Because we live in a fast paced, immediate need fulfillment society, there is the unrealistic expectation on the part of entrepreneurs and business owners that people with money are willing to finance our hopes and dreams and let us start living the good life faster than is realistically possible.
Start up capital is hard to raise for one very important reason…the request for business financing is based on theory not practice.
While every would be entrepreneur or serial entrepreneur is convinced that their latest idea or plan is sure to succeed, statistics related to business failures in start ups would prove otherwise.
As I mention to individuals that call me to help finance basically their business plans, debt financiers and equity investors are looking for those individuals with the good ideas, accompanied by the proof that they’ve figured out or learned the first thousand things required to make money in a given business pursuit.
The analogy I will typically provide is that most entrepreneurs or business owners with a great idea and solid market opportunity available have done a great job of learning the first hundred things that are important for them to make money in their chosen en devour. However, at that point in the evolutionary process of getting to market, they start asking for large sums of money to accelerate the process.
In most cases, people with money are not interested in funding those who have not been able to get further down the learning curve, closer to the knowing of the thousand things that are important unless its some kind of mind blowing surefire thing a ma jig.
In the early stages of developed, no matter how well the business plan is written and how thorough it identifies and addresses all significant risks to moving forward, its still all theory.
What I mean by theory is that it hasn’t been done yet.
Moving from theory to practical application where actual results are generated, measured, and shown to be profitable is the ultimate pathway to finding all the business financing you could possibly require.
In order to accomplish this, the entrepreneur or business owner needs to figure out what the smallest possible scale he or she can work at to achieve the desired result and how much money will be required to develop and implement this smaller scale model of the grand design.
This is going to be a much smaller amount of money to locate than the big picture funding most are looking for, and in the event that the mainstream market is still not interested in funding, the requirements may be small enough for bootstrapping and the recruitment of investors from the friends, family, and fools section of the market.
Once proof of concept and practical, measurable results are in hand, its going to be a lot easier to get someone to take you more seriously.
Of course this approach will likely mean slowing down the march to market domination and will put off the quest for larger development dollars until one or more economic cycles of the business model can be completed.
But by taking the long way around, you’re going to go through the learning process in much more depth and get closer to the thousand things you need to know.
Or, you can continue to aggressively look for overly aggressive money in the hope that you will be one of the lucky few with more ambition than practical proof of concept that will get the funding necessary to carry on.
In order to acquire any amount of business financing, the lender, investor, or funding source needs to be able to be comfortable with the risk of loss versus opportunity for profitable return. Clearly the latter must out weigh the former, or no business loan or other form of capital is coming your way any time soon.
Especially these days as we continue to crawl out of the recession, lenders are much less likely to take on any level of risk than they were two or three years ago. Which has created a considerable problem with business owners in that they don’t generally know that the bar has been raised on lending applications and if they want to secure financing of any sort, they are going to have to not only show a debt lender or investor that the risk of loss is low, they are going to have to proactively put things into place to protect the source of capital from losing money.
In taking from some marketing vernacular I heard the other day, its all about “stacking the cool”. This refers to marketers giving you so many features and benefits, many times above and beyond the core product, that you become strongly motivated to make a buying decision in their favor.
Same goes with business financing folks.
If you’re looking to secure money, you’re wearing your marketing hat as much as your finance hat. And its not just about accurately telling a good story about why someone should give you money. Its also about how you are going to make sure they get paid back with their expected return, or how are you going to stack the cool?
Obviously my analogy is somewhat of a stretch for the stuffy world of finance, but bear with me.
I was recently working on a rather tough deal that provided enough lender risk that we weren’t getting any where with relevant financing sources. So we started to stack up ways to reduce the lender risk…Corporate guarantees, personal guarantees, higher down payment, vendor repurchasing agreement for a portion of the asset value, etc.
Of course all these things are trade offs and can provide greater risk to the borrower. But if you need the money and no one is prepared to give it to you at any price, then its time to start taking on more of the risk or finding other ways to generate the capital your business needs.
