Posts Tagged ‘investors’
Business Financing Sources Are Moving Targets
November 30th, 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.
Tags: The Cost Of Capital Is Directly Tied To Risk
November 20th, 2009
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.