If you’re like most business owners, the answer to the question of having an actual formal business financing strategy is likely No.
The status quo for decades for most businesses has been to focus on what generates cash flow and deal with business financing as a short term project, whenever its required.
This typically has some form of time pressure associated with it, and because there is no regular attention spent to how to properly go about getting financing arranged, brute force tends to be employed to get through the process, get the required money in place, and then get back to work.
This has been the “business financing strategy” for many small and medium sized business largely because it worked.
Leaving things to the last minute and scrambling around to get funding in place has been an effective strategy for many. Yes, it can be a pretty stressful process to go through, but its not required very often, the results get achieved, and the pain generated quickly dissipates due to small time box everything is forced into.
The challenge going forward is that the world, at least for the foreseeable future, has changed. The probability of leaving business financing needs to the last minute and then depending on brute force and will power to muscle things through has gone way down for a number of reasons.
First, there are significantly less business lenders now than 2 years ago, and the number continues to decline on an almost daily basis as the recession continues to unfold.
Second, many of the surviving lenders aren’t lending money as they scramble to collect the accounts they already have. Even if they wanted to lend money, many of them are having a hard time finding sources of funds to finance new business loans.
Third, the more established lenders are taking a more cautious approach to the market and are being more selective with opportunities and taking their time with deal assessment, not being particularly interested with anyone in a flaming rush.
And based on the current state of the capital markets, things are not going back to the status quo any time soon, effectively changing the status quo.
So now is the time to move to a more formalized business financing strategy and approach. This is something that all businesses require. Obviously smaller businesses are less capital intensive, but they still have cash flow and have to be able to fund it if they want to stay in business.
In my next post, I’m going to get into even more specifics as to why a business financing strategy is something that business owners are going to have to start investing time in to either stay in business or grow their business.
Most everything we here about the prime lending rates being kept at historically low levels by their respective country administrators to keep the global economy from stalling out during the recession is a bit of a farce for the small and medium sized business that contribute to driving the economy.
Yes, if you’re a well established company with a senior bank credit facility, your cost of operating has gone down due to historically low interest rates. But in many cases, the cost saving that are realized wouldn’t make or break established companies with the balance sheets to qualify for low interest rate debt.
If a company gets offside of their balance sheet and income statement covenants with a bank, they either get their interest rate jacked up nullifying any savings, or end up with a special loans tag which can lead to a forced payout that is even more expensive if not fatal in some cases.
For all other businesses that are looking to start, expand, grow, replace assets, and so on, interest rates near prime are mostly a myth.
Unfortunately, no one told business owners who are frantically in search of business capital right now, working off their long term conditioning of what should be available to them based on where the prime rate is sitting, that things are not what they seem.
Whether this is good or bad, fair or unfair isn’t really the issue. Prime plus rates are difficult to secure because the economic risk is higher and lenders are being more cautious until the recessionary impacts work themselves out.
The key learning is that things are not what they seem and as a result, business owners need to reassess their ability to access incremental capital and the related cost that comes with it.
Failure to adjust to the current environment can not only waste valuable time and money searching for something that isn’t there, but it can also put basic business operations and incremental sales opportunities at risk.
The solution may be to forgo expansion or new business endeavors in the short term, or focus on lower levels of potential profit to cash flow a higher cost of capital.
For businesses offside on their financial covenants that have received a demand for repayment from their senior lender, it could be very unlikely that a similar senior lender is going to be available to replace the existing one and an extended search for money that has a low probability of being there could run the business out of time for structured and civilized refinancing.
Adjusting financing expectations sooner than later can have a profound impact on the long term health of the business.
I’ve written a lot lately about many of the changes in the capital markets and many of the ways these changes have impacted the ability of small and medium sized businesses to locate and secure financing.
The hard part of these recession driven changes to the market is that there isn’t going to be a near term return to the market conditions we’ve basically gotten used to over the last two plus decades.
Let’s face it, the capital markets have not seen anything like this since the end of the second world war.
A large percentage of the capital markets were driven and built up over time by the long run health of the overall economy. Yes, there have been some significant bumps in the road over the last thirty or so years, but nothing as game changing as what we’re seeing right now.
Large parts of the market have disappeared all together as record numbers of bank and commercial financing company failures lead the headlines on an almost daily basis.
When the economy gets back to steady monthly growth, the crater in the market we now see isn’t going to fill up anytime soon.
