Construction Loans For Residential And Commercial Projects
Construction Loans Can Come In A Number Of Forms
Construction loans are typically a second mortgage registered against the property where the construction is taking place. If there isn’t sufficient value in the underlying property to secure construction financing, then other security would also have to be provided to the lender.
The basic premise of a construction loan is that money will be advanced to complete a predefined stage of work. Once the stage is completed and inspected, the property will have increased in value, providing additional security value for draws or advances for future stages of building.
Construction loan amounts as a percentage of the overall project cost can vary considerably depending on the lender and the specific project. For instance, some construction financing programs are capable of funding 100% of the building costs, where others require the borrower to provide an equity investment at the beginning or end of the project.
The equity portion can also vary considerably among lenders. For lower risk, lower cost construction financing, the equity portion required by the borrower will be higher and range from 50% of the total project costs up to 75%. In many cases, the key risk element that can separate lower cost lenders from higher costs lenders is the amount of equity the borrower has available to invest in the project.
Keep in mind also that the borrower will also need to cover off inspection, appraisal, legal, and administrative costs as well as any taxes associated with the construction project, which are all costs above and beyond the actual project costs considered for financing.
Construction capital products can also be quite specialized among residential home and commercial building applications. Larger, more complex commercial projects tend to have a smaller lender population that can be more international in nature as the related funding sources primarily focus on the same types of large projects over and over again.
Construction related capital may also be connected or disconnected from the longer term mortgage instrument. A connected construction financing facility will provide advances for construction and once the project is completed, the total advances will be immediately rolled into a long term mortgage.
A disconnected construction loan would be totally independent from the longer term mortgage and would likely involve two separate lenders, one for the construction portion, and one for the long term mortgage.
Because of the risks associated with any construction project, there is much greater lender interest in financing a completed building than one under construction, so its not uncommon for the construction financing piece to be stand alone capital that needs to be paid out by a separate lender.
Regardless of the size of construction loans, accurate estimates and solid project management are the keys to getting the projects completed within in the funding approved. Cost overruns and delays can result in capital shortfalls that may not be easily covered off.
Cash Flow Survival Tips During Recessionary Periods
Cash Flow Management Actions To Consider
When news breaks about a recession coming or present, perception becomes reality as consumers and business owners start to change their spending habits and prepare for what may lie ahead. In effect, the recession becomes a more prolonged reality because we make it one through our actions.
The primary action by consumers taken is lowering on expenditures, especially on non essential purchases or on larger items that can be put off for awhile.
Ok, so this is nothing earth shattering.
But as a business owner or manager, how do you choose to react to what is unfolding? Its hard to know how the collective recessionary impacts will ripple through an industry or sector with respect to timely and collective magnitude. So how do you decide what actions to take and what to prepare for?
Unless, you have little or no debt and have some sort of cash reserve at your disposal, I suggest considering some or all of the following.
Quoting Intel’s Andrew Grove, “Only the paranoid survive”. And from one of my former type AAA colleges, “in life, you can be homicidal or suicidal, I choose the former.” Point here is that its better to prepare for the coming storm, expect it will reach you directly, and take all necessary measures available to you to survive the impact.
This may seem a bit dark and paranoid (and it is). And there is a chance that a recession does not have a material impact on your business. But what if it does? Will you have time to react effectively?
The goal is to protect the life blood of your business …cash flow. Here are some actions to consider.
Being homicidal with respect to cash flow entails a number of things. First, the working assumption during recession is that sales, on average, will go down…that less money will be spent. So, in order to protect cash flow, you would protect inflows by offering sales and discounts on a regular basis and typically ahead of seasonal offers so that you get the cash first. Yes, you will make less margin, but you’re keeping cash coming in to pay the bills.
Second, on the outflow side, you should consider reducing inventories. The focus is on making sales early, not trying to maximize on sales late in a sales cycle or seasonal period.
Third, reduce fixed costs through layoffs and delay of major purchases. If you have to cut back on marketing, do so on the branding side, not on the direct response side that’s going to bring in sales. There is going to be strong competition for less spending dollars, so make sure you offers are well communicated to get your share.
