Business Financing Is Primarily An Unplanned Event

It drives me crazy and never fails to surprise me as to how business owners and managers approach securing business financing for their companies.

The thought process tends to leave the search for capital too long into the business planning process and when it’s finally begun the expectation is that it will be a relatively simple and straight forward process.

Some advise to consider would be starting the search for money sooner and even managing it into a path parallel to the business planning process its connected to.  The reason for this approach is that locating and securing the right capital can many times prove to be the most difficult element of any potential project.  Furthermore, as potential financing sources are uncovered, their related terms and conditions may require actual revisions to the business plan and the sooner this is known the more likely it can be allowed for in the planning process.

The standard assumption for not doing the above is that any financing source will be flexible enough to adapt the lender or investor program and criteria to suit the business.

In many, many, many cases, this assumption could not be more wrong.

The second problem business owners come across is assuming the process will be timely.  I’ve personally worked on deals that took over a year to complete and dramatically delayed the business plans that were draw up.  Business financing applications are not like applying for standardized things like a credit card, car, or even house.  Each application is really unique in some way and therefore takes more time to evaluate.

Obviously requests for small amounts of capital, say under $250,000, can be more timely and predictable most of the time.  But as the amount of business financing required increases, so does the degree of difficulty finding the financing source that wants to do the deal, and then actually securing the funds and getting them disbursed.

This is why I call the process of business financing an unplanned event.  Its just supposed to happen on cue and doesn’t need to be planned for ahead of time.  This could not be further from the truth.

And in all my years of working on financing projects, I’ve come to expect that there will be a strong sense of urgency when someone is looking for financing (due largely to the fact that s been left too late) and that the process is going to be difficult to manage.

While it doesn’t have to be that way, it almost always is.

Perhaps the problem stems from the lack of basic financing education we get in school or because the process of business financing tends to be infrequently required, so there’s no real need to learn how to properly go about it.  When the need exists, just scramble through it somehow and move on (or something like that).

For companies that are on a growth path and plan to be there for a long time, there is definite value in gaining a greater understanding of how to best approach locating and securing the capital they need to effectively manage their growth.

Time has proven over and over again that business financing doesn’t have to be planned, but it sure can help if it is.

Business Financing Tradeoff – Lower Taxes Versus More Borrowing Power

I’ve written a fair bit lately about the importance of financial statements and their importance to business financing activities, especially after the year end.

One of the biggest challenges with getting the most financing power out of your financial statements is to have a tax planning strategy that is in line with your business financing strategy.

Too often, accountants will go through tax planning strategies in a bit of a vacuum, not having any knowledge or appreciation of what the business will require for capital or what if any refinancing will need to take place in the year ahead.  Even if there isn’t an immediate capital need that’s planned, there still is the consideration of things that could unfold and allowing for their potential capital requirements.

And when financial statements are optimized for tax purposes only, they can reduce and potentially destroy your ability to borrow incremental capital in the process.

Effective tax strategies can lower net income which is required for debt servicing and lower retained earnings, which will reduce the amount of equity on the balance sheet available for financial leverage.

What confounds the whole process even further is that each lender will have their own series of add backs and adjustments to income and cash flow that may or may not be impacted by certain tax strategies.

In reality, paying taxes can be viewed as a cost of borrowing in that if the business is not in a taxable position, it won’t have the financial results necessary to acquire and service debt.

So how do you optimize the financial statements for both taxation and financing at the same time?  This is a bit of a difficult question to answer due to all the unknown variables involved on the business financing side.

One approach to consider when the business is actively seeking capital prior to the completion of the year end financial statements is for the accountants to prepare a draft version based on the collective best guess work of the business owner and their third party accountant as to what level of earnings would be acceptable to the target lender or investor.

The draft version can be put forth with the financing application and if an approval can be secured based on these numbers, the statements can be finalized as written.  If financing can’t be obtained for the sought after terms and condition, the draft financials can be further adjusted to optimize the tax position of the business if appropriate and finalized via a revision.

