Archive for July 2011
Debt Versus Equity Financing
July 26th, 2011
“What Are The Main Differences Between Debt And Equity Financing”?
While there are many shades of gray between debt and equity financing, I’m going to take a stab and providing some of the more prominent distinctions most common between the two sources of business financing.
My motivation for writing typically comes from the discussions I’ve had during the week with clients, business people, lenders, and investors and this post follows the same basic source of inspiration.
Individuals looking for business financing are many times looking in the wrong places or asking for the wrong form of capital, most typically debt when they should be looking for equity.
A debt based lender is someone who is extending capital typically for a fixed interest rate and repayment term, where the actual interest rate and terms quoted are indicative of the level of risk associated with the use of funds and with the business as a whole. This means that the risk must be readily quantifiable in some way to place a cost to any money that gets borrowed.
With debt financing, there also needs to be a high probability of repayment of the debt in a timely fashion and if there is not, then there will be other actions the lender can take to reclaim what is owing to them.
Equity financing in many ways is the opposite of debt financing in that there many times is no set repayment term and the return on capital provided is a share of the future profits compared to a fixed rate of return.
As mentioned at the outset, there are infinite variations around either a debt or equity financing theme, but for the most part, if you don’t have a readily quantifiable risk with a clear means to repay the debt in one or more different ways, then you are looking for equity financing.
This is not to say that absolutely no one would provide you with a loan, confirming the notion that anything is possible…but not probable.
Regardless of the form of capital, if you don’t have something tangible or intangible to leverage, then its very unlikely you’re going to find much of either.
A well established cash flow is more likely to be able to acquire debt than a developing cash flow. And if a developing cash flow can acquire debt financing, its going to be at a higher price in accordance with the risk associated with growth and development.
In the debt financing world, regardless of the financing model, cash is basically king as loans need to be serviced and servicing comes from the cash flow generated from the business.
In the equity financing world, opportunity and cash are both very important, with proven opportunity capable of securing equity financing before cash flow is established.
The key point here is that “getting a loan” is not likely going to happen unless you can provide a lender with a high degree of confidence that they’re going to get their money back and their cost of money, in a timely fashion.
Securing equity can potentially be far more difficult to secure, but near impossible if you don’t have something of real value to leverage, in which case you would likely better off asking for neither.
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Business FinancingWorking In The Right Direction
July 18th, 2011
“Getting Into The Details Early On Will Result In Better Business Financing Results More Often Than Not”
When you’re in the process of trying to locate secure business financing, make sure that you’re prepared to get into the details related to your request right off the bat in order.
The reason is simple.
Because the business financing market can be fairly fragmented, its important to be spending your energy and time working with lenders or investors that can actually help you.
Too often, business owners will gloss over the details thinking that they may not be required to get the financing they are looking for.
Well here’s a news flash… the details are going to be required 95% of the time. And of the 5% of the time they aren’t required, most of the time you’re looking at some sort of financing scam that is more promise than substance.
When I speak of the details, I’m taking about full disclosure of what exactly you’re looking for and the credit and financial profile of your business.
Too often, little details will be missed on purpose because a business owner is trying to hit the warts of the business. But in the end, these items will come to the surface and can kill the deal after considerable time has been already spent.
This is also a problem when working with business financing consultants.
A business owner may gravitate to the financing consultant or broker that is asking for the least amount of information in the hope that he has some sort of special access to funds that can avoid having to do the Full Monty on business.
This is a tactic by some brokers to get you working with them. Later in the process, when you get annoyed with their false promises, you may likely just stick it out and go through the real process with them instead of starting over with someone new. And because business financing placements are usually one off transactions, the broker or financing consultant doesn’t have to worry about losing out on repeat business that likely wouldn’t happen anyway.
Banks and institutional lenders can also be guilty of asking you for bits of information at a time, pretending that they’re not going to ask for everything eventually in order to get you going with their application process.
And when I talk about asking for everything, I mean at least three years of completed accountant prepared financial statements, the current year interim statement supported by A/R, A/P, Inventory, and Equipment sub ledgers, transactional details to support margin levels, two to three years of financial projections, income tax statements, notices of assessment, government remittance histories, personal net worth and credit profile, and so on, and so on.
