When you’re in the process of trying to locate secure business financing, make sure that you’re prepared to get into the details related to your request right off the bat in order.
The reason is simple.
Because the business financing market can be fairly fragmented, its important to be spending your energy and time working with lenders or investors that can actually help you.
Too often, business owners will gloss over the details thinking that they may not be required to get the financing they are looking for.
Well here’s a news flash… the details are going to be required 95% of the time. And of the 5% of the time they aren’t required, most of the time you’re looking at some sort of financing scam that is more promise than substance.
When I speak of the details, I’m taking about full disclosure of what exactly you’re looking for and the credit and financial profile of your business.
Too often, little details will be missed on purpose because a business owner is trying to hit the warts of the business. But in the end, these items will come to the surface and can kill the deal after considerable time has been already spent.
This is also a problem when working with business financing consultants.
A business owner may gravitate to the financing consultant or broker that is asking for the least amount of information in the hope that he has some sort of special access to funds that can avoid having to do the Full Monty on business.
This is a tactic by some brokers to get you working with them. Later in the process, when you get annoyed with their false promises, you may likely just stick it out and go through the real process with them instead of starting over with someone new. And because business financing placements are usually one off transactions, the broker or financing consultant doesn’t have to worry about losing out on repeat business that likely wouldn’t happen anyway.
Banks and institutional lenders can also be guilty of asking you for bits of information at a time, pretending that they’re not going to ask for everything eventually in order to get you going with their application process.
And when I talk about asking for everything, I mean at least three years of completed accountant prepared financial statements, the current year interim statement supported by A/R, A/P, Inventory, and Equipment sub ledgers, transactional details to support margin levels, two to three years of financial projections, income tax statements, notices of assessment, government remittance histories, personal net worth and credit profile, and so on, and so on.
Even though its a bit of a pain to go through the details a number of times, its far more fruitful most of the time to sit down with someone and spend an hour providing a very detailed picture of what you want and what you have, so that they can provide you with more honest and immediate feedback as to the potential that they can help you or not.
Unfortunately, most business owners AND sources of financing do this onion peeling approach where the information is revealed bit by bit.
If you’re talking to the wrong source of financing, this can be death by a thousand cuts. If you’re talking to the right source, late disclosure of certain things can cause problems getting funding completed later on in the process.
The investment in time in the beginning of the process is a may me now or pay me later type of thing.
By investing time up front, the overall process is likely going to be more efficient because you’ll be working with the most relevant sources of business financing sooner versus starting the process over and over again with unsuitable dance partners.
When you’re looking to finance a commercial real estate property, there may be some better short term options available than the bank.
Let me explain.
The commercial property financing process with an institutional lender is a time consuming process.
More specifically, it will likely take 60 to 90 days from the time you apply for a commercial mortgage to the time its approved and funded, or even longer.
Banks and institutional lenders are the preferred sources of commercial property financing because of the lower rates they can offer, and when you’re working with a mortgage at or above million dollars, every percentage point is going to be important.
But even more important is getting financing in place when you need it so you can avoid 1) missing out on a property acquisition, 2) take advantage of a profit opportunity, or 3) avoid incurring a cost.
Business financing should always be about the net cost of funding, not just the stated interest rate. And when it comes to getting something done in a hurry or in a predictable period of time, banks and institutional lenders are not that predictable in terms of indicating if they will fund a deal, and then when it will actually be funded.
So if time is of any concern to you when arranging a commercial mortgage, you may want to consider a private mortgage lender before even going to the bank.
Because a private lender can potentially get the lending / funding process completed in 30 days or less, providing an avenue to get capital in place when required, even if you have to pay a bit of a rate premium to do so.
And in today’s market, if you have a great piece of property and the loan to value required on financing is under 60%, the private mortgage lending rates can come very close and in some cases rival what a bank or institutional lender could provide.
Then, with business financing in place, you can take your time surveying the market and getting the best available deal where you are in control of the process and not in a take it or leave it type of scenario with time running out on the clock.
This is where the net cost of the transaction comes in.
If you end up paying a few extra dollars in interest over a year or two, but end up saving or making ten times that amount or more from having financing in place when it was required, then the cost of a private mortgage becomes cheap compared to the cost of not having the financing in place when you needed it.