There are other approaches to consider.  Just keep in mind that in order to get the best result for both taxation and capital procurement potential, the business owner and manager need to make sure that they provide their taxation expert with their forward looking plans and capital requirements so that some effort can be made to allow for both requirements if necessary.

For more information on business financing, click here.

The Business Financing Benefits Of Year End Financial Statements

While not everyone has a December 31st year end, most small and medium businesses do, and with the middle of January quickly approaching, here are some things to consider with respect to business financing and year end financial statement preparation.

Keep in mind that this advise applies to any fiscal year end.

Whether we like it or not, the process to secure capital is largely driven by the historical financial statements of the business.  And financial statements that are less than 6 months old have more lending value than those greater than 6 months since the end of the last completed fiscal period.

And while the required filing of corporate income tax and the related financial statements is typically not required until 6 months after the year end is completed, there may be significant reason to get this completed sooner.  Here are two reasons in particular to consider.  You need incremental financing for your business or you’re planning on requiring more business financing in the near future.

The first thing to consider is the profitability of the income statement and the leverage of the balance sheet.  If the income statement shows profit capable of servicing incremental debt and the balance sheet has enough equity to support additional debt acquisition, the you will have a powerful asset to assist with securing capital once the financial statements are completed.

Here’s some other things to consider.

If you’re applying for financing after year end but before the year end financial statements are completed, then its highly likely that a lending facility will not be put into place until the accountant gets the statements finalized and filed.

If you plan to wait until the financial statements are completed 6 month after the year end before applying, remember that the financial statements are now effectively 6 months old.  If the lender’s assessment process takes some time to complete, the lender may turn around and ask you to get a 6 month interim financial statement completed, creating what could be a significant delay to your plans while increasing your accounting costs.

Even if you have no immediate need for incremental financing, you may want to consider how to best utilize a strong financial performance of the year past in terms of business finance and the relate costs.

For one example, you could utilize a strong year end to help leverage better terms at your bank by shopping around to the competition.  Rarely will you have better leverage to secure better rates and terms that when you have strong financial statements.  And you may even be surprised at the competitive offers that come back which may prompt you to make a move.  With out freshly prepared financial statements from a strong year of operating performance, this possibility is going to be a lot less likely.

Another situation to consider is leveraging a set of strong financial statements to increase your credit limits or add credit lines.  You would be basically trying to secure financing you don’t need or are not planning to use but may end up using if you’re having an off year.  For a seasonal business, this scenario can play out more often than not over a long enough period of time.

I had a client with a seasonal business that was highly profitable and dependent on winter weather.  They had great credit and had very well established short term and long term financing with a chartered bank.  Then one year there wasn’t severe enough winter weather for their business to operate (first time in over 20 years of business history).  At that moment of cash flow crisis, it was not possible to borrower more money and everything that was built up over the years was put in jeopordy.

You’d think that a bank or any lending partner could see past this anomaly in financial performance.   In most cases they can’t or won’t, so its up to you to create your contingency ahead of time and one way to do so is by increasing your available credit when the opportunity presents itself.

On the flip side, if the financial statements are not going to be profitable, there is likely no rush in getting them completed sooner than later.   And if the bank requires copies, you may want to wait as long as you can so that the business results can improve prior to providing the historical results.

Business Financing Strategy

Do You Have A Business Financing Strategy?

When a business starts out, many times it will take whatever financing it can get. But over time, a business financing strategy becomes more necessary not only to secure the best terms and rates, but also to access and secure capital on a timely basis.

With business growth comes more complexity, perhaps more business entities, and more capital requirements. Business finance facilities will come due, need to replaced, or added to. So it becomes more and more important to understand the different ways you can leverage your assets and cash flow.

As an example, say an individual owns three different businesses and wants to start a four one, but requires capital to do so. One strategy could be to utilize the borrowing power of one or more of the other companies. But for this strategy to work, the additional financing being sought can only be secured if there are no terms and conditions or covenants attached to the existing businesses that would preclude this from happening.

This comes back to having a semi conscious financing strategy and always considers the needs of today and the needs of tomorrow versus signing up for anything you can get your hands on and worry about the details later.

