“Business Financing Basics For Small Business Acquisitions”
When a small business owner intends to sell their business, and when someone is considering purchasing a small business, there are some business financing basics that both sides should consider.
And for the purposes of this discussion, when I speak of small business, I’m talking about a business entity with no greater than $2,000,000 in annual sales.
When it comes to business financing, the most important aspect of any small business purchase is historical cash flow that is supported by third party financial statements and seller provided source documents.
The harder the cash flow is to figure out or verify, the harder its going to be to get both sides to agree on a sale price.
The second element of financing a small business purchase is the composition of the assets being purchased and offered as security to a third party lender.
When the sales price is allocated into tangible and intangible assets, third party lenders are going to be very interested in the amount of goodwill that is included in the deal.
Goodwill represents the value placed by the seller on the future revenues of the business which represents potential revenues not yet earned.
Its not uncommon for a third party source of business financing to only finance a portion of goodwill or none at all.
The expectation of the lender is that either the buyer will be paying cash for the goodwill or the seller will finance it over time.
The biggest risk to the lender when considering a business acquisition financing request is the change of control risk.
The transition period when ownership and control shifts from the buyer to the seller will always be key to longer term business success.
To help manage this risk, business lending sources will look to a financing structure where the risk of potential loss is shared fairly among the buyer, seller, and lender.
Many small business purchases are financed on this basis with each party contributing or being responsible for financing a portion of the final purchase price.
Especially when there is a significant amount of goodwill involved, the lender may only be interested if the vendor is also providing financing.
This is also why its very uncommon to see a small business purchase being financed exclusively by just one third party lender.
When you have a buying or selling situation where all parties involved understand and are prepared to help guard against short term business failure, then its more likely that third party business financing can be arranged to complete the transaction.
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“Once You Get To December, Business Financing Activity Quickly Starts To Slow Down”
The reality is that in the business financing world, not much is going to happen after December 15th in any given year and the progress on applications and funding requirements in the two weeks prior will not likely be moving at any great rate of speed either.
And once we hit the middle of December, everything basically comes to a stop until the second week of January.
So if you you’re just starting a search for business financing, or you’re in the middle of an application to one or more lenders, then be prepared for things to slowly grind to a halt in the days ahead.
While the same can be said for other industries as well, this is especially true in the field of business financing due to the number of individuals that can be involved with any one particular file.
And the more complex the financing requirements, the less likely anything will get completed from the middle of December through to the middle of January.
It only takes one key person in a deal to be away to prematurely grind things to a stop as well. That can be an accountant, lawyer, insurance broker, appraiser, environmental consultant, dealer, underwriter, and so on.
So even though the actual lender you’re dealing with may be open for business and ready willing and able to move the file forward, there can be outside elements that are required to be completed that will hold everything up until the new year when everyone is back in action.
The key message here is that December business financing activities can be very much like beating your head against the wall and the holiday time is more likely better spent on other things.
If this year marks your first experience with this sort of occurrence with your business financing activities, then please make a mental note of it for future years so that next time you will consciously get things started sooner, or at least allow for the down time and not try to push a rope up hill during the holiday season.
If you’re trying to get a deal funded and are near the end of the process, a full court press may get things done, but don’t count on it.
Being at the mercy of others is never any fun, but working to hard against what is inevitable is likely going to be even worse.
The year end time period is a good time for financial performance reflection and planning for the coming year. Much of anything else in the area of business financing is not likely to be fruitful.
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“Here Are Some Tips For Being Ready For
Business Financing Applications”
One thing that many entrepreneurs are not not keen on is paper work and bean counter type activities that may drive them to the Aspirin or Tylenol bottle for headache pain relief.
But regardless of what a business owner or manager likes or believes is a good enough representation of their business, debt financing sources and equity investors have other ideas.
To this point, whether you are looking for business financing today or not, there is a certain degree of readiness that should always be in place so that there are no delays in applying for financing and there is no lost opportunities from a lack of basic information being available or presented to a source of capital.
For instance, one of the most basic requirements any lender or investor will ask for is the last two or three years of third party accountant prepared financial statements for the business.
If this is not always available and up to date, it should be as it will be very difficult to be considered for financing without historical financials.
And if the amount being requested is over a couple of hundred thousand dollars, then the type of accountant opinion is also going to be important.