Even though its a bit of a pain to go through the details a number of times, its far more fruitful most of the time to sit down with someone and spend an hour providing a very detailed picture of what you want and what you have, so that they can provide you with more honest and immediate feedback as to the potential that they can help you or not.
Unfortunately, most business owners AND sources of financing do this onion peeling approach where the information is revealed bit by bit.
If you’re talking to the wrong source of financing, this can be death by a thousand cuts. If you’re talking to the right source, late disclosure of certain things can cause problems getting funding completed later on in the process.
The investment in time in the beginning of the process is a may me now or pay me later type of thing.
By investing time up front, the overall process is likely going to be more efficient because you’ll be working with the most relevant sources of business financing sooner versus starting the process over and over again with unsuitable dance partners.
Click Here To Speak To A Business Financing Specialist For All Your Business Financing Requirements
Business FinancingCommercial Property Financing
July 13th, 2011
“Commercial Property Financing – Making The Case For Private Mortgage Lenders”
When you’re looking to finance a commercial real estate property, there may be some better short term options available than the bank.
Let me explain.
The commercial property financing process with an institutional lender is a time consuming process.
More specifically, it will likely take 60 to 90 days from the time you apply for a commercial mortgage to the time its approved and funded, or even longer.
Banks and institutional lenders are the preferred sources of commercial property financing because of the lower rates they can offer, and when you’re working with a mortgage at or above million dollars, every percentage point is going to be important.
But even more important is getting financing in place when you need it so you can avoid 1) missing out on a property acquisition, 2) take advantage of a profit opportunity, or 3) avoid incurring a cost.
Business financing should always be about the net cost of funding, not just the stated interest rate. And when it comes to getting something done in a hurry or in a predictable period of time, banks and institutional lenders are not that predictable in terms of indicating if they will fund a deal, and then when it will actually be funded.
So if time is of any concern to you when arranging a commercial mortgage, you may want to consider a private mortgage lender before even going to the bank.
Why?
Because a private lender can potentially get the lending / funding process completed in 30 days or less, providing an avenue to get capital in place when required, even if you have to pay a bit of a rate premium to do so.
And in today’s market, if you have a great piece of property and the loan to value required on financing is under 60%, the private mortgage lending rates can come very close and in some cases rival what a bank or institutional lender could provide.
Then, with business financing in place, you can take your time surveying the market and getting the best available deal where you are in control of the process and not in a take it or leave it type of scenario with time running out on the clock.
This is where the net cost of the transaction comes in.
If you end up paying a few extra dollars in interest over a year or two, but end up saving or making ten times that amount or more from having financing in place when it was required, then the cost of a private mortgage becomes cheap compared to the cost of not having the financing in place when you needed it.
If you’re at all pressed for time when trying to finance a commercial property, it can be very dangerous to assume that you won’t run out of time with a bank or institutional lender, or that the terms and conditions you’re going to sign up to for the long term are going to be acceptable to you.
There can definitely be a significant benefit attached to the potential incremental cost of an asset based loan and at the very least, the incremental cost is insurance to make sure your deal get done, or funds are available when they need to be for other purposes.
Click Here To Speak To The Business Financing Specialist For Your
Business Financing Requirements
Challenges With Financing Growth
July 5th, 2011
“What’s The Best Way To Finance Growth For The Greatest Economic Return?”
The best approach to business financing growth is a short term vs long term type answer.
That is, do you focus on short term profitability or long term profitability or both?
If you have unlimited access to a cheap source of capital, then an optimal profit focus in the short term and the long term is going to be preferred with an emphasis on accurately managing margins to gain market share as fast as possible without eroding profits.
But most small to medium sized businesses in a growth period do not have an unlimited supply of cheap money, so there is a couple of different ways to look at the best approach to financing growth.
On the one hand, you could argue that its better to grow at the speed at which you’re low cost supply of money will allow you, even if this is not as fast as you could penetrate the market.
On the other hand, you could also argue that the cost of capital you’re prepared to pay should be dictated by the margin you generate in the market and that as long as you’re covering your cost and believe you can gain and keep share in the mid to longer term, that the speed more capital provides you is desirable as long as you can afford it.