Business financing can be a very tricky animal in this regard as lenders are always going to take as much security and provide as much restriction as they think they can get away with in order to protect their interests. If you’ve planned ahead, then there should be enough time to negotiate terms and security structures that will secure the lender but not unnecessarily restrict future financing options and flexibility to arrange financing.

Unfortunately, most financing activities are undertaken with some time pressure or business duress in place, resulting in the business owner settling for a sub optimal capital structure in order to complete the deal on the table or take advantage of an opportunity where time is of the essence which most are.

A business financing strategy is all about maintaining a solid understanding of the different ways your assets and cash flow can be leveraged as well as having your financial statements, contracts, and customer accounts up to date and in good order to withstand lender due diligence if and when required.

A lack of a business financing plan for a growing business can result in a balance sheet that looks like a patch work quilt of financing facilities cobbled together over time that don’t collectively provide any incremental flexibility to acquire capital if the need arises.

In many cases, especially when there are different types of assets involved, there can be many different financing approaches that can be considered, provided that the existing financing structure will allow for their consideration.

For example, is a business owner better off leaving his or her senior lender in place and securing subordinated debt financing, or seeking out a new senior lender that will provide greater leverage? Is it possible to secure incremental asset based lending on a priority basis? Can greater leverage be achieved by refinancing certain assets or combination of assets? Is there more opportunity to cross collateralize the other business entities, or will their existing debt financing facilities permit greater leverage and/or other lenders in a secondary or tertiary position?

And so on and so on.

A solid business financing strategy can allows you to 1) expand your business on a timely basis, 2) take advantage of acquisition opportunities, 3) generate the necessary capital to deal with down cycles or even cash flow losses in a timely manner, etc.

Lack of one can leave you scrambling for money and may result in lost opportunity or even business failure when economic circumstances work against you.

To find more about how to develop a sound financing strategy for your business, please sent me an email or give me a call.

Business Financing | New Year Considerations

If You’re Trying To Secure Capital In Q1 of 2010, Here Are Some Things To Consider

First of all, Happy New Year to everyone.

The page has turned and we are now into a 2010 business financing environment, quarter number one.

Now many of you may ask, what difference does a few days make from the end of December, 2009 to the beginning of January, 2010?

While the differences may be subtle to some, there is a definite shifting of gears from a business finance point of view and can have a significant impact on your ability to secure capital and your cash flow management.

If you’re either in the process of securing business capital, or just starting and you have a December 31st year end, many lenders will not provide you with an approval for funding until your Dec. 31, 2009 financial statements are completed.

Yes, even though the required filing of your annual statements is probably not until the end of June, 2010 (depending on your country of tax jurisdiction), your chosen source of financing may require you to do it much sooner.

Once the calendar turns to January, accounting firms enter their busiest period of time related to December fiscal year ends and personal income tax filing requirements.  So if you need your business financial statements done quickly, you’d better get the work booked with the accountant as quickly as possible and also make sure that you have all your own information up to date so that the process does not get delayed.

For Debt lenders that have December 31st year ends, January marks a new fiscal period of them as well where they will have new budget targets and potentially new programs and lending criteria to apply.  The key point here is that whatever they were doing in December with respect to loan approvals can be very different in January.

Banks and other debt lenders are going concern businesses trying to manage their profit pictures and balance sheets just like everyone else.  So if a debt lender with a Dec. 31st year end enters their last quarter below budget and targets, they are likely going to be more aggressive in their lending practices in the last quarter, all things being equal.

If the lender is way ahead of targets in the last quarter of 2009, they may become very conservative in their approval process for the remainder of the year in an effort to bring higher quality loans onto the books that will improve the risk rating of the overall portfolio.

On the flip side, the start of a new year can trigger a conservative lending approach whereby lenders try to see if there are enough low risk deals out in the market place to meet their goals.  If this doesn’t prove to be the case, then lending criteria will likely loosen up in Q2 and Q3.

There will also be lenders that have January, February, and March year ends where the same type of thinking can apply in each case as managers work to hit their numbers.

In business financing, timing is everything and when the year changes over, there are likely going to be some noticeable differences that will impact your capital procurement efforts.