For small financing amounts, a notice to reader accountant statement can be sufficient to most lenders, but as the amount of financing requested and overall financing outstanding and the overall level of business complexity growths, the more importance will be placed on the accountants opinion through either a review engagement or audit.
These additional levels of verification cost more money, but these can also be the difference between getting serious consideration from the type of lender or investor you want to work with and missing out on a good business financing opportunity.
The same can be said for management accounting reports that show product margins, variance reports, and operating break even. Projections and forecasts of both cash flow and income are also going to be important to complete the picture of where the business is headed.
Having good records of company assets and reports of good standing with with respect to any government tax accounts and regulations can also be helpful.
These are some of the basics that relate to virtually every business and the more these items are kept up to date, the faster the business will be able to react to capital requirements.
Scrambling to get many of these items up to date can not only cause delays, but lead to mistakes and a poor representation of the business and your business management.
Having the basic core financial information for past, present, and future at the ready provides confidence to lenders and investors, which can immediately separate you from other applicants they are considering.
Click Here To Speak Directly To Business Financing Specialist Brent Finlay For All Your Business Financing Needs
“Things To Consider When Recapitalizing
Your Existing Equipment”
One of the ways that business owners and managers access incremental capital for business operations is through the refinancing or recapitalization of equipment that is owned outright by the company or nearly owned outright with significant equity in the assets to leverage.
We call this refinancing because in most cases the equipment was previously financed and since been paid off. For longer use types of equipment, there can still be an opportunity to refinance the assets a second time around in order to inject capital back into the business.
While this practice does work and in theory sounds reasonable to most, there are some things to consider when crunching the numbers.
First of all, there can be considerable variability among sources of equipment financing in terms of the amount they will consider for an equipment refinancing application. The range can be from 85% of Orderly Liquidation Value to 60% of forced liquidation value of the owned equipment.
So if you think the orderly liquidation value of your assets is $1,000,000, the forced liquidation value may only be $750,000, which can make quite a different in the amount of funding that can be made available, depending on what you can qualify for with a lender you're applying to.
Second, the cost of financing that is available can also have a large range, going from Prime plus one or two on the low end to prime plus nine or ten on the high end. The higher cost of financing is not in itself unreasonable and can be explained in terms of risk to the lender, but it still needs to be factored in to the cost of financing you can expect.
In situations where the business is in financial distress, the cost of financing will be even higher, likely falling somewhere in the 18% to 24% per annum range.
Third, these transactions may be done as a new equipment loans, but many will need to be done through a sale and lease back transaction where by the financing or equipment leasing company purchases the assets from the business and provides an equipment lease back in return for a defined period of time. The sale and lease back transaction can potentially trigger income tax effects due to the fact that the assets are being sold, so this also should be factored into the transaction.
Fourth, the process, especially for the lower cost sources of equipment refinancing, is going to take some time. Third party appraisals are typically required as well as background searches on the assets to make sure a clear title is available to the financing company. The entire process from application to funding can take 30 to 60 days to complete. Faster money is typically going to be more expensive money, so its important to plan ahead and not leave this financing option to the last minute.
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“When Should Equity Financing Be Considered As A Source Of
First of all, lets get clear as to what we mean by equity financing.
Equity financing occurs when ownership in a company is sold in exchange for an agreed upon purchase price.
The purchase price becomes new capital in the business and is recorded as such on the balance sheet.
In the business financing world, there are basically three general forms of financing…debt financing, equity financing, and some combination of debt and equity.
Equity financing, in many situations, occurs when a business or company can not qualify for debt financing.
Part of the reason for not being able to qualify for debt financing may be a lack of equity on the corporate balance sheet. Once this has been corrected through an equity investment, the business entity may immediately be eligible for different types of debt financing programs.
When a business is in a startup and development mode and has not generated revenues nor is cash flow positive on a monthly basis, then an equity investor is typically required to provide the cash flow necessary to complete the development process and get to a cash flow positive position.
Higher rate forms of asset based lending that provide financing debt to equity ratios higher than conventional lenders, will say that they are renting equity to the business due to the high level of debt and risk that the business is covering.
All things being equal, most business owners will prefer to debt finance their business needs as it comes at a lower cost than and equity investment in most cases, and the business owner retains ownership and control of the company.
That being said, debt financing can be difficult to manage, especially when you are working with more than one lender where the risk of being offside with some lender covenant is going to be that much higher. Debt financing sources can also demand repayment at times for no reason or wrong doing on the part of the business, potentially leaving the business owner or manager scrambling to manage cash flow.