After weeks of coming up with different risk reduction strategies, a financing commitment was provided that otherwise was never going to happen in the current market in the time the borrower had to work with. In better times, the process may not have been so hard and the borrower may not have had to take on as much risk as they ended up taking. But then again it may have been very similar, even in better times.
Point is that you need to be prepared to off load lender risk by taking on more yourself or finding someone else to participate. As I mentioned above, sellers may be interested in helping reduce risk to sell their products. Insurance companies may have programs that can reduce certain types of risks the lender is uncomfortable with. The more you strengthen the deal, the better your odds of getting funded.
Now that would be cool.
One of the most frustrating aspects of trying to locate and secure business financing from private debt or equity sources is that the process hardly follows any type of formula. The people with the money entertain offers from people that want to utilize the money and sometimes deals are worked out.
Sorry, but that’s about as scientific as it gets.
The people that either own or control the gold make the rules, make them up on the fly, or change them whenever they want. If you don’t like their approach, don’t try to work with them. The problem, however, is that most sources of private financing are going to act in a similar fashion.
And as I have been told on more than one occasion when I got into a discussion as to how a financing deal could or should be structured…”Its my money and I’ll do whatever I like with it”.
Obviously if private funding sources were always completely unreasonable and unpredictable they would never lend or invest much of anything. So for the most part, there is a method to their madness. But that doesn’t stop weird and unpredictable things to happen from time to time.
As a business owner seeking capital, you need to be prepared for this type of experience and temper your ego and tolerance level at times to allow for funding opportunities to eventually unfold in your favor. The passive and patient approach isn’t always going to work, but its going to score more results than a frustrated and demanding demeanor will.
Since 2008, there are arguably less active sources of higher risk capital reviewing more potential requests for capital. So for venture capital, angel investing, and hard money lending they basically have their pick of deals and tend to take their time in order to make the best potential choices.
Another challenge with private funding sources is that these are typically not large organizations and usually are operated and controlled by a handful of people. So when they are in the middle of one or more deals, it can be hard to get their attention until some time in the future. They will also have finite resources so its also a case of having a deal they like at a time when they have money available to put out into the market.
And if a better deal comes along when they’re 90% along with your deal and they don’t have enough money for both, guess who’s going to lose out.
Acquiring private capital is both art and science, can require great patience and perseverance, and has a lot to do with timing.
Keep these points in mind before starting on your quest for capital.
What the right cost of funds should be for any given deal is always an interesting question to ponder. Business owners will get a certain interest rate or rate of return locked into their mind and won’t settle for anything less. If they have properly gauged the market, this can be a good strategy, provided you have time to beat the bushes for the best deal.
In reality, however, every business financing scenario where a debt lender or investor extend money to a business for some application is a customized solution. No two are the same and at any given point in time there can be radical departures among what is available in the market for otherwise seemingly similar deals.
Sometimes you get lucky and step into a rate that would not typically be available to your business and the desired application of funds. Sometimes you’re not so lucky and its hard to find anything where the cost of funds is what you would consider reasonable.
So what is the right answer in terms of when is the cost of capital too high?
Assuming you have properly approached the market with your financing requirements, the appropriate cost of funds, at a given point in time, is what you cash flow.
If you must have money right now for operations, expansion, survival, etc., then you need to determine if you can cash flow the best available deal in the market. If you can’t, don’t take the dough. And when I say cash flow, I don’t mean come up with a forecast based on some low probability assumptions. If you can’t debt service the financing proposal on a cash flow projection with at least a 70% probability of success, then the cost of money has gotten too high.
No one wants to pay more than they need to at any time. But business financing is very fickle and even more unpredictable, so some times the deal is better than others.
The main objective is to make decisions that will allow you to fight another day versus the alternative.
If you’re too focused on securing a low cost of financing, you could run out of time and blow a good deal. If you take on financing that can’t be cash flowed within reasonable certainty, you may very well have sold the farm.
The point here is don’t get hung up on interest rates or rates of return, get hung up on cash flow and time lines. The longer you stay in business, the more often the cost of money will be in your favor and allow you to bank good returns. Its just not always going be that way, so get used to it and make the best decision today to assure better future opportunities.
