Posts Tagged ‘working capital’
Business Loans Come In Many Forms
October 24th, 2009
What Are The Different Types And Forms of Business Loans?
First of all, what is our working definition of a business loan. For the purposes of this post, I will define it as a debt instrument with a stated rate of interest and defined period of repayment.
Any business loan is further defined by the purpose of its use, the security involved, and the timing of the related cash flow stream tagged for repayment of the principal and interest.
When the purpose is for working capital, business loans or debt instruments will come in forms that are short term in nature and are predominantly secured by short term assets like accounts receivable, inventory, and potentially equipment.
Working capital instruments for low leverage balance sheets and strong credit profiles will include lines of credit and term loans of 5 years of less. Lines of credit will rise and fall with the cash requirements of the business, while term loans will have a fixed repayment term, drawing money out of cash flow for structured principal repayment.
For higher leveraged balance sheets and/or weaker credit, working capital can be provided through asset based business loans, inventory financing, accounts receivable factoring, and purchase order financing.
While all of the above are technically asset based loans, lets discuss each one separately. The standard asset based loan provides working capital funds as a percentage of the liquidation value of accounts receivable, inventory, and equipment value, similar to a line of credit. Unlike a line of credit, the leverage tends to be higher and is more closely managed by the lender through the lender collecting all the customer proceeds due to business and then continually adjusting the loan outstanding according to the current security value. With a line of credit, there are balance sheet ratios that need to be maintained and reported on a monthly basis, but the cash is collected and managed by the business as long as the business owners and manager stay within the stated covenants.
Accounts receivable factoring is extended as a business loan on the strength of the customer that owes the receivable and provides the lender with rights against the receivable that’s outstanding. There are many different forms of factoring and the rates can vary tremendously.
Inventory financing provides a business loan for the purchase of inventory and uses the inventory for security. Some inventory financing models have the lender control the inventory in third party warehouses to protect their interest in the inventory while other inventory financing models will allow the inventory to remain on the business owner’s premise if the facilities and control systems can provide the lender with sufficient comfort.
Purchase order financing provides business loans based on an advance against the value of a customer purchase order. The credit rating of the customer, the nature of the order, and the time period required to complete the transaction will determine the amount of purchase order financing. For instance, most purchase orders are provided on the purchase of commodity goods that have an active market and can be readily liquidated by the lender to get their advanced funds back if required. Inventory financing is also primarily provided on commodity type goods for the same reasons. Both inventory financing and purchase order financing command higher rates of interest than traditional forms of working capital related business loans
Other forms of short term debt can be subordinate debt financing where a business loan is provided against assets that already have debt registered against them, but with sufficient security value available to secure additional capital in a second security position. Because of the second position, the cost of these funds will be higher than the first position debt.
For intermediate term lending on the acquisition of assets with a useful life of 2 to 10 years, business loans come in the form of term loans or demand loans for equipment. A demand loan can demand repayment at any time while a term loan cannot. Equipment can also be financed through leasing which is different from a business loan in that the lease company retains the ownership of the assets acquired and/or provided as security while in the case of a business loan, the assets are owned by the business with security registered to the lender.
Longer term business loans for longer term life assets such as buildings and real estate are typically financed by commercial mortgage instruments.
There are still other forms of business loans such as convertible debentures and mezzanine financing that are more elaborate in nature and tend to be utilized when loan amounts are in the millions of dollars and more complex business enterprises are involved.
There are so many variations around all these forms of business loans, that each would require a separate discussion.
The point here is to remember that if the business has something of value than can be readily sold or liquidated in the market place for a predictable amount, then there is potentially a form of business loan available to that particular business.
Tags: How To Secure Business Capital
September 28th, 2009
The question of how to secure capital for your business is commonly asked and pondered by most small and medium sized business owners and managers at one time or another.
When you search the internet for the answer, you tend to get the same lame regurgitation of things like new businesses should look to friends, family, and fools for capital; existing businesses should look to banks; and that you need to consider debt financing versus equity financing that gets into the whole venture capital versus angel investor rhetoric.
Wow. Really revolutionary and informative information. Some even go so far as to say these are secrets if you can believe it.
Now I’m not implying that these various terms I just threw out don’t need to be explained or are not important. No sir/madam. I’m merely saying that all these terms with some amount of abbreviated explanation are thrown at you like a bucket of water in some weak attempt to answer the question.
Perhaps its because the generic answer set I’ve outlined is pretty basic and safe and even friendly.
But useful?
Instead of starting at the beginning, lets start at the end. A bad ending. Depending on whose stats you read, over 50% of businesses will fail, fold, go kaput in less than 5 years of existence. Whether its 43.7% or 71.2% that fail in 5 years doesn’t really matter. The point here is that its a lot and its alarmingly high.
So, why is it so high and what that got to do with securing capital? Answer, it has everything to do with securing capital.
The internet for one is awash with people looking for money to finance their business ventures, either start up or existing, and most of the solutions that they come across are geared towards lending them money based on nothing to do with their business.
Business Financing in large part, is not based on business. Its based on personal credit, personal net worth, liquidatable (new word) assets, third party guarantees, government grants and guarantees, etc. This applies not just for start ups, but for existing businesses as well.
The point (yes I do have a point) here is that if you try hard enough, you can probably find someone to give you some money for what you’re trying to accomplish that you say requires capital.
But your ability to be successful is dependent on 1) having a tested business model; 2) having a tested marketing approach and position; 3) having enough necessary experience, or access to the necessary experience for the venture, and finally 4) accurately estimating the capital required to become cash flow positive (business can generate enough cash to pay bills and generate a return on the capital you secured) including a substantial contingency plan for all the things that may go wrong along the way.
If you don’t complete the above 4 points, my first question to you would be, how do you know how much capital you really need? My second question would be, if you don’t Secure Capital sufficient to complete whatever you’re starting (your estimate was out and now you’re short), what are you going to do?
So how to secure capital for your business starts with how much capital do you need and is that much capital going to be able to generate a return based on your plan of attack.
In most business failures, if they did the exercise first (honestly and objectively at the very beginning), they wouldn’t need to secure capital because they’d find so many holes in their own logic and planning that they’d stop and revise things until they made more sense.
I’m not saying planning is perfect, because its not. And no amount of basic planning and analysis will stop business failure. But I’m telling you, its not going to be anywhere near 50% either.
The final point today is that when you make the effort and figure out what business approach should work (and I do say should as planning is imperfect) and clearly outline the capital you need to secure, you will not only have an easier time securing business capital (well thought out plans have a higher probability of getting funded), but you’re also more likely to meet or exceed your profit expectations (well thought out plans have a higher probability of making money).
We’ll get into a lot more on how to secure business capital as there can be a lot to it, depending on what you’re trying to do.
But the starting point is not “where do I apply?”, or “what tricky things can I do to get an application approved?”
If you that’s where you want to start, you’re looking to become another statistic.