If you’re at all pressed for time when trying to finance a commercial property, it can be very dangerous to assume that you won’t run out of time with a bank or institutional lender, or that the terms and conditions you’re going to sign up to for the long term are going to be acceptable to you.
There can definitely be a significant benefit attached to the potential incremental cost of an asset based loan and at the very least, the incremental cost is insurance to make sure your deal get done, or funds are available when they need to be for other purposes.
The best approach to business financing growth is a short term vs long term type answer.
That is, do you focus on short term profitability or long term profitability or both?
If you have unlimited access to a cheap source of capital, then an optimal profit focus in the short term and the long term is going to be preferred with an emphasis on accurately managing margins to gain market share as fast as possible without eroding profits.
But most small to medium sized businesses in a growth period do not have an unlimited supply of cheap money, so there is a couple of different ways to look at the best approach to financing growth.
On the one hand, you could argue that its better to grow at the speed at which you’re low cost supply of money will allow you, even if this is not as fast as you could penetrate the market.
On the other hand, you could also argue that the cost of capital you’re prepared to pay should be dictated by the margin you generate in the market and that as long as you’re covering your cost and believe you can gain and keep share in the mid to longer term, that the speed more capital provides you is desirable as long as you can afford it.
This is where many SME’s struggle with using asset based lending compared to bank margining during a period of growth.
Bank financing is going to be cheaper on the surface, but may not be as cheap or as flexible as you may think.
For instance, if you’re talking about a margining facility in the millions of dollars, you’re going to have to provide audited financial statements on an annual basis and some pretty detailed monthly reporting and potentially third party measurement services as well. The incremental cost of these requirements can push up the effective rate considerably.
But the cost is the cost, and is bank margining is cheaper, then it should be used, provided that its also readily available and flexible enough to deal with your growth curve.
This is where bank or institutional margining in the short term can be very inefficient and costly to growth, even at a lower cost of borrowing plus the incremental administrative costs.
While many banks can be very cautious with extending credit limits, and sometimes even putting the brakes on their financing position, regardless of what their initial commitment may have indicated, asset based lender tend to follow more of a linear path and as long as you fall within their lending ratios and maintain the quality of assets, capital availability can growth at the right speed.
Once again, the key measuring stick is the collective profitability over both the short and long term.
The source of capital you use at any given point in your growth cycle should provide you with the capital required to growth the market as fast as you can manage at the least amount of cost, provided that you can cover the cost with the cash flow being generated.
This can also mean changing from one source of capital to another over time.
For instance, a business may start out with a bank or institutional working capital facility, move through one or more traditional asset based lenders as capital demands increase and then make a final transition to bank or institutional asset based lender that can provide the best rates versus leverage, but only tend to become interested when your monthly sales levels are at $5,000,000 or higher.
There can be tremendous challenges in figuring this out, but figure it out and stay ahead of the growth curve you must, otherwise you may loose momentum or be overtaken by someone else in the market that has figured out how to finance their growth.
If you run a business that has good commercial real estate in your asset mix, then you need to make sure that you’re getting the best value out of the leverage that real estate can provide.
Regardless of whether you’re trying to arrange business financing for across your business entity or just focusing on getting a commercial mortgage for piece of property you own or are trying to acquire, don’t underestimate the power of the real estate security that is being offered to the lender.
When you’re looking at full balance sheet financing through an institutional lender where A/R, inventory, equipment, and real estate are being collectively leveraged to provide you with the amount of financing you’re looking for, the strength of the real estate will impact both the overall rate and total leverage you will receive.
Unfortunately, many times business owners don’t break things down fine enough to understand what the real estate is contributing to the financing package and in many cases do not receive optimum financing value from the commercial property or properties they own.
The same is true for arranging a stand alone mortgage on a single property where the offerings you get back from bank or institutional lenders may not be considered optimal or superior to what you should be able to acquire.
This is one of the main frustrations of commercial financing in that commercial lenders are totally portfolio driven, so if their portfolio has a higher risk rating than its supposed to, or they already have a lot of your type of property in their investment mix, the offer they make isn’t going to be as strong as compared to when the portfolio is balanced more in your favor.
And if you’re not in a highly competitive market area, there may not be a lot of other options to chose from. Or even if there are, you may not have enough time to go look for another option right now.
One solution to this type of situation is to consider a certain amount of asset based lending from private mortgage lenders.