Because equity financing is connected to ownership, its typically not always straightforward how an owner will be able to sell their shares and exit the business. Most corporations have shareholder’s agreements that outline this process, but it can still take considerable amount of time to exit and there is no guarantee that the initial investment will be reclaimed.
Equity financing in many cases is considered to be a more patient form of capital as its placement is usually connected to the future earnings potential of a given business versus existing financial returns.
The higher risk associated with speculating on future returns also demands a higher risk which is going to be expected by most any equity investor.
More and more often, we are seeing business financing solutions with both debt and equity elements where the investor/borrower is only looking to be in place for a period of three to five years, exit the business, and make a high rate of return on the capital provided upon exit.
For most start up business situations, the entrepreneur is first utilizing their own equity to get the business going, leverage debt to grow the business, and then use third party equity financing to scale out the business in order for it to reach it market potential.
So depending on where you are at in your business cycle, there can be different debt and/or equity financing solutions that are going to be more relevant to you.
The key point here is that each situation is unique and as a result most business financing solutions are customized towards available sources of debt and equity that are available and relevant at the time of need.
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“Asset Based Loans – When To Consider Them”
First of all, there can be many definitions of asset based loans.
For this discussion, we are referring to asset based loans in the context of a working capital facility that leverages the equity in accounts receivable at a minimum, but can also provide leverage on inventory, equipment, and even real estate.
The standard asset based loan or ABL type arrangement requires the borrower to open a joint account with the lender and that all funds paid to the business be deposited in this joint account.
The lender will, as they say, sweep the account every day and apply funds coming in to the balance outstanding on the loan. The borrower will request funds from the lender on a daily or weekly basis, depending on the requirements, to pay bills as they come due.
This is a highly simplified overview of how an asset based financing facility actually works from an operational stand point… each lender and financing scenario will have its own unique aspects.
Now back to the original question as to when ABL’s should be considered
There are two basic scenarios (with lots of variation within each one) where asset based loans can be considered to finance business operations.
The two scenarios include situations of growth and situations of financial distress…basically opposite ends of the lending spectrum.
In both cases, what is common is that the business requires high asset leverage to generate the cash needed to operate the business.
Under both these scenarios, conventional lending parameters may not provide sufficient leverage, causing the business to fail outright, or not be able to take advantage of growth opportunities immediately available to the business.
Most asset based loan facilities are born out of the inability of a conventional financing arrangement through a bank or institutional lender to provide the level of financing the business requires.
In highly stable companies with very strong balance sheets and cash flow, the ABL solution can be provided in house through the conventional lenders own asset based lending group. These institutional asset based lenders provide the higher leverage required at slightly higher rates than what their conventional business division would lend money out at. The large bank asset based lending programs are also only going to be available for growth and market development scenarios.
When a business cannot qualify for what we’ll call low cost institutional asset based loans, they turn to boutique lenders that provide ABL services at similar leverage, but at higher rates.
If a business is in distress, the asset based lender will provide higher leverage on assets and very tight cash management to give the business the best chance to turn things around or wind down the operations without destroying equity. Either way, this tends to be a short term solution until the business can once again qualify for a lower cost source of capital.
In situations of growth, the higher cost, traditional asset based lender will once again provide higher leverage at higher rates and serve as the senior lender until the business can qualify for a lower cost form of financing within a manageable range of leverage.
Unless a business is being funded by a low cost form of institutional ABL, the time period of business financing via an asset based loan is typically two or three years as the high cost of financing cannot be sustained over a long period of time in most cases.
Therefore, most traditional asset based loan providers are a form of bridge lender that does not expect to be financing the business into the long term.
Once again, there are many variations to these asset based loan programs, each with their own unique fit in the market place.
To better understand what type of asset based loan facility might be appropriate for your situation, you might consider utilizing the services of a business financing specialist that can help you navigate the landscape.
Click Here To Speak To Business Finance Specialist Brent Finlay For All You Business Financing Requirements
“The Ability To Borrower Money Is Directly Related
To Government Debt In Arrears”
When a business starts to have cash flow issues, one of the first things that start to fall behind is government remittances for income tax, payroll deductions, and sales taxes.
The argument from the business owner is that there is no money available to pay these bills and still cover off wages and essential operating costs, so the government will have to wait.
And while this may very well be the case, the long term survival of the business is going to depend on having this be a short term scenario.