This tells us that the go forward business financing market is going to take on a very different look for some time to come and it may take decades to get back to anything close to what has been in place in recent memory.
The biggest benefit to business owners with the old status quo was that there were numerous sources of capital all trying to carve out their own unique place in a market that seemed to be growing without end. Similar to the residential market, the commercial sub prime market exploded as companies raced to get their share of the market demand for more capital.
But when the economy slowed down, and highly leveraged companies started crashing all over the place, starting a domino effect like nothing we’ve ever seen and are still experiencing, collapsing the capital market structure that was created over several decades.
And while government bailouts have helped stabilize the money supply to some extent, its hard to know if the main beneficiaries are actually going to make structural changes to their practices or continue on overheating the economy once things get back on track, getting us all set up for another recession in the not too distant future.
Bottom line to all this is that things are going to be different from now on and may be significantly different for decades to come when it comes to locating and securing business capital that your going to be able to cash flow.
Business owners have been spoiled by the funding choices available to them, causing them to practice what I would call less that optimal business finance practices. In fact, in many cases, there is no business finance strategy at all.
The reality is that when you borrow money or take on an investor, the money belongs to someone else and they are going to want it back. The building up of debt over time without a plan to pay it down is good in theory from a weighted cost of capital point of view, but in reality sudden changes in the fortunes of your lender or investor can turn your business upside down in a hurry with no solution in sight.
Business owners need to get back to contingency planning, having some amount of capital buffer to weather financial market storms, and managing their balance sheets so that debt levels are kept in check.
The days of fast and loose money are gone for now and I’m not sure if and when they’ll be back.
We hear so much about the collapse of the U.S. sub prime residential market, but we don’t hear a whole lot about what I refer to as the global business sub prime lending market.
For business financing, there are three basic levels of financing. The first level is for “A” credit and where corporate finance mostly lives. Then there is the “B” level or sub prime level for slightly higher risk situations followed by the “C” credit level which is asset based lending. There can be forms of asset based lending that are more A or B in nature, but for the most part asset based lenders lend strictly on the liquidation value of the assets.
In March of 2010, the “A” type lenders are still largely sitting on the fence and not lending out much money. Most of their time is being spent trying to figure out what to do with all the customers that are behind or offside with their financing covenants.
The C lenders are lending, but the rates are high, and because their is so much used equipment and real estate flooding the market, the assessment of liquidation value, upon which the amount of financing that can be provided is determined, is very low producing much lower amounts of capital than the business owner is expecting in most cases.
And then there’s the B, or Sub debt lenders, who have basically vanished from the scene.
So right now, if you’re a business that just come off a bad year, but have pretty good options ahead of you, the types of financing options available to you are going to be limited. In most cases, the only options that are actually lending money will be asset based lenders, and they will be taking a big bite out of your available equity with large debt service costs.
Business owners, for the most part, have not adjusted to this market shift and are still looking for cheaper money that isn’t available right now. It is a hard decision to take on higher priced debt, but if you can make the math work in your cash flow, 2010 may be more about survival than profitability.
If you are in need of business financing, give me a call and we can discuss your options in more detail.
In the world of business financing, everything is all about timing.
Too often business owners and managers get overly focused on their ideal form of financing versus what’s available to them in the time they have.
A good example is the current situation in 2010 where many businesses are starting to see a return to more normal business patterns as we get to the back side (hopefully) of the current recession, but they lack the working capital resources to take advantage of available opportunity.
But because last year was challenging, they not only have weak financial statements to work from but also potentially strained working capital and credit due to needing to cover cash flow short falls over the last 12 months.
And even though they may have never experienced an off year before, they still may not be able to secure incremental working capital from their bank or move to another bank to gain access to a different source of capital.
But what is likely versus what they are focused on can be two completely different things.
This is where having a basic understanding of how business financing works can be so critical to your business. In times when a dog won’t hunt, its better to not go hunting, or take a different approach.
Lately I’ve been getting a rash of very predictable phone calls for this time of year from business owners frantically getting nowhere trying to secure additional funding with a weakened financial profile.
Is it possible to secure incremental financing or refinancing at prime plus rates in a weakened financial position while we’re still within in this more conservative recessionary lending period?
Yes it is.
Is it probable.
No it’s not.
There’s the famous Albert Einstein quote that the definition of insanity is doing the same time over and over again and expecting different results, which could have been written about business owners not understanding how to go about securing business financing at any given point in time.