In certain situations, private mortgage lenders may be offering very similar rates to banks or institutions, especially on grade “A”properties pledged by solid borrowers.
Under these circumstances, you may be better off going private for one or two years, giving you time to locate and secure a better commercial financing deal where you’re getting full lending value for your real estate.
In the short term, if the private lending rate is comparable to the institutional rate, you’re not really losing anything on cost, and on cash flow you’re likely paying interest only to service the debt which makes more cash available for other things.
Many times private commercial mortgages can be arranged with no prepayment penalty after a certain number of months, so when you finally have the bank or institutional deal you’re looking for, you can pay out the private lender at any time.
This strategy has the potential to create a significant cost saving to you in the long term, especially when you’re talking about higher leverage and interest rate differences of 0.5% or higher over time.
I remember back ten plus years ago having some conversations about the low Canadian Dollar and what was likely in store for Canadians in the near and longer term future.
One American friend held the opinion that Canada should just give up its currency and adopt the U.S. greenback instead.
Another Canadian friend warned about manufacturing complacency setting in with a lower dollar and that Canadian companies needed to become more cost competitive for when the dollar inevitably started moving the other way.
And as a former Winnipeg resident who was on the scene when the Jets left town, unable to complete in the NHL having to pay player salaries in U.S. dollars, its more than interesting to see things come full circle in the hockey world. Go Jets Go!
Ok, so what’s my point?
Simply that with everything going on in the global economy right now, its only a matter of time before interest rates go up.
Business financing rates are about as low as they can get and have been that way for quite some time.
But of course, predicting the magical time when rates will start to climb and stay up IS impossible and who ever gets that one right should be buying lots of lottery tickets as well to cash in on their luck.
Just like the change in the dollar, so will follow interest rates.
When you are at one end of the spectrum, its only a matter of time that you start to move back towards the middle and perhaps beyond.
That’s the way things work… That’s the way they always have worked and will work.
So, as a business owner today, are you getting prepared for a higher cost of capital and potentially higher sustained levels of energy costs?
You do this not knowing when you’re going to be impacted by these inevitable changes, but do it nonetheless because its going to be part of long term survival and prosperity.
Just like people who got accustomed to the easy access to commercial credit from WWII to about 2007 when the recession hit and made the process for securing capital that much more difficult, and just like when much of the Canadian manufacturing sector was set up on the basis of a $0.75 dollar, a certain degree of apathy has set in about interest rates due once again to a lack of meaningful movement over an extended period of time.
Everything right now is pointing to global interest rates going up.
When that’s going to happen could be months or years…your guess is as good as mine.
But this isn’t about if, its about when.
So as a business owner, are you getting your financial house in order and balance sheet in shape to take advantage of the opportunities that always come about due to material shifts and changes in the market, or are you going to be one of the vanquished that did not pay attention to signs?
One of the classic problems buyers have when trying to get business financing or acquisition financing for a business they want to purchase, is that the financial statements don’t accurately reflect (or easily reflect) the true profitability of the company or the amount of net cash flow future owners will have available to them.
This is because the seller disguised his or her drawings with expense items that don’t clearly show whom the benefactor was of the cash paid by the company.
Whether the expenses are legitimate deductions or not are another matter.
But the seller’s tax planning (or tax avoiding strategy) ends up showing a picture where the company’s profits are minimal to avoid paying corporate or business income tax.
To compensate for this historical approach to tax planning, I’ve seen different sellers prepare their last completed fiscal year end financial statements prior to putting the business up for sale to show a significant profit in the hope that this will be sufficient evidence of true profitability for the buyer and potential third party sources of debt financing.
And while the buyer may be convinced of the real cash flow via the last year’s numbers alone, sources of business financing will likely remain skeptical.
Its not unusual that for an acquisition loan, a lender will ask for five or six years of the seller’s past financials to gain a better understanding of the profit and cash flow trend line.
Business brokers will call me and explain how they have “recast the financials” to more accurately show how much disposable income is available for debt service and owner drawings.
While on the surface, I have no doubt there is credence to these numbers, there are unsubstantiated by an unbiased third party and will likely not be considered by a lending source unless third party verification comes into play.
This is can be a real dilemma for the seller in that if he or she was tax planning in the grey area, they don’t want anything documented that could come back to haunt them.