Fourth, start to extend your terms of payment as much as possible. From a cash flow management process, always allocate resources to cover labor and fixed costs and manage any cash flow gaps with suppliers as much as possible. Cash flow management can be very stressful with many sides looking for money, but you must always plan out how to make payroll or you’re out of business. Many times, when cash comes in from accounts, its quickly paid out to bring things up to date with suppliers without enough being held back to assure payroll gets made in the coming weeks. As recessionary impacts ripple through supply chains, its typically the businesses that understand their cash flow leverage points and plan out contingencies that get through the period with less cash flow problems.
Fifth, bring your financing profile up to date, and develop a solid understanding of how you can obtain money if there is a shortfall. Business financing can take some time to secure and will be harder to locate during a recession so being prepared can be half the battle. Refinancing term loans and mortgages before problems exist can provide cash flow relief on a money basis that will cost you some additional interest over time, but basically serves as insurance against potential future cash flow problems.
Sixth, proactively determine what, if any, personal funds you are prepared to lend to the business. Use personal funds only as short term bridge loans that can come in and out in predictable fashion. If the business goes south, you want to have your personal resources available to you for future living expenses.
These are some basic steps you can take with your cash flow during times of recession. This is not an exhaustive list by any means, but more so a list to get you thinking about how to make sure your business gets to see better days after the recessionary period ends.
Non Notification Funding Makes Factoring More User Friendly
Non Notification Versus Notification Factoring
As a quick overview, Factoring is a form of business financing whereby a finance company purchases your outstanding accounts receivable at a discount and provides you with an immediate advance against the outstanding invoices in order to increase business cash flow.
Factoring is more commonly used when traditional bank working capital facilities cannot provide sufficient leverage against good quality accounts receivable.
What I would call traditional factoring was based on a customer notification model and was very controlling on the part of the factor. With notification, the financing company or factor would basically take over the contact and collection process with your customer.
The factor would essentially inform your customer that certain invoices outstanding with the customer were sold to the factor. The factor would invoice the customer for payment, collect payment, and provide any residual balance after deduction of fees back to you.
For many companies that qualified for factoring, the notification and customer control process left them uneasy and in many cases resulted in businesses taking a pass on what otherwise would have been a great form of working capital financing for their business.
Business owners did not want their customers to get the wrong impression about the financial health of their business when all of a sudden a financing company gets directly involved in the collection process, nor did they want to risk customer service issues to a forced third party interface.
To better serve the market, Factors are now offering Non Notification financing to more and more of their clients.
Under Non Notification Factoring, the financing company does not contact your customer and lets you remain in control of the transaction including the collection process. Your customer would still issue payment to your business and you would in turn forward the check to the Factor to be cashed in a joint bank account with both yourself and the factor named on the account. Wire transfers would go directly into the joint account.
In this manner, the factor is controlling much of their risk at the end of the process with the cashing of checks or receipt of wire transfers.
A business still has to qualify for non notification financing with respective accounts receivable financing companies. There may be cases where some Factors only feel comfortable offering Notification financing based on the risk assessment for a given account.
But for those that do qualify, Non Notification Factoring can be a powerful financing tool for a growing business.
When Is The Best Time To Sell Your Business?
How To Know When To Cash Out
Every business will change ownership someday. Some will have internal family succession plans while others will just decide one day to place the business up for sale.
But when is the best time to sell a business?
If you follow some of the investment bankers and business brokerage firms, they will speak to the M&A cycle, and where its at, at any point in time.
The basis of the M&A cycle is that over a period of time, buyers are more actively interested in acquiring businesses and business assets than at other times. Factors that feed into the formation of an actual cycle are available capital, the economic landscape, market potential in different industries and so on.
While there is definitely a pattern to overall M&A activity, it also becomes a selling tool for M&A firms, brokers, and consultants, all in the business of making money from buy/sell transactions.
The is also the more traditional approach to simply building your business year over year until you reach retirement age and then, at that point, if there is no internal or family succession, then sell your business interest in the open market.
Personally, I subscribe to a third approach…
Sell your business when someone wants to buy it for a fair or inflated price.
Under this approach, your business is always for sale whether you’ve been operating for 20 months or 20 years. By being open to this possibility, there may be more opportunities to consider over time than you may have thought possible.
The rationale for always being ready to sell is quite simple. It takes a buyer with access to capital to complete a sale and without buyers that have the desire and means to take action, there is no market.