Taking it even one step further, even if it were possible to secure your ideal financing in less than optimal lending circumstances, can this be accomplished in the time you have?
What good will it do to get the optimal commercial financing in place if you’ve missed the boat on solid business that could have helped you get back on track or at least generate some positive cash flow during the last 6 months of unrealistic money shopping?
When there is no financing contingency in place, and additional cash is required sooner or later to take advantage of opportunities or keep the balance sheet from further deterioration, the best capital to go after is capital that can be secured in the time required.
Once you get into this mindset, its not about getting the best potential deal, its about minimizing the costs associated with the most probable deals. And the most probable deals are likely going to be asset based with higher costs. They will also be bridge loans in that you’re not going to want to pay higher financing rates any longer than you have to.
Once you get focused on financing options that work with your capital needs and time requirements, the exercise becomes picking an option that you’re going to be able to afford even if the best case scenario is breaking even.
Remember, this is a short term fix because you believe better days are ahead.
But if business owners refuse to adjust their financing expectations for any point in time, they may not only descend into madness, but insolvency as well.
If you’re trying to start up a business or have been in business for less than one year, the acquisition of business financing is typically just personal financing in disguise.
It doesn’t matter how thick or fancy your business plan is, or how many letters of intent you have signed, or your wealth of industry experience, if you trying to start a small business and require capital to do so, you are basically limited to what you’re personal financing profile can provide.
Take a look at banks for instance.
Unless they can get you approved through a government backed loan program for equipment, leaseholds, or real estate purchases, they are not going to extend you a business loan. And even for the government supported programs, if you have below average credit and no personal net worth, you won’t qualify for that either.
Whether we like it or not, start up financing is equity driven, not debt driven. If you’re looking for debt financing of any kind, it will be based highly on your personal credit, personal net worth, and sources of personal income.
The reasoning for this is quite simple. Depending on whose statistics you read, over 40% of start up’s will fail in 5 years. From a lender’s point of view, if 4 out of 10 loans don’t get paid back, the lender will be out of business themselves.
So to get started, you need your own money or the equity investment of others to fund the business.
The business financing side is a bit bizarre in that if you apply for a business loan and are approved on the strength of your personal credit, earnings, and guarantee, you’re still going to be charged a business rate. If you were able to secure the same amount of borrowing through a personal financing program that relies on the same personal factors and security features, the rate would likely be lower.
In many cases it makes far more sense to secure the personal financing available to you from secured and unsecured loans, and then lend the funds acquired to the business as a shareholder loan. This will immediately save you money in lower interest costs.
But because entrepreneurs have their mind set on getting a business loan, lenders are more than happy to provide a personal loan in disguise at a higher rate.
Take a look at the trucking industry. Many leasing companies require owner operators to own a home and have at least an average level of personal credit. The trucker may think he’s applying for business financing, but the lending or leasing decision is mostly based on personal financial and credit factors.
I’m not saying this is right or wrong, good or bad; it just is.
For anyone starting up a business, the sooner they understand the above, the sooner they will stop beating their head against the wall trying to find something that doesn’t exist.
The key take away is that when you have a new business, you need to focus on leveraging your personal credit attributes to gain the best financing deal possible, regardless of what type of lipstick a lender puts on it.
There is quite a difference between searching for residential mortgage financing and different forms of commercial or business financing.
On the residential and even consumer side, it is a well accepted practice that borrowers will shop for the best deal and could contact several different lenders during their search for financing. And if a broker is involved, an application for financing can be quickly distributed to a large list of lenders for their individual consideration.
The same is not true with most forms of commercial financing, especially when the transaction value gets into the millions of dollars.
Unlike residential and consumer financing deals, commercial financing is much more difficult to put in place due to the higher degree of risk associated with business financing as well as all the relevant information that may have to be reviewed for any one application.
So when a business owner or manager goes on a shopping spree, sending out their information to anyone they can find that may be potentially interested in their deal, there are several problems that can occur.
First, if several brokers are involved and end up applying to the same lenders, the lenders are going to know that the deal is being broadly shopped around and may decline their interest almost immediately.
Because they’re not prepared to consume resources on a deal review that has a low probability of giving them any type of return. Because there is so much work involved compared to consumer financing, they may instead focus their efforts on applications that appear to be more focused on their services.
