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.
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.
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.
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?
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.
Until you’ve actually tried to secure capital for a business, you may not completely be able to relate to my answer to this question. Securing business capital can be complex, frustrating, and difficult at times for the following reasons: 1) borrowers needs don’t fit closely enough to a lender or investor program; 2) lender or investor criteria and/or application of criteria can change suddenly as their portfolio changes; 3) secondary elements like appraisals, environmental assessments, recourse agreements, and other third party requirements can increase cost and time to close.
Taking into consideration the above statement, there are basically three ways to access business financing.
You can contact lenders and investors directly, work through a broker, or work with a financing specialist (basically a value added broker).
If you plan to manage the process yourself, make sure you have sufficient time to devote to the cause. If there is a rule to go by, the smaller the dollar amount, and the simpler the application of capital, the more likely that you can self manage the process yourself.
As deal size goes up, so does complexity due mainly to higher risk assessment and lender requirements.
Depending on what you’re trying to secure capital for, some sources of financing can only be accessed through a broker, so a self administered approach can also result in a smaller market and potentially sub optimal alternatives.
The broker versus financing specialist distinction is a personal characterization of the market. Many business owners and managers start out seeking business financing on their own. If they are unsuccessful, they will try to find an intermediary to assist them.
And like most industries where brokerage is involved, there is the good and bad, the high value added and the no value added. Most brokers (my opinion) do not have the ability or knowledge to work in your best interest and are mostly focused on collecting as much information as they can from you and getting it in front of as many sources of capital as possible in the hope that one of them gives you money.
While its important to qualify a lender or investor to make sure you are focusing your efforts with relevant lenders, the same holds true for brokers and financing consultants.
A capable broker or financing consultant has the ability to determine what sources of capital are relevant to your needs at a specific point in time, has the ability to access said sources, and can assist you in properly applying and closing the deal so you get funded.
If you can project manage the process yourself, by all means do so as it will likely be a very rich learning experience that can benefit you in the long run.
If you get bogged down or realistically don’t have the time to manage the process of securing business financing to completion, then take the time you have and qualify those individuals offering their services to assist you. The right financing specialist can more than save you what they may end up costing you both in terms of dollars and time.
My standard pre-qualifying statement is that there are no absolute answers to offer to business financing questions, but that being said…
Being incorporated does not have much impact on business financing nor does it protect you very much.
I had a call today from a service company that just got incorporated a couple days ago and was looking for prime plus one business financing for the new business, without any real security being offered or any guarantees of any sort.
Its not uncommon that business owners think that 1) being incorporated gives them greater access to capital; and 2) that financing through a corporation will reduce their personal liability. Both of these statements tend to rarely be true.
Yes, being incorporated demonstrates a certain level of stability and continuity. But when it comes to business financing, especially debt financing, a lender doesn’t care how many corporations you have set up, or how you have arranged ownership to guard against risk. For the most part, everything is looked as being in one basket, whether its inside a corp, or outside, spread out over multiple corps, or buried deep in a vertically integrated corporate structure.
The basic business rule for acquiring debt financing is that the lender needs to be sufficiently secured by marketable assets. If the security ratio is thin, then a guarantee or surety of some form will also be required. If the corporation has sufficient retained earning to support the required level of guarantee, then the liability of the financing facility will be limited to the corporation.
But if the retained earnings are insufficient to cover the guarantee or covenant, then personal guarantees are required. Its really all about math and coverage ratios. Corporate structure is basically irrelevant.
Business owners don’t like to hear that and usually say something like “why did I incorporate if I can’t limit my liability?” My answer would be if the only reason you incorporated was to avoid high ratio debt liability, then I’m not sure why you did either. However, most business owners incorporate for a whole host of reasons of which liability protection is only one.
As an incorporated business, you should always try to negotiate personal liability out of the terms of a credit facility, and even if you have to provide personal or corporate guarantees, you should also continually work to reduce them over time as your debt level is reduced.
Otherwise, its just about the numbers.
When seeking any type of business financing for any sized business, small or large, there are four and only four uses or applications of capital. I’m going to go over each of them and why this is important to know and understand.
First of all, why is this at all important? Identifying the exact use of capital creates greater relevance in the capital procurement process.
OK, I’ll speak English. Locating suitable capital funds, either debt financing (business loans), equity financing(investor capital), or a combination of the two, will depend to some degree on how the funds will be applied in your business.
Lenders and investors can be very specific in deals they will seriously consider funding and one of their key criteria will be how the funds will be applied.
Certain applications of funds will completely remove certain lenders and investors from the mix. By understanding this at the outset, you can create greater relevance in your search to secure capital by screening out the sources of money that will automatically not be interested in your deal.