This is where many SME’s struggle with using asset based lending compared to bank margining during a period of growth.
Bank financing is going to be cheaper on the surface, but may not be as cheap or as flexible as you may think.
For instance, if you’re talking about a margining facility in the millions of dollars, you’re going to have to provide audited financial statements on an annual basis and some pretty detailed monthly reporting and potentially third party measurement services as well. The incremental cost of these requirements can push up the effective rate considerably.
But the cost is the cost, and is bank margining is cheaper, then it should be used, provided that its also readily available and flexible enough to deal with your growth curve.
This is where bank or institutional margining in the short term can be very inefficient and costly to growth, even at a lower cost of borrowing plus the incremental administrative costs.
While many banks can be very cautious with extending credit limits, and sometimes even putting the brakes on their financing position, regardless of what their initial commitment may have indicated, asset based lender tend to follow more of a linear path and as long as you fall within their lending ratios and maintain the quality of assets, capital availability can growth at the right speed.
Once again, the key measuring stick is the collective profitability over both the short and long term.
The source of capital you use at any given point in your growth cycle should provide you with the capital required to growth the market as fast as you can manage at the least amount of cost, provided that you can cover the cost with the cash flow being generated.
This can also mean changing from one source of capital to another over time.
For instance, a business may start out with a bank or institutional working capital facility, move through one or more traditional asset based lenders as capital demands increase and then make a final transition to bank or institutional asset based lender that can provide the best rates versus leverage, but only tend to become interested when your monthly sales levels are at $5,000,000 or higher.
There can be tremendous challenges in figuring this out, but figure it out and stay ahead of the growth curve you must, otherwise you may loose momentum or be overtaken by someone else in the market that has figured out how to finance their growth.
Click Here To Speak To A Business Financing Specialist About Financing Growth At Different Stages
Business FinancingSecuring Better Long Term Rates
July 1st, 2011
“Here’s An Approach To For Improving Your Long Term Commercial Financing Rates”
If you run a business that has good commercial real estate in your asset mix, then you need to make sure that you’re getting the best value out of the leverage that real estate can provide.
Regardless of whether you’re trying to arrange business financing for across your business entity or just focusing on getting a commercial mortgage for piece of property you own or are trying to acquire, don’t underestimate the power of the real estate security that is being offered to the lender.
When you’re looking at full balance sheet financing through an institutional lender where A/R, inventory, equipment, and real estate are being collectively leveraged to provide you with the amount of financing you’re looking for, the strength of the real estate will impact both the overall rate and total leverage you will receive.
Unfortunately, many times business owners don’t break things down fine enough to understand what the real estate is contributing to the financing package and in many cases do not receive optimum financing value from the commercial property or properties they own.
The same is true for arranging a stand alone mortgage on a single property where the offerings you get back from bank or institutional lenders may not be considered optimal or superior to what you should be able to acquire.
This is one of the main frustrations of commercial financing in that commercial lenders are totally portfolio driven, so if their portfolio has a higher risk rating than its supposed to, or they already have a lot of your type of property in their investment mix, the offer they make isn’t going to be as strong as compared to when the portfolio is balanced more in your favor.
And if you’re not in a highly competitive market area, there may not be a lot of other options to chose from. Or even if there are, you may not have enough time to go look for another option right now.
One solution to this type of situation is to consider a certain amount of asset based lending from private mortgage lenders.
In certain situations, private mortgage lenders may be offering very similar rates to banks or institutions, especially on grade “A”properties pledged by solid borrowers.
Under these circumstances, you may be better off going private for one or two years, giving you time to locate and secure a better commercial financing deal where you’re getting full lending value for your real estate.
In the short term, if the private lending rate is comparable to the institutional rate, you’re not really losing anything on cost, and on cash flow you’re likely paying interest only to service the debt which makes more cash available for other things.
Many times private commercial mortgages can be arranged with no prepayment penalty after a certain number of months, so when you finally have the bank or institutional deal you’re looking for, you can pay out the private lender at any time.
This strategy has the potential to create a significant cost saving to you in the long term, especially when you’re talking about higher leverage and interest rate differences of 0.5% or higher over time.
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Business Financing