Second, aggressive shopping is likely going to generate a lot of term sheets from the lenders that are trying to “take you out of the market”. Terms sheets can provide a basic overview of what is possible, but are no means binding in any way, and there may be a major difference between the best case scenario provided and the more typical rates and terms approved for similar deals.
And even though the borrower is in search of the best deal, these initial term sheets can get them going in the totally wrong direction, by passing the best available options in the process without the borrower being any the wiser.
Third, whether its a term sheet or exaggerated promise, marketing managers and brokers will also overstate what is possible to try and secure the interest of the borrower, knowing full well that it will be highly unlikely that they can deliver in the long run.
Part of this is the lender or broker telling the borrower what they want to hear and part of this is to gain a competitive advantage.
The strategy here is to get the borrower far enough along in the process that there won’t be enough time to go anywhere else and even if a forthcoming commitment delivers less than expected, there may be no choice but to accept it. But what’s even worse for the prospective borrower is if the application ends up getting declined. Now they may be out of time with no financing solution, and the shopping process that made so much sense at the beginning has ended in potential disaster.
Shopping for business financing needs to be done with a rifle not a shot gun. It requires a certain amount of knowledge of the market and the current lending criteria of relevant lenders. If the business owner or manager does not have time to develop this intelligence, they would be well advised to find someone who does.
As a business financing specialist, this is what I do every day for my clients. Its all about focusing attention on relevant lenders and working with them to get the deal done.
There is the temptation when applying for business financing to omit things that are negative and gloss over other things you personally don’t consider to be important.
The result is this semi-complete story of what you need financing for and the justification as to why it should be granted to you.
And while you could be well justified in not wanting to provide all available information, here are few things to consider when putting an application package together.
First, never purposely lie or exaggerate anything you put forward to a lender or investor. If you ever get caught in a lie, regardless of the size, the game at that point is typically over as the lender or investor may no long view you as credible.
Second, never hold back information that would be considered material to the business or the financing facility being requested. If something is material, then by definition it’s important and can cause an impact to other parties like providers of capital.
Third, provide what is requested as completely, accurately, and neatly as possible. You can make judgment calls as to whether or not you wish to provide certain items, but this is also one of the fastest ways to get declined. Remember that especially in the case of debt lenders, their financing requirements tend to be quite rigid. If you can’t provide what they ask, then they will just pass on the opportunity.
Fourth, proactively explain all negatives that are most likely to be detected during due diligence anyway. The best examples are negatives in business and personal credit reports. The first thing a debt lender will do after receiving an application for financing is pull the applicant’s credit profile. If there is no proactive explanation of any negative items that may appear, then the lender is left to draw their own conclusions.
Fifth, be conservative in your go forward estimates and have as much back up as possible to support your assumptions. Too many times the application is lost at the point of proforma financial statements that don’t reconcile or are too “pie in the sky” for the lender’s or investor’s liking.
Nothing is worse than to be 90% of the way through a business financing process where the finish line is in sight, only to be declined close to the end due to some non disclosure or inaccuracy that could have been dealt with in the application without impacting the financing decision.
Making assumptions of what you think is important or germane, versus what the capital provider wants to review, can be suicide to a deal. Providing near full disclosure, if at all possible, avoids this from being a problem.
And remember that even if you do manage to secure funding through what I’ll call creative disclosure, the longer you have the relationship with the lender or investor, the more likely the truth will be found out anyway.
If the capital provider has the ability to demand repayment, they likely will, potentially putting you into a major bind.
Recently I was working on a client’s financing request and had a business financing solution arranged twice, but got blinded sided both times when the lender’s due diligence turned up non and/or incorrect disclosure issues.
Not only was the whole process a big waste of time, but if full disclosure was provided from the start, completely different sources of financing would have been approached that were more relevant to the whole story.
Securing capital is all about the story. But nonfiction is preferred over the alternative.
As I have mentioned many times previously, the process of seeking capital for a business is largely an unplanned event in that 1) it is assumed that the process for securing business financing will be easy, and 2) that it won’t take long.
When reality sets in, then there can be an all out panic to try and locate financing sources before time runs out on a particular deal. If this occurs, then the business owner or manager may start working with multiple lenders and multiple agents all trying to find money in time.
This would be the wrong approach for a number of reasons:
First, commercial business financing deals can be a lot of work, and if relevant lenders find out that everyone and his uncle is being asked for financing, some of the better options will immediately decline from the party as they are not interested in doing a whole bunch of work for a small chance of reward. There can be considerable due diligence that goes into a commercial deal as compared with buying a house or a car and as a result, market shopping is frowned upon by lenders.