When seeking capital funding for any business venture, there can be a lot of different trade offs to consider with the different sources of capital that may be interested in funding a particular deal.
The most common forms of business capital come from debt and equity financing sources. And even though equity equates to ownership, there is still an implied cost of capital that needs to be factored in before accepting this type of money.
The most common problem business owners have when seeking capital is trying to locate money at a cost that does not likely exist. The second biggest problem is not properly comparing different forms of business capital when deciding on how to fund the business.
With problem #1, the business owner or manager does not understand the market and continually rejects potential offers to finance at rates above their target rate. There is nothing wrong with this approach provided that the target rate actually exists for the deal or will appear before the business runs out of time.
In order to avoid being in this situation, a more realistic perspective needs to be established. Remember that the cost of money always has to do with risk and supply with risk and supply typically being inversely related (as risk goes up, supply goes down).
As an example, its not uncommon for a business owner to seek unsecured business capital from private lenders at 10% interest or lower because they can’t secure anything from a bank and they have no assets to leverage. The proper perspective is that private lenders can lend their funds (and do) all day long on real estate and be fully secured and still lend at 10%+ interest rates. so why would they take on a higher risk (unsecured debt financing) for the same cost of capital?
With problem #2, the business fails to properly make an apples to apples comparison with different forms of business capital and defers instead to self created rules or assumptions.
For example, when a business requires business financing capital in a risk range that could be funded through debt or equity the costs and trade offs between the two forms need to be properly weighed.
Higher risk deals can command debt financing rates in the high teens. Most equity investments want a similar return or higher. Yet when a business owner sees an 18% interest rate as an example, many will immediately believe that’s too high and turn to an available equity solution that could actually be higher over time.
With debt, the best things about it is that you retain ownership and if you pay it back you retain control of the business. With equity, unless there is a buy out provision structured at the start, there may be no easy or cost effective way to pay out the investor as the business grows, creating a very expensive source of capital. Even with a structured buy out, the true cost of capital, if anyone spent the time to figure it out, could be substantially higher than the original debt financing solution.
If the cash flow is available to service the debt, the high interest rate loan option should not automatically be dismissed.
The search for capital often times tends to be left too long so business owners are forced into taking what they can get. But when choices are available, being realistic on your expectations, and crunching the numbers to better understand the true cost, can mean a tremendous saving in the long run.
In the present commercial lending environment, it can be more than a little difficult to get a loan request of almost any sort approved and funded within what most would consider a reasonable amount of time.
Here as some of my observations into some of the current challenges debt lenders are having in the market.
First, the recent recessionary forces have eliminated a significant number of lenders from the market at large or from some of the country markets that multinational lenders service. The result has been more applications being directed at fewer lenders creating an instant back log.
Second, while economic growth would suggest we are climbing out of the recession, the capital markets are still trying to stabilize from all the fall out, causing debt lenders and equity investors on average to be more cautious in their approach to lending or investing new capital.
Third, many business owners and managers will make several applications for the same capital requirement to multiple lenders in order to try and get the best available deal. This also increases the application burden on the system, further contributing to the slowed down response time.
In an attempt to reduce the back log and get focused faster on deals that can actually be completed, more lenders have gone to requiring the borrower to pay a deposit after the initial deal assessment process is complete. For the most part, the deposit is used to cover third party costs incurred for assessing a deal such as appraisals, credit reports, etc. If the deal can’t be approved, the deposit is returned less third party costs incurred. If the deal can be approved and the applicant does not choose to take it, the deposit will likely be lost.
Outside of covering lender and investor costs of assessment, the deposit serves as a commitment to the borrower to continue with the business financing process and risk the deposit if they don’t take a commitment that follows the initial lending proposal provided.
