lenders ability to provide funding in situations where conventional or traditional lenders will not be interested. By becoming focused on a slice of the asset lending market, the lending competition can be very minimal in many locales, creating an opportunity for pricing that reflect the underlying risk to the lender.
If you ask an asset based lender why their pricing may be substantially higher than a conventional financing source, the lender will regularly offer back that you’re renting equity due to the fact that the business does not have sufficient retained earnings from profitable operations or paid in capital to secure cheaper forms of money.
While some may feel this is a bit of a cheeky answer to the question, there is a lot of truth and merit in it as well.
First of all, the next option for financing if an asset based loan is secured will likely be an equity investor or equity injection from the current owners. Any investor will require a return on capital at or above what an asset based lender will be charging.
Second, by acquiring capital in the form of a loan, it can be acquired without diluting ownership and paid back according to an agreed upon repayment schedule.
Which leads us back to bridge financing. Outside of institutional asset based lenders that are priced off of the prime rate, the next best pricing options will need to get comfortable with how they are going to get paid back in one or two years or they won’t fund the deal.
Why? Because they know the cash flow will not be able to handle the higher cost of financing for an extended period of time and that without some realistic transition plan to cheaper money in the future, they will likely pass on the financing opportunity. This will then lead to even more expensive asset based loans that are more closely aligned with liquidation and price their financing accordingly, knowing full well that may of the borrowers will fail to turn the business around or find an exit strategy that will repay the debt.
That’s why its important to only enter into an asset based deal if you can clearly see the other side of the bridge or the probability of getting something in place is pretty high.
Otherwise you’ll on a bridge to nowhere fast when the cash flow can no longer service the debt.
Click Here To Speak To Business Financing Specialist Brent Finlay
Business Financing