This doesn’t mean the deal is good or bad, its just not going to be relevant to certain sources of business financing. So you can save yourself a lot of time and aggravation focusing on relevant sources. There are of course other criteria that helps determine relevance, but for today let’s stick with use of funds.
So what are the 4 uses of debt financing and/or equity financing?
– Start Up. The start up of a new business venture.
– Acquisition. The acquisition of an existing going concern business.
– Expansion. The Expansion of the assets of an existing business for the purposes of growth.
– Debt Consolidation/Reorganization. The repackaging of existing and potentially new debt into a modified or new debt instrument or instruments. This predominately relates to businesses in some distress or downturn that need to either inject more capital into the business to cover losses or move short term debt to a longer term debt instrument to improve the balance sheet and security position of lenders.
Within each of these uses, there are even more specific sub uses such as:
– working capital to finance day to day operations
– short term capital to purchase and add value to inventory
– short term capital to finance accounts receivable
– longer term capital to acquire other tangible assets like equipment, buildings, and land.
– capital to acquire intangible assets
If you are seeking business financing for a start up venture, there are many sources of capital that don’t fund start ups. Identify them, and don’t waste your time asking them for money.
If you’re looking to acquire an existing business, don’t seek funds from someone providing trade credit related to working capital type assets only.
As I alluded to earlier, there are other twists to this as well as certain lenders and/ or investors will consider expansion funding, but have other criteria to determine if the deal is relevant to them (amount of funding, industry, debt to equity ratio of the balance sheet, debt service coverage, assets to be acquired, security ratio, etc.)
Each lender will have their own criteria set for each application of funds they will seriously consider. I say seriously consider because most lenders state at the outset they will look at virtually any deal to maximize their marketing efforts, but in reality, they all have a pretty narrow focus.
That’s why its important to understand how to accurately describe the business financing you seek and then qualify the universe of funding sources so that you’re only spending time with a relevant list.
But more in depth lender qualifying is a topic for another day. Stay tuned.
Several times each week, I talk to small business owners who are seeking capital for their new or existing business and several times I have a very similar conversation with each of them that I thought I’d share today.
At the beginning of the conversation, I always ask the same two questions: How much money are you looking for? what’s the purpose of the funds?
I would say that at least 75% of the time, I have to re-ask these two questions two or three times before they’re answered. Most people think that telling me a long drawn out story of what they want to do and how they came to do it will be more important than answering these two questions.
What tends to come out after a few minutes is that the individual is hunting for what I call stupid money. You know, the kind that is prepared to write you a check on a very thin and likely non existent business plan where the lender is taking all or close to all of the financial risk.
Example. Someone has a great idea for a tennis equipment store. They have picked out a location and now need $300,000 for start up costs, working capital, and inventory. They have poor credit, personal debt, zero net worth, and no capital to contribute to the venture.
Is it possible that this individual could secure small business financing of some sort? Yes.
Is it probable? No.
That’s the great thing about the money business, virtually anything is possible, and I’ve seen enough to know first hand. After getting off the phone with me, this would be entrepreneur could go to the coffee shop, strike up a conversation with someone about his or her golf shop idea, and leave with a check in hand for the capital sought. Is is possible? Absolutely. Is it likely to occur? The odds would likely be lower than playing the lotto.
That’s why I’m always careful to not generalize about small business financing, as there is an infinite sea of money out there and strange things happen all the time.
But lets also get real. Just because its possible, doesn’t mean your new business financing strategy is to start going to coffee shops.
For the most part (can never generalize), money has a basic intelligence. If intelligence is not applied, the source of money will disappear very quickly based on making bad decisions.
People supply money to business ventures for a return. If you can show them a path to the return they seek within the level of risk they’re prepared to take, then eventually, you will find a source of capital for your small business financing requirements.
And here’s my tip of the day on this subject: You must have something to leverage and something to lose in order to have a realistic probability of getting business financing, whether it be for a new venture or existing business.
Something to leverage for low risk credit is your credit score, personal net worth, external cash flow, third party guarantee. Something to leverage for higher levels of credit risk would also include things like asset security, established cash flow, signed purchase orders from reputable companies, patents, intellectual property, contracts, etc. Remember also that something to leverage has to have a value to the source of money or there is no leverage.
Something to lose is at the very least the capital that you directly invest into the venture. 100% financing of anything is quite rare unless you’re taking about residential real estate and look what problems that has caused in the markets over time. Personal guarantees and corporate guarantees would also fall in this category if there was enough net worth to make them meaningful.
As the amount of leverage and borrower risk increases, so does the probability of securing capital.