But if the financial statements as written do not provide sufficient support for debt servicing, then it can be difficult to sell the business as buyers requiring financing (which tends to be most buyers) will have a hard time putting the necessary capital together.
Its hard to say what the best approach is as ultimately the goal of the seller is to pay as little income tax as possible before and after the sale of the business.
This is where the business finance aspect of your exit strategy comes into play.
Its well advised to think through all potential scenarios for selling two or three years in advance of putting the business up for sale.
In order to achieve an optimum sale price, solid cash flow is going to be required to prove out any cash flow multiplier.
Choosing a tax strategy that provides minimal if any taxable earnings may not only lend to a much lower potential selling price, but it may leave the seller as the only financing option for the purchase if third party financing is required.
The key to developing a proper exit strategy is to work with an experienced business finance professional who can work through the various potential scenarios with you so that a path with a higher probability of success (and lower probability of tax) can be laid.
As a business finance specialist, I am regularly engaged in the conversation of why a business owner should want or need to pay for my services.
Its a good question for sure.
And on the surface at least, it would appear that there are enough business financing options out there that any business owner should be able to walk through the door of their local bank or institutional lender and get all the business financing they require. Right?
Unfortunately, perception and reality are a bit different in the world of business finance.
The process of securing business financing is typically harder and longer than most people think it will be.
There are many reasons for this of which I will only touch on a few.
First of all, most business loans or financing facilities are customized financing in that no two businesses are exactly the same in terms of what they do, the stage of business development they are in, size, scale, etc. So there is work going into assessing each and every business case compared to something like an application for a residential mortgage.
Second, lenders are always trying to balance their portfolios, so effectively what they can lend on at any given time is a moving target making it easy to waste a considerable amount of time focusing on the wrong source of capital at any given time.
The end result is that the overall process for locating and securing proper financing can be very difficult to figure out and when you do get a bearing on the way things work, everything could change before you’re going to need to draw on that information again in the future.
I was reading an article in the Globe And Mail about the small business owner’s reluctance to outsource. You can check it out by following this link … http://www.theglobeandmail.com/report-on-business/small-business/grow/expanding-the-business/small-business-owners-still-reluctant-to-outsource/article2060249/?utm_medium=Feeds%3A%20RSS%2FAtom&utm_source=Report%20On%20Business&utm_content=2060249
The article basically describes how business owners want to outsource, but are unsure of the value of doing so, and end up doing too many things themselves.
This is very true in the world of business financing as well.
With respect to source business capital, there are two basic costs that you have to consider as a business owner.
The first set of costs is your out of pocket costs, opportunity costs for your time, and lost opportunity cost for not getting the right type of financing when its required. In my experience, this can be many times the cost of third party assistance with the financing process.
The second set of costs revolves around not continually looking for better fit financing or contingency financing. Most business owners will only look for capital when its absolutely required and don’t take into account how the capital in place may be priced too high compared to available alternatives, or is not allowing for optimal growth. Once again, the true cost of not having a proper balance sheet in place can be incredibly expensive over time.
Utilizing the services of a business financing specialist is another outsourcing choice that needs to be weighed on the basis of the cost and projected benefit. This may or may not be required for every business situation, but it should likely be at least considered more often than not as the do it yourself approach can produce significant visible and hidden costs that can potentially be avoided.
According to a recent survey by the Canadian Institute Of Chartered Business Valuators, half the businesses in Canada have no succession plan or exit strategy, and 70% of business owners will be at retirement age by 2020.
For more specifics on the Financial Post article that features this survey, click on this link … http://www.financialpost.com/Management+exodus+threatens+aging+boardrooms/4918926/story.html
Not having a succession plan is not necessarily new in the world of business. But what has been changing are the competition dynamics brought upon us by the last recession.
In the past, business owners were not overly concerned about finding a way out of their business at retirement age as the booming economy provided ample opportunity for continuation of the family business or sale to a the open market.
But since 2008, the economy has tightened up, capital for business financing is not flowing as freely, and competitors are taking more drastic actions to either retain market share or out right survive in the market.
As the article mentions, many business owners have moved from a position of just riding their cash cow into the sunset to now struggling to figure out what to do with an Albatross now hanging around their neck.
All of this speaks more than ever for the need of a plan and a longer time horizon for completing a succession or exit.
And none of this is to say that the sky is falling or that all hope is lost for small and medium sized business owners without a plan.
Far from it.