If it can’t be made short term, then a growing or consistent level of government arrears is likely going to start a death spiral for the business.
This is largely because you start the process of death by a thousand cuts.
Lets discuss further what can potentially transpire.
First, your existing primary business lenders will typically have a covenant that you are up to date with your government remittances. If you fall behind, at best they will charge you a higher interest rate until the remittances are brought up to date. At worst, they will demand repayment and kill your cash flow if you are utilizing any type of bank or institutional operating facility.
Second, if you want to try and restructure your existing debt, even if you have the cash flow and equity to attract more business financing capital, no lender is likely going to advance any new funds to you unless the government arrears are brought up to date. If there isn’t enough incremental capital available to do this, then restructuring will not be possible. Even if there is a way to restructure to get everything in order, it will likely involve moving to another lender, potentially a higher cost lender that works with company’s in a certain amount of financial distress, where the costs of transfer to the lender can be considerable, further putting you behind the eight ball.
Third, at some point the government will take action against you. Many times you can negotiate a repayment plan to catch things up, but if this goes sideways, then in many jurisdictions the government agency you owe the money to will step in and seize your bank account, register garnishee orders with your customers, and put you in cash flow management hell.
If you can keep the government stuff paid up to date, you improve your chances to maintain existing credit and improve your chances to secure incremental debt or equity financing.
When you’re behind with these accounts, your options are limited and in most cases non existent.
Having a plan to stay out of government arrears, or putting a plan in place to pay them up as quickly as possible is going to be important to long term survival of the business.
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“What Exactly Is A
Business Financing Specialist?”
While there can be several different definitions to what constitutes someone calling themselves a business financing specialist, I’m going to give you my own spin based on my own opinion of the role.
To start with, a business financing specialist must be someone that is well versed in both finance and accounting with some direct experience working in a business.
The reason for these specific requirements is that the key to being able to assist a business owner or manager with their business financing needs is to first be able to understand exactly what is going on in the business and what their financing and credit profiles look like.
By having a solid background in business and finance, a business financing specialist can then determine what types of financing strategies will work and what types won’t work.
The second key requirement that a business financing specialist needs to possess is access to sources of debt and/or equity financing that providing business financing to the market that the business finance specialist serves. In addition to having direct access, the specialist must also be able to understand the lending/funding requirements of each and every source of business financing they work with and he or she must also stay up with their funding interests and criteria on an ongoing basis.
A business financing specialist is middle man (or woman), trying to connect borrower to lender, owner to investor, and so on. Without both sides of the equation, no amount of brilliant understanding of customer needs is going to do any good. The exercise here is to locate and secure capital that meets the requirements of the client.
If the business financing specialist or financing consultant cannot meet the client’s expectations, then he or she needs to work with the client to better define a financiable scenario or decline the engagement. Pushing a rope up hill is not an options. Either you have a workable engagement or you don’t.
The next characteristic of a business financing consultant is the ability to properly assemble information into a format and presentation that proactively addresses the targeted lender or investors key questions, concerns, and criteria. This is partially art and science which is developed over years of practice. The ability to tell the story properly separates the good consultants from the not so good.
The final main characteristic I will speak about is the ability to get a deal approved AND funded.
There is no consolation prize for getting close. Many times a financing deal will be 95% complete and fall apart at the last minute or level of sign off or both material and obscure reasons.
The ability to stay ahead of everyone else in the funding process, communicate on relevant and clear information on a timely basis, and problem solve issues as they arise are all keys to having business financing success.
The business financing or commercial financing process is not easy, and has even gotten harder since the start of 2008 when we have been pushed into a financial market place not seen since the second world war.
As a result, the need for business financing specialist is more prevalent now then ever.
It costs money to utilize this type of expertise, but that is no different than with other professionals including accountants, lawyers, insurance brokers, and so on.
The questions business owners and managers have to ask themselves are 1) do I know enough about the business financing process to do it myself; and 2) do I have the time to invest in the process or is my time better spent on core business activities?
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“Equipment Leasing Can Potentially Create Faster Asset Write Offs And Lower Income Tax Bills”
One of the first things I hear business owners say about equipment leasing is that they are going to be able to write their payments off and get a tax break from doing so.
While this may be true, its not always going to work like that for a number of different reasons.
First of all, only an operating lease that is properly structured can allow you to write off all lease payments as an operating expense.