Business Financing | Why Special Loans Aren’t So Special

Things To Consider About Having A Special Loan Status

In Canada, banks call business loans that are not meeting their required financial covenants as “special loans”.  I’m not sure what they’re called in other parts of the world, but the implications are the same.

When a loan falls into the special loan category, the bank must now decide what their course of action is with the account.  In 2009, word has it that there are large numbers of special loans on the books due largely to the impacts of the current recession.  And unlike past recessions, the banks appear to be a bit more patient with borrowers or at least they have been to this point.

In the past, when borrowers would fall out of covenant, the special loan officers jobs were to help get the loan back on side, or figure out an exit strategy for the bank to get their money back.  In most cases, the latter tended to occur both frequently and quickly.  This time around, the banks have been going to greater lengths to work with clients, especially those that are marginally offside with their requirements.

And perhaps this has been a good strategy to maintain bank revenues.  With recessionary forces in affect basically all of 2009, lending is way down with much of the decline directly attributable to lenders being more cautious with new lending approvals.  So working with special loan accounts, at higher interest rates due to the higher inherent risk, has created a new source of earnings.  So you get a double win… fewer loan right downs and higher net average earnings (in theory anyway).

But is this likely to continue in 2010.

Its hard to say.

As recessionary forces subside, new lending will be more prevalent, perhaps creating the opportunity for lenders to return to past practices of getting their money out of special loans as fast as possible.

But if there is any type of government support available to lenders to offset the higher risk they’re carrying in their portfolio, then perhaps this “working with the client” strategy will continue.

Regardless of what does transpire, one should always be concerned with carrying the special loan (or its equivalent) tag.  Lender policies can change quickly and just because they have been working with  you in 2009, there is no guarantee that this goodwill at higher rates will continue into next year.

For any business owner classified with a special loan status, they would be well advised to thoroughly assess their refinancing options with other sources of capital and repeat the exercise every quarter to make sure they are on top of what plan B and C may look like if the banks choose to go in another direction.

Things can change quickly and refinancing a business can be very time consuming, so its best to spent time not only trying to get the lending covenants back in line but also to build out a contingency plan to keep the business  a float in the event of a change in lender strategy.

Small Business Financing Is Mostly Personal Financing

What’s The Difference Between Business & Personal Financing

For small businesses, there isn’t much if any difference between the two.

There are a couple of  key reasons for this.

From a credit point of view, small businesses, especially new ones, don’t have much in the way of business credit established.  So lenders will rely on personal credit scores and histories to make business financing decisions.

Even if a small business has been in existence for several years, there still is no guarantee that any amount of business credit will have been established due to the fact that a business credit history is developed by transacting with companies that not only offer credit terms, but also report outstanding credit to credit reporting agencies.  Many small businesses either don’t utilize much supplier credit, or way only work with suppliers that are too small to be actively reporting to credit agencies.  The result in both cases is that business credit does not build much over time.

From a guarantee point of view, most small business financing facilities will require a guarantee from either the business itself or the owners of the business.  If the business itself does not have sufficient retained earnings to provide meaningful value to a guarantee, then a personal guarantee will be required.

Many business owners get frustrated with the fact that even though they are incorporated, they still have to open themselves up to liability personally by having to provide personal guarantees to secure business loans.  Unfortunately, incorporation can be more important for tax reasons than liability protection, especially when it comes to securing business capital.

Over time, as the business earns profits and grows its retained earnings, then personal covenants and guarantees may not be required and can even be removed from existing financing facilities.

The key though is to increase the value of the businesses ability to repay debt obligations.  If the owners are always striping out the available cash from the business, then the personal guarantees will likely continue to be required due to the fact that the personal side is where all the equity value is being held.

Business Financing Sources Are Moving Targets

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.

Before Applying For Business Financing, Make Sure You Know Your Stuff

There’s Nothing More Impressive Than First Hand Knowledge

Have you ever had a conversation with someone where they just knew everything relevant about a subject?  What ever question you through at them, they instantly came up with a factual, accurate, no fluff answer that left you impressed?

That type of focused and detailed knowledge can also be the making of a great first impression if used properly.