And you never know when you have created something of value for someone else. Take a look at websites like YouTube.com and more recently Mint.com where young entrepreneurs were offered small fortunes to acquire their business models, only a few years after start up. Perhaps you would view these as extreme cases, but the point here is when opportunity comes knocking, what will you do?
When a motivated buyer is interested in what you have it typically doesn’t hurt to at least listen. And the motivation for buying could be all over the map… You own a property with a location of interest, you’ve developed a new technology or have a strong product brand, and so on.
The other side to this coin is what happens if you don’t take advantage of a great offer from an impatient buyer? You could end up better off over time, but that most certainly is not guaranteed … a bird in the hand …
If the buyer is a competitor with money, then the competitor will likely take another approach to gain market share and end up becoming a stronger competitor in the future.
Another scenario to consider is when a small company hits the market right and starts growing like crazy, attracting buyer interest in the process. If a larger company steps forward to buy you out because they have the infrastructure and resources to take advantage of your business offering, will you be able to scale the business yourself if you turn them down?
People can look back in the rear view mirror and say so and so business was foolish to sell out to XYZ company because of the profits generated from XYZ over time. But there is absolutely no guarantee that the buyer would have been able to achieve the same level of success and in fact could have ended up failing badly and cashed out for nothing.
Too often, sellers establish their own time line for exit with the hope that there will be a fair market when the time comes to put the business up for sale. And when you view your exit strategy decades into the future, this becomes a form of long term horizon gambling.
I’m not saying you should sell anytime someone shows an interest in a business you own, I’m merely saying you should consider it.
The best time to sell may be sooner than you think.
The Cost Of Capital Is Directly Tied To Risk
In Almost All Cases, Risk and Cost Of Capital Are Closely Related
If you have ever studied the theory of finance (and managed to stay awake through it), you will have been exposed to yield curves, CAPM , risk free rate, weighted average cost of capital, term structure of interest rates, and so on.
Basically, the more risk that’s present in an application of capital, the higher the related cost of capital.
Yet, I continually see business owners that are trying to change the equation while searching for low cost capital with a high associated level of risk.
The lowest interest rates are reserved for opportunities where the lender is well secured, there is well established cash flow, excellent credit, and a reasonable amount of total debt load.
Rates for both debt and equity capital will go up as these investment characteristics become less excellent.
This is pretty straight forward stuff that most people would understand and agree with.
However, the context of society’s basic understanding on the cost of capital is based more on mortgage rates and car loans than anything else.
Business financing can be a whole different ball game due to the higher levels of inherent risk and when we speak of risk, its risk of lender or investor loss.
From a lender or investor point of view, risk has everything to do with the liquidation pathway which stated in different terms means “how do I get my money back if things go south”.
For residential mortgages, the lender puts the house up for sale and gets the funds back in 3 to 6 months, depending on the market and the foreclosure procedures in play.
For a commercial mortgage, the same applies, but the market can be a lot thinner in terms of buyers, and the time period for sale could turn into years which will require payment of property taxes, maintenance, utilities, etc, which all reduce the proceeds and increase the chance of loss.
Higher risk equals a higher cost of capital.
When you look at unsecured loans based on stated income and credit, the risk is again higher. For in the event of a failure to pay, what’s the likely hood of the lender getting any money back?
Equity capital is significantly higher than debt capital in most cases due to higher risk of loss by the investor. Equity investors will demand a wide range of returns, but the range can be as broad as 15% to 30% or even broader … depending on the risk.
Yet I’m still amazed when medium to high risk ventures are convinced they should be able to secure low risk capital.
Unproven business models and business start ups for example are not prime plus type risks.
Many times start ups and unproven ventures get upset with me when I propose relevant business financing solutions that they view to be high or even extortion. I have had many discussions with entrepreneurs seeking 8% to 12% money for a 18% to 25% risk. They have nothing to offer in terms of security except the future cash flow projections of their business idea or project.
I then provide the best analogy I have to try and bring them back to earth which is as follows.
A private investor will place second mortgages for 12% to 14%, fully secured by residential properly, providing a higher than normal rate of return due usually to the bad credit of the borrower. Their relative risk is small, although they will have to be prepared to deal with some foreclosures, but the profit margin is still very good.