There are pros and cons to this approach. From the lender side, the required deposit at a certain stage of the process gets rid of their back log as only those seriously interested in what the lender has to offer will proceed. On the other side of the coin, borrowers are concerned about the integrity of the deposit in that does it truly relate to third party costs required to complete the commitment process, or is it just an easy way for a lender or investor to grab fees without having any real intention or ability to issue loans for all the deposits received.
The answer to getting the overall system working better is likely some mix of the old and newer ways of doing things. But until there is a significant overall change, expect the time lines for acquiring capital to be considerable.
Almost every time I work on a business financing assignment, the business owner or business manager is pressed for time to get capital secured and funded.
And almost every single time I get asked the question, how long is it going to take?
If you’ve ever worked on any type of business financing request, you know that this is the ultimate loaded question. Lenders have a process they are going to follow and when the process is complete, that’s when everything will be done. To put an exact time line on that at the beginning is basically a waste of time.
I’ve worked on business financing cases where it took several years to complete the process. This is not to say that the lending or investing sources are slow. This is to say that it took that long to complete the process.
The biggest challenge in estimating time for the overall process comes in not knowing how fast everyone will do their part. The more people that are required to provide information to support a financing decision, the more likely its going to take an above average amount of time.
I’ve written about this subject before, but its one that never gets old and continually needs to be explained to business owners.
Just the other day I had a client press me for a time line for a transaction that had to get done in a few weeks. The initial time prediction was that if there was no wasted time in getting information sent back and forth, the deal should be completed in 2 to 3 weeks.
After wasting 3 days debating why it would take so long, the client agreed to get moving on the process. The financing process was outlined and three weeks later, the client still had not completed the requirements for step one.
This is far from an unusual situation.
The point is simply this.
All you can do is commit to the process and get everything done that is required, when its required, completed as fast as possible. That and a little luck here and there will get your business financing requirements satisfied in above average time.
If you’re focus every day is on making sure that you’re not holding up the process in any way and are communicating effectively with other parties (lawyers, accountants, appraisers, etc.) that may be contributing information or services to the process, then you’re doing everything you can.
If you’re lined up to the wrong type of money, no amount of effort or commitment to any process will yield the result you’re looking for.
And trying to apply brute force to the process or attempt to bully someone into taking action on your behalf isn’t likely going to get you very far either.
When pressed for time, the best thing to do is develop your short term contingency plans to address any delays that may occur in getting business financing in place.
Finesse and forward thinking tend to out preform brute force and out right panic most of the time.
When working through business financing scenarios where a business needs to secure capital for some reason, there are a few things that tend to be extremely common from one situation to another.
First, the business owner is in a rush or pressed for time to get financing in place. This can be due to a number of reasons, but the most common would be that the process was started too late or the business owner spent too much time trying to secure business financing from the wrong type of lender before realizing they were wasting valuable time.
But even when you find the right lender and provide a good solid package of information, the amount of time it takes to get money advanced to complete your deal can be considerably more than you are anticipating.
Take one of my recent projects. The borrower had an immediate financing requirement that needed to be completed and funded in a matter of days. The nature of the transaction was that it typically would take two to four weeks to complete.
Why would it take so long?
Because of the number of steps that needed to be completed by different people. This is always a function of time you can expect a deal to take.
If everyone involved in the process does everything required when required, the deal could potentially get completed in less than a week.
But the moon and stars don’t typically align like that and the reality is that everyone is working on a number of things at any one time so the probability of each task getting done in the least amount of time seldom works.
From a lenders point of view, they are going to estimate more time than what is possible as the last thing they want to do is stick their neck out on a certain amount of time and then get yelled at when everything doesn’t get completed by that date.
From the borrower’s view point, someone in a hurry cannot possibly see how the outlined steps will take so long to complete.
In the recent project I’m referring, during the first five days of trying to get the deal closed, there was failed wire transfer, an email system that went down, and a main frame printing system that when down.
Each unplanned event added more time to the process and in almost every business financing scenario I’ve ever been involved with, something from the unexpected happens. It can be things like sickness, holidays, long waiting lists, people new in position, the weather, someone having a bad day, and just about anything else that Murphy’s law can offer up.