Too often when business owners or managers apply for business financing, they are not completely up to date on the details and specifics of their own business.  Yes, they can answer questions at a strategic level, but when lenders or investors start to drill down into the specifics,  they don’t have much to offer or have to overly rely on reports and notes or even their  employees to answer the questions posed.

Outside of the underlying business opportunity, there is nothing that impresses a lender or investor more than a business person who they can grill in all directions but can still consistently come up with a solid and specific answer.

Why?

Because this type of demonstration of knowledge is hard to fake with some last minute cramming.  It tends to speak to someone who is on top of the key metrics of their business, pays close and regular attention to the things that matter, and has thought about things enough to have a strong opinion if required to provide it.

The key though is in the delivery.  Being a “know it all” can totally destroy the potential good Karma created.  No, the better approach is to let them come to you.  Let them ask the questions and expand further on your answers.  All you have to do is provide the answers and let the interview flow.

I mean, if you had some extra capital and wanted to lend it out or invest, who would you be more willing to trust with your money… a business person with general knowledge or someone who gives you all kinds of warm fuzzies when they blow you away with their depth of knowledge and attention to detail when describing something to you.

It’s not a hard answer for me.

Too often potential business financing opportunities go up in smoke when the business owner or manager either lays an egg or basically does not impress when they get their opportunity to close or advance the deal.

Making Money Versus Saving Money

Return On Investment Versus Cost of Capital

The common challenge faced by business owners and entrepreneurs is how to take advantage of short opportunities that require capital.

A typical scenario would be entering a contract to deliver a good and service that you have access to but the buyer does not.

Lets make up some numbers to better illustrate.

Say you have an opportunity to supply 100 widgets to a company you’ve never done business with before for $10,000 each for a total sale price of $1,000,000.  Your cost to supply before financing costs is $600,000 so there is a potential $400,000 margin in the deal.

You have the access and ability to complete the deal and all that is required is capital.

Like most deals, there is some time requirement to deliver.  In this case, lets say its 3 months.

So all that’s missing is capital to make this highly profitable deal go and with 3 months to work with, you should have plenty of time, right?

Potentially.

You’d probably be surprised to see how many of these deals never happen or have to survive a mad scramble at the end to make them work.

Operational issues aside, the main reason for failure or distress is from the inability to secure capital for deal.  And in many cases, this failure to secure capital comes down to the mind set of the business person (or none business person in charge).

The starting assumptions of most people is that 1) money won’t be hard to find, and 2) it will come at a reasonable cost.  For these high value, unproven transactions, these assumptions are almost always wrong.

Especially when its your first time through with a transaction like this to a new customer, the goal is to get it done and make some money in the process versus trying to maximize the return.  If the deal gets done, there will potentially be future deals with the customer and potentially other customer now that there is a track record established.  If the deal doesn’t get done, it was all a waste of time as well as a liability issue if breach of contract occurred.

The capital that tends to be available for these types of transactions is opportunistic in nature and come with a high cost of use.

I’ve seen cases where the source of capital required the borrower to split the margin with them.  I’ve seen cases where the capital source wanted 3%+ for the use of the funds and a large fee on completion.

When business owner and managers hear these types of numbers, they scream foul and walk away in disgust if they’re new to this game.  And instead of getting the deal done and making some money, they tend to spend and waste their time looking for cheaper money that will save them money on the deal.

Look,  I’m all for saving money and maximizing my return on a deal.  And as far as high cost sources of financing go, I don’t like or dislike them.  This is not about what someone thinks is far or unfair.  This is what all business financing scenarios are about, and that in one word is RELEVANCE.

Business financing is always about finding the source of capital that is relevant to your specific needs and situation at a given point of time. And what is relevant is what is available to complete the transaction in the time period required.

Too many times business people shoot themselves in the foot by holding out for a better deal, for a cheaper source of capital.  If you can find one, great.  But if time is ticking and the next best option will get the deal done but grossly cut into your profits, what do you do?

I say get the deal done, make some money, and build off of your successful transaction so that the next time around you have a chance at a greater return.

But that’s just me.