So if these guys can get 12% to 14% all day long secured by real estate, why would they ever invest in a venture looking for even a lower rate of interest and not offering any real security except the promise of future profits?
Some times I get through, but most times I don’t.
I guess hope does spring eternal.
Click Here To Speak Directly To Business Finance Specialist Brent Finlay
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.
How To Access Business Financing
How To Do You Locate A Suitable Source Of Business Financing?
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.
There Are 4 Reasons To Secure Capital For Your Business
Can You List The Four Reasons Why Someone Would Need To Secure Capital?
There are 4 and only 4 reasons to secure capital for a business. Each reason or purpose for business financing will impact the type of lender or investor to approach as well as the manner in which you approach them.
The 4 reasons for seeking more capital for a business are as follows:
Start Up. At the commencement of a business entity or operation, funds may be required for working capital, fixed assets, intangible assets, leaseholds, inventory, and so on.
Growth. An existing business looking to expand may require capital to increase its capacity as well as the working capital required to fund a larger volume of activity.
Acquisition. When one business acquires another, it must purchase either the shares or the assets of the target business with a combination of cash and external capital from debt or equity sources.
Debt Consolidation and/or Re-organization. In times of business downturn that create financial losses, capital must be injected into the company from debt or equity sources to cover the costs of operation and allow the company to continue. Another scenario would be when the term structure of the debt outstanding does not match up against useful life of the assets securing it. In these cases, a debt restructuring will take place to balance out the balance sheet. A third example would be when outstanding debt exceeds the leverage against equity allowed by the lender, requiring a debt reduction and/or an infusion of investor or shareholder equity.
Each of the reasons to secure capital or apply for business financing have their own lending and investing criteria. A business manager or owner seeking incremental capital would be well advised to gain a greater understanding of what is required for each and work towards identifying lenders and/or investors that are relevant before proceeding too far with any inquires to secure business capital.
We will get into more of the specific for each of these uses of funds in future posts.
If Business Finance Is The Ying, What is The Yang?
Business Financing Is the Ying?
When I was working inside the last multi national meat grinder that employed me, I had the unique opportunity during the time I was there to sit on both sides of the corporate fence, first as a CFO and second as a director of strategy.
The two sides I’m speaking to is marketing and finance. So in keeping with the title of this post, if business finance and financing is the Ying of business then Marketing, business development, and sales are the Yang.
And if you look closely at virtually any of the fortune 500 companies, they are all organized around these two sides, Marketing and Finance.
If its not completely obvious, the Ying and Yang analogy has everything to do with the totally different ends of the spectrum that marketing and finance occupy.
Marketing and Finance people don’t even tend to get along as the former tends to be aggressive, even to a fault at times, and the later tends to be conservative, even to a fault at times. Even if these two sides don’t have an ongoing hate for each other, they’re not highly likely to become the god parents for each others kids.
But.. And its a big but, a business (any business) cannot achieve any type of sustainable long term success without marketing and finance being in balance.
This well established business structure is designed to create conflict and push from both sides so that optimal results can be achieved that otherwise wouldn’t if one had power over the other.
For many small and medium sized businesses, the primary focus, as it should be, is marketing, because without customers, nothing else really matters. So the yang tends to be strong, but what about the ying?
Unfortunately, finance takes a major league back seat in most businesses which tends to cause considerable imbalance, and suboptimal results over time.
Business finance has an important role to play and somehow it needs to be worked into the mix for companies whose size does not support a full blown corporate structure.
Basic things like budgeting, a financing strategy, cost control and measurement are important to any business and need to be covered off somehow in order to allow a business to fulfill its potential.
As an example, what I really notice more than anything else in this regard with small and medium sized business is that over 80% (my numbers) of business financing activities are unplanned events, do not adhere to any type of financing strategy for the business, and are difficult to get into place in the time required.
Because of the lack of business finance focus, finance related events are crisis managed when they occur and then immediately put off to the side until the next crisis occurs.
It doesn’t have to be that way, but it will likely be that way without an understanding of why marketing and finance need to balance off against each other.
For business owners and managers, it can very well mean sitting on both sides of the proverbial fence at times to achieve some amount of balance. And for those that do, they develop a competitive advantage that can lead to both growth and survival.