Uncoventional Business Financing
“Sometimes, The Best Source Of Financing Available To You Is Not On Your Radar Screen”
The standard option most business owners and managers have is that any amount of business financing they are going to require over time is going to come from their bank or some other banking institution.
After all, banks and institutional lenders will regularly tell you that they want your business and can take care of all your business needs.
But the stark reality is that the Major banks and secondary lending institutions, especially the ones that are the most visible in the market place, are only looking for “A” deals and are frankly more interested in your investment portfolio, insurance policies, and any other financial service they can offer that tend to be far more lucrative and much less risky than almost any type of business loan.
And truth be told, the majority of small and medium sized business (SME) financing does not come from banks. Depending on whose numbers you choose to believe, the actual annual lending extended to SME’s is about 1/3 of what’s actually required by the market place.
But because the economy continues to go around and around, the money has to be coming from somewhere. And many times, these sources can be very unconventional compared to the formalized lending practices of a bank.
The key to any lending or debt financing arrangement is that the borrower has something of value to the lender than creates a basis for a loan to be made.
When the circumstances of a given business do not fit into the lending criteria of the primary or even secondary market sources, its time to look to more unconventional options.
Once again, the key is to understand the value you have to leverage and who would be interested in providing capital against specific assets you control. This can be anything. Patents, specialized equipment, strategically located property, etc. The possibilities are limitless. But unless what you have has a value to someone else, there is no business financing equation to work from.
As an example trade credit is a major form of capital provided by manufacturers and suppliers to move inventory through their systems. And while most trade credit is based on the financial strength of the customer, there are many variations to trade financing that come into play based on the value or opportunity available to the company providing it.
In most of these and other unconventional business financing scenarios, there is a steep walk away price to the borrower for not repaying the debt as written. The incentive of the lender is the opportunity to acquire something they consider as valuable at a discount or even at market price if its something that is exclusive or hard to come by.
Asset based lending is pretty much grounded on the premise that in the event of loan default, the borrower will either retain the security or knows how to liquidate it to get his or her money back.
But in reality, there are many, many unconventional loans provided every day from some of the most unlikely of sources.
So when you’re pushing rope up hill and have been turned down for the umpteenth time from the usual suspects, its time to think outside of the box and develop a business financing strategy that someone will be interested instead of continuing to push one that everyone clearly isn’t.
Click Here To Speak Directly To Business Financing Specialist Brent Finlay
The Business Financing Calendar
“Being Successful With a Business Financing Application Can Have A Lot To Do With The Time of Year”
If you’re going to apply for business financing from an institutional debt lender, the time of year can have more of an impact on your application that you may think.
Like any business, a commercial lender has a budget, a fiscal year end, and financial reporting requirements.
As of this writing, we are currently in the October or the start of the fourth quarter of the calendar year which will be the fiscal year for many of the lenders out there. This means that banks, credit unions, trust companies, pension funds, etc., will be getting their books in order for their up coming year end.
For commercial lenders where the year has allowed them to already meet their targets, the last quarter is going to likely be characterized by a stiffer application of lending criteria with the intent to only take on additional loans that will lower the portfolio risk. Debt financing is a business and the people that run these organizations are going to be working hard to hit their targets to earn whatever bonuses may be available to them.
On the flip side, if a lending institution has not hit its budget by the fourth quarter and is even potentially a bit behind, there could be an opportunity to see a loosening of the credit criteria in order to get more business through the door before the clock strikes midnight on the year end.
For debt financing sources that don’t have fiscal years that match the calender year end, the same circumstances can apply.
At the beginning of the year, its not uncommon for lenders to start out with a more conservative approach to see how much low risk business will come their way. By the second quarter, if lending is below budget, the reins can once again be loosened in order to try and hit the lending numbers that will pay the bills and potentially those bonuses.
From a business owner’s point of view, it can be difficult to determine who is lending and who is less likely to lend based on the time of year.
Just keep in mind that money will tend to flow the most free in the second and third quarters, all other things being equal.
While there is no exact science to figuring out how this can impact your business financing efforts, it can be a good idea to stay connected to financial consultants and industry experts that have a better sense as to what the main players are doing at a given point of time based on whatever inside or quasi inside information they may have access to.
Here in 2010, the market in general appears to have slowed down going into the fourth quarter. While it may be too soon to draw conclusions as to what to expect from different lenders for the next few months, its definitely something to stay aware of, especially if capital is going to be required for your business in the near term.
Click Here To Speak To Business Financing Specialist Brent Finlay.
Short Term Equity Financing
“Especially In Growth Situations, Short Term Equity Financing or Quasi Equity Financing Can Be a Preferred Financing Approach”
For the purposes of this discussion, short term equity financing is defined as capital that is acquired in exchange for a portion of ownership that will be paid back in 5 years or less with the original ownership being restored in the process.
This type of equity financing approach is best suited for growth companies with good margins that can afford to pay the higher cost of capital associated and can in turn secure the capital they need to effectively grow and scale their business.
Too often business owners are hung up trying to find high risk debt that will require debt servicing which can drain cash flow and cause implosion if things don’t go exactly as planned.
At the same time, its also understandable why business owners are apprehensive about selling off part of their business and potentially giving away too much of their future.
The business financing solution to high growth, high margin situations where there’s a good probability that the plan to grow will succeed, can be satisfied by equity investors or forms of convertible debt financing that share the same objectives as the business owner, only in reverse.
For the short term equity investor, the goal is to put funds into a company in exchange for ownership and have the company execute its plans and generate the expected return in the shortest time possible at which point the money invested is paid back with a healthy return and ownership sold back to the original owners.