But they are going to have to start knuckling down and start spending some serious time and money building a plan that is going to take them out of the business and provide the retirement they are looking for.
Its hard to say when the days will return where you could get away without planning the end and still do ok financially.
Continuing to take that type of position may put all you’ve worked for in jeopardy, both in terms of your legacy and retirement comfort.
What I’m about to say may sound counter intuitive, but bear with me for a moment.
When a business is being acquired or a business is purchasing assets from another business, the one main deal killer is getting the amount of required financing in place in a defined period of time.
And because many times the deal cannot or even will not be completed by the purchaser without sufficient leverage being in place, it can be hard to get deals done, especially if the amount of leverage required is considerable.
Even if you know you are strong enough financially to qualify for the required amount of business financing, the process for getting the financing can take longer than you have, especially when dealing with a bank or institutional lender.
So what can you do to avoid this problem or at least reduce the chances of it being a factor?
Choose another approach to financing.
This can involve leveraging other assets you may own that are free and clear, going to an asset based lender who has a faster application and assessment process, putting more short term cash into the deal, and so on.
The point here is that there are ways to get money in place faster than perhaps the ideal financing structure.
But once the deal is closed, you can spend whatever time is necessary to arrange a better financing set up.
Will this type of approach cost more money?
Well, potentially yes, but it depends on how you’re adding up the cost and building them into your decision making.
An asset based lending approach for instance is going to be more expensive than a bank or institutional credit facility, but if you can’t close the deal, what good is the cheaper money to you and how much opportunity cost have you lost by not moving forward.
The key here is that you’re confident in your ability to secure the right type of financing sooner than later, so the costs of taking a faster approach to closing are ones that should be factored into the initial purchasing decision.
If you buy into the argument that business financing is going to be difficult for anyone to arrange for the deal, and that its unlikely what you’re trying to acquire will be purchased for cash, then why not discount your offer to purchase to reflect the costs associated with a faster close financing strategy?
By being more creative in terms of how you price the opportunity and get the deal closed, you are putting yourself in an enviable position in the market to land great deals and avoid the frustrations of your competitors who take the traditional (but may times flawed and ineffective) approach to business financing.
In a business acquisition scenario, if you can get through the business ownership transition process quickly without negatively impacting the bottom line, you may actually be able to secure a better long term financing deal after the fact as the transition risk from the sale has been removed from the lender’s list of things to be worried about.
This approach isn’t always going to work, but if you have cash and other assets to play with, and are confident in your ability to generate positive results from your capital investments, then faster close strategies are something to think about.
Ontario asset based lenders lead the Canadian market in terms of coverage of the market place.
Because of the size of the Ontario market compared to other areas of the country, asset based lending in Ontario can function in a relatively small geographic area which is very appealing to asset based lenders who typically require regular monitoring of accounts.
The term asset based lending can mean a number of different things, but for the most part its about lending against the market value of assets that a specific lender knows how to liquidate in the even of default.
Asset based financing is by definition higher risk lending because more of the lending decision is based on the security value of the asset as compared to bank or institutional lenders that require lower levels of overall balance sheet leverage in order to justify a loan request.
With an asset based lender, the lending decision is more about the difference between the immediate liquidation value of assets and the amount of financing they provide. As a result, it is much more formulaic than conventional bank lending.
That being said, a growing area of larger Ontario Asset Based Lending is in the bank’s own specialized niche for asset based loans.
In this particular space in the market, larger banks are providing higher amounts of leverage to clients that are in the lower risk range of the asset based lending world. These are typically asset based loans for $5.0 M plus, so are only available to a small percentage of the market.
For the majority of small business and medium sized businesses in Toronto and the Greater Toronto Area, there are a considerable number of different asset based financing options where either one type of asset is the focus such as a pure accounts receivable factoring house, or a number of assets can be considered collectively.
Each model typically has its own unique fit into the market and financing costs and structure.
The challenge for a business owner, especially for one that has a variety of assets that can be financed through asset based lending, is picking the right model.
In some situations, using more than one asset based lender can be preferred in order to obtain both maximum leverage and a lower cost of financing.
But more lenders involved can also lead to more deal complexity and greater administration requirements to meet the needs of all parties involved.
The best way to approach this area of the market is to work with a business financing specialist that works in the market and has direct experience with a variety of Ontario Asset Based Lenders