Second, to get a deal done in a compressed period of time can require a great deal of attention and effort on the part of the borrower to get everything lined up for lenders, lawyers, accountants, insurance providers, appraisers, consultants, and so on. If a borrower’s efforts are diluted among various scenarios, the probability of success is going to go down.
Third, there are likely only a hand full of lender options that are even relevant to any particular deal. Critical time can be wasted on chasing the wrong options due to the business owners lack of understanding of who can provide what in the time required.
Lets look at the right way.
If you have a significant sized deal at stake and you’re under a time pressure, your best bet is to first go to your primary lender to see if they can provide what you need. If that isn’t possible, then you should spend your energy locating a suitable business financing specialist who can quickly zero in on the best available options for your particular deal at that particular point in time.
Lenders and investors are always changing their level of interest for different types of deals based on changes to their portfolio or the economy. A lender that was relevant to a certain type of deal in a certain location 6 months ago is not guaranteed to be interested in the same deal today.
Talk to a few different financing consultants to see which one can best address your needs and then pick one and only one to work with. Working with multiple consultants and brokers is just as bad as contacting all the lenders in the phone book yourself for the same reasons mentioned above.
After going over your options with a financing expert, pick a strategy and stick to it so that your efforts are not diluted by too many different lending or investing scenarios. Once chosen, manage the heck out of your best option and keep you fingers crossed. Many times success is in the details and providing all your efforts into a solid option can be the difference maker in getting financing in place in the time required.
Keep in mind that hunting for money with a rifle is usually more effective than a shot gun.
If you’ve been in business for awhile and you have a sizable line of credit with a major bank, say for at least $1,000,000, you may have been going merrily along with your business without ever having any real issues with your banking facility.
Every year, your making a profit, meeting your banking covenants, and having a game of golf or two with your bank manager. If there are a few bumps in the road, they are typically handled without much problem and you feel pretty secure in your banking relationship.
This tends to be a pretty common scenario for businesses in operation for more than ten years and generating $5.0M plus in annual sales.
Now comes a long the worst recession since WWII.
In fact, its the first real recession in 20 years.
Banks have slowed down and in many cases stopped lending all together. Bank portfolios that are weighted in some of the harder hit sectors have taken a beating. As a business, banks are inwardly focused and taking care of their own business.
Its at times like these that business owners can develop a false sense of security with their banking relationship and even believe they have some influence or clout with the bank based on many years of paying for bank services.
But in times of recession, all bets are off. Every man for himself and all the rest of that jazz.
Senior lenders, almost without exception, provide business financing for working capital and equipment on a demand basis. We don’t think much about the demand loan terminology until its actually applied.
If a banks portfolio is going in the wrong direction and your portion of the balance sheet is viewed to be higher risk, then your senior lender may decide to demand repayment of your loans …or… provide additional security to lower their risk.
Sound familiar? In North America, banks have choked the money supply and asked governments to help them better manage their risk through guarantees or pledges of assets.
Talk about having you over a barrel. And they do.
So when your senior lender calls you up and says they need to improve their security position or they will be forced to reduce your line of credit or call your loans on demand, what choice do you have?
You can try to move to another Senior, but in the middle of a recession it may be very difficult if impossible to accomplish.
You can move to an asset based lender, which may very well be possible to achieve, but likely at higher rates.
You can see if they are bluffing and refuse to sign off on what they’re asking for.
Or you can cave into their demands and hope they don’t call everything anyway once they are in a stronger security position.
This can be scary times for many business owners, especially if you’re offside on any of your bank covenants, in which case, there will surely be requests for additional security, reductions in facilities, higher rates of borrowing, demands for repayment, or some combination of the above.
This is part of what comes with cheap money. Senior bank facilities are traditionally the lowest cost source of financing a business can have. Security can be based on assets like inventory that really don’t have any security value to the bank, but are still leveraged based on the strength of the overall business and the overall economy.
When times tighten up, like they are right now, senior lenders tend to hold their cards close to their vest and can be very unpredictable.
The best way not to draw their attention in recessionary times is to keep a low profile, and above all else, make sure you understand and meet your bank covenants.
And if they start talking about changes required with your banking facility, take them very seriously and weigh the pros and cons carefully before making any decisions.