Short term equity investors are looking for opportunities to flip their money in and out of a business and double it or better in three to five years. They are not interested in long term ownership and the risk and administrative complexity that can entail.
Some business owners may feel that paying an investor back double what they put in as an excessively expensive form of financing. But when confronted with this opposition, I will paint the picture of the business owner sitting on some sandy beach 10 years from now, after reaping the success of getting their business scaled up to its potential as quickly as possible, and revisiting this decision to use short term equity capital. Will they really be saying to themselves, dam I gave away too much in cost of capital 10 years ago to build my wealth? Not likely.
The long term benefits can far out weigh the costs, provided everyone goes into the equity financing arrangement with a well defined beginning and end to the relationship.
Click Here To Speak Directly With Business Financing Specialist Brent Finlay
Term Structure of Commercial Debt Financing
“Understanding Commercial Debt Financing Term Structures Can Be The Key To Optimal Leverage”
Commercial debt financing has a lot to do with figuring out the term structure jigsaw puzzle that relates to your business or the capital requirements of what you require funding for.
Each category of asset will command a different type of risk profile and will attract different lending programs. On the surface, that seems clear enough to most, but the challenge comes in trying to get the right amount of leverage at the lowest cost of borrowing.
For instance, many lenders will have primary and secondary financing options. They will provide you with their primary offering on a certain class of assets and a secondary offering on other assets you hold. Or they can bundle their offering whereby you can get the business financing you’re after from them, provided that you transfer personal financing requirements and investments to them.
For more established businesses, the challenge is to take what you have to leverage both commercially and personally to secure the best potential deal at any give point in time.
This may involve one lender or a number of lenders, each focusing on a different classification of asset and term structure of debt. While the single lender model may be preferred, it doesn’t always provide the amount of leverage required. For greater leverage, the different categories of assets (working capital – accounts receivable and inventory, equipment, real estate) need to be financed through lenders that specialize in that particular asset class. This can also drive up the overall weighted average cost of borrowing, but this may be a necessary trade off to secure the amount of capital required in the short term. Obviously there will need to be sufficient sales and margins to cover the cost of financing and over time the goal would be to reduce the cost of funds and take on a better term debt structure overall.
The challenge to any business owner is that their situation will always be somewhat unique to anyone else and therefore a customized solution is required whereby the business owner figures out the best lender offering or combination of lender offerings that best fit his or her business at a given point in time.
And once a financing structure is decided on and put into place, there is still going to be an ongoing requirement to stay ahead of the curve and either find better financing options that improves leverage and cost requirements or provide for alternative financing scenarios in the event that one or more lending partner changes their interest in financing your business.
Click Here To Speak With Business Financing Specialist Brent Finlay
Institutional Asset Based Lending
“The continual Evolution of Institutional Business Financing Programs Towards Asset Based Lending”
While asset based lending models have been well entrenched in the U.S. landscape for decades, they are still evolving in the Canadian market place.
This is largely because corporate lending criteria doesn’t work in recessionary periods and post recessionary periods where the economy as a whole is operating at a lower level of performance resulting in poor or suboptimal financial statements in many industries.
Corporate finance lends off of financial statements that show strong cash flow and low debt to equity ratios. During and immediate after a recession, especially one as severe as the current one, hardly any money is being provided from these sources for businesses to operate and in many cases, the money supply is contracted due to risk and perceived risk.
Enter the world of the asset based lender where there is a stronger link between lender and borrower with more established rules for managing cash flow and risk that allows the lender to participate in situations where they would otherwise have to pass.
In the last few years in Canada, all the major banks and several U.S. entrants into the market have jumped into the asset based lending world with some being fairly aggressive with their programs for lending money.
While most of these programs are only focused on loan requirements of $5,000,000 or higher, the advancement of the industry in general is good news for small and medium sized business owners who are scratching their head trying to find a source of capital they can cash flow within the profits available in their business.
Institutional asset based lending can have considerable pricing variations off of prime, but this is still considerably cheaper than what I will all traditional asset based boutiques that start at 18% and go up from there.
The key to getting the money and making it work for you is to take on or evolve your financial discipline so you can make all the rules and regulations with this type of money work. In the end, the discipline that any asset based lending facility injects into a business is almost always a good thing that will help not only with short term survival but also long term growth and prosperity.
From a commercial lenders point of view, the evolution to asset based lending makes a great deal of sense in terms of not only managing risk but being more comfortable putting money out into the market.
I believe asset based lending will continue to evolve in all lending categories and become a more prominent form of business financing for many business owners now and in the future.
Click Here To Speak Directly With Business Financing Specialist Brent Finlay
True Cost Of Capital
“While There is Never Any Absolute Rules When It Comes To Pricing Money, Here Are Some Things To Consider When Trying To Understand The True Cost of Capital For Any Particular Application”
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.
Click Here To Speak With Business Financing Specialist Brent Finlay
No Such Thing As Easy Money
“When Looking For Business Financing, There Is No Such Thing As An Easy Deal, A Simple Process, Or a Certain Approach To Getting Money”
Ok, so perhaps this is a slight exaggeration as I probably can recall a few business financing deals I’ve worked on over the years that went fairly smoothly, got closed on time, and provided the business owner with what they were looking for without any grief.
I can also easily count these situations on one hand and have some fingers left over.
The process for securing capital, especially since the most recent recession is gotten harder to achieve in most cases, most of the time. Its not that everything can’t fall into place with a funding process, its just not likely to happen and you need to plan for some challenges, costs, and time.
The basic adage is to prepare for the worst and be pleasantly surprised when everything comes together without a hitch.
This may seem like very pessimistic, the glass is half full kind of thinking and it is. But in all my