An operating lease has a number of different rules, which can vary by tax jurisdiction, but for the most part, require the lease obligation to have at least 10% of the original asset value be outstanding at the end of the lease along with the lessee having an option at most to acquire the asset at the end of the lease.
This is in contrast to a capital lease where the lessee is obligated to purchase the asset from the leasing company at the end of the lease term for a predetermined nominal amount in most cases.
If a lease qualifies as an operating lease, the payments can be classified as an operating expense and a write off against earned income in most tax jurisdictions (check with your own accountant or tax adviser).
But what does that really gain you?
If you have a capital lease, you basically fall under the same guidelines as owned equipment, which can be financed by some combination of cash and third party debt.
With a capital lease, you depreciate the asset and write off the cost of financing, if there is any, just like you do with an equipment loan.
Therefore, an operating lease does not give you a greater write off so to speak, but it can potentially allow you to write off the allowable tax expenditures faster.
For instance, one of the situations where an operating lease can have a nice fit is in the financing of grain bins.
A grain bin is going to be depreciated over 10 to 20 years as it has a long potential useful life. So the capital cost of the asset is going to be applied against earnings over a long period of time, minimizing the tax write down that is available in any one year.
But if the grain bin (or granary if you want to be really accurate) is financed via operating lease with say a three year term, 90% of the capital cost and 100% of the business financing cost can be written off in three years instead of ten or more years.
The other key element for getting an immediate tax advantage from an operating lease is you have to be taxable with a higher marginal tax rate being more beneficial than a lower tax rate.
Bottom line, there can be tax advantages to equipment leasing, but you better go see your accountant first and crunch the numbers as there is automatic benefit to leasing and the lease payments are not automatic write offs either.
Click Here To Speak Directly To Business Financing Specialist Brent Finlay
“Here Are Some Basic Rules To Consider When Shopping A Commercial Or Business Financing Deal”
As a business financing consultant my first response to the question of how to best shop around a commercial deal is not to.
There is a saying in the commercial financing world that shopping is death.
While this may be a bit melodramatic, there is a message carried with the expression that should be considered by all business owners and managers seeking business financing.
Unlike a personal credit or residential mortgage application that is evaluated on three to five readily available metrics, a business financing application can take a considerable amount of work to complete.
Each lender only has so much time and resources to invest in reviewing all the applications for financing they receive, so it only stands to reason that they are going to put their efforts into deals they think they can fund with borrowers that are committed to working with them.
The more a deal gets spread around, the more likely the lenders involved are going to become aware of this and when they do, there is a good chance they may automatically decline the deal and move on to the ones they feel they have a better chance at closing.
If you are shopping your own deal around, one of the tell tale tip offs to a lender that you are in full shopping mode is the inquiries on your credit report. Any type of application for business financing will require a credit check and when your credit gets putted and there are ten other lenders listed who have recently made inquiries, then its going to be pretty obvious to any given lender what you’re approach is and they will respond accordingly.
This may be a chance you are prepared to take, but keep in mind that the lender that declines you for shopping (even though they will never say that) could have been the best option available.
The other way shopping can go horribly wrong is through the use of financing brokers. Employing more than one broker plus submitting applications yourself will likely result in lenders receiving applications from more than one source. This again can instantly kill your options with a lender as they wonder how widely this is being shopped and how serious you are about their funding services.
As a business owner or manager, the most important thing for you to do is to manage your own deal. What that means is that you need to keep track of all the places your deal has been and if you have third party agents working for you, they need to tell you where they are planning to send the deal so that there are no instances where the same deal crosses paths.
The second part of managing your deal is not allowing a lender to pull your credit until the end of the application process. One of the ways to get them to move forward without pulling your credit at the outset is to provide a copy of your credit that you have procured yourself for your personal profile and the business profile. This won’t take away the lender’s need to pull your credit before anything is finalized, but it does allow them to make an assessment based on something reasonably current. By doing this, you are eliminating all the inquires to your credit that are dead giveaways to other lenders as to how broad this deal is being circulated.
The most important aspect of searching for business financing is to intimately understand your own financial and credit profile as well as the lending targets that are going to be interested in both at a particular point in time so you can hunt with a rifle instead of a shot gun.
The best way to do this is to work with a business financing specialist who can develop a detailed understanding of your profile and requirements and get you in touch with the most relevant lender or lenders right away so that you’re not wasting valuable time trying to cover the whole market with applications.
Click Here To Speak With Business Finance Specialist Brent Finlay For All Your Business Financing Needs