The key point here is that a business owner has to try and build in as much buffer into the process as possible and even development contingency plans if the unplanned delays are excessive. Failure to factor in more time than what you think should be necessary can cause a deal to blow up in your face, a contract to be terminated, or more costs being incurred.
Sometimes a particular financing opportunity, especially when there are hard assets involved, can have many different business lending models that apply to it.
Even within a single lender there can be multiple groups that could potentially consider your deal. As an example, a major bank can have a business financing group, a corporate banking group, a subordinate debt group, a leasing division, an asset based lending group, and so on.
While there are some demarcation lines between the different lending groups, there still is some over lap and many times confusion as to who you should be talking to or what you should be considering.
The reason this exists is that lending models tend to be very specific in terms of what they will consider and how deals can be structured. They are also rather inflexible so as to maintain a certain amount of integrity in the lending policies that have been established in the first place. Following the rules is a big part of effectively managing risk and straying outside of the lines is not.
So for each different business lending application, there tends to be a different business models that are going to apply to provide a frame work from which money can be advanced to customers.
The challenge to the business owner is that each business is somewhat unique to any other business in terms of size, age, credit, asset composition, management, etc.
So many times, the financial profile of a given business can attract interest from different lending models. The hard part is trying to figure out which ones apply and which ones would be the better fit for the business at a given point in time.
Remember that business lending models are also somewhat fluid in that they can be discontinued, or make changes to their lending policies and practices. For instance, if a business lender has made a large number of loans and placed a significant amount of dollars into certain assets of a certain industry or sector, the lender may stop issuing capital at some point in order to keep its overall portfolio in balance. So a lending program that was available last week is no longer available through the same lender this week for a similar application.
The same can be said for loss concentrations in a particular sector like we’ve recently seen in the automotive industry where business lending all but dried up for any one requiring capital from that business sector.
The best way to approach the market at any given time is to work with a business financing specialist who knows the lay of the land and can quickly apply your requirements to the market at a given point of time so that you’re always focusing on the most relevant options available and not wasting time on shifting sands.
The recent recession has elevated the importance of the asset based lending market, creating both higher supply and demand in the process.
Asset based lending has a number of different slices, but essentially we’re talking about lenders that have a primary focus on the asset resale or liquidation value for determining loan amounts and security ratios.
Surprisingly to some, major banks also house asset based lending divisions to focus on providing higher leverage to companies with well established cash flows. The bank version of asset based loans are also priced off of the prime rate, making them very rate attractive compared to more conventional asset based lenders.
The growth of this business financing segment has been built on the ultra conservative approach being taken by banks and other institutional lenders. A large chunk of debt financing has traditionally come from small business and corporate banking where the strength and steady advancement of the economy were factored into the lending equation.
But when things turn bad, banks tend to have a harder time realizing on security and getting full loan repayment from asset liquidation. Banks are also not set up to monitor business operations as closely as asset based lenders tend to monitor transactions versus collecting periodic financial reporting.
The extra steps taken by asset based lenders to manage lending risk creates additional cost which is another reason why traditional asset based lending is more expensive.
But even with a higher cost of financing across the board for most asset based loans, business owners are lining up to pay more for their debt financing requirements. And the reason is quite simple. In many cases an asset based loan is all that’s available at the present time.
From a lender point of view, there are more asset based sources entering the market, especially in terms of private mortgage lenders. As the affluent baby boomers grow older, asset based lending provides an alternative to the stock market with solid potential returns and underlying security to protect the investment.
Because corporate or bank financing has contracted for the time being, asset based lenders are also getting a higher quality deal flow than they would normally expect to see, creating competition among lenders for the better deals.
This has resulted in better pricing for the better deals with asset based rates getting close to bank rates in some cases.
Asset based loans have also become a transition step to the future as well. Any business that has suffered through the recent down turn, is trying to expand for growth, or going through ownership transition is likely going to have to look to an asset based loan in the short term. Once earnings stability can be established, they will look to move to lower cost traditional options.
But in the mean time, even at a higher cost, asset based loans are providing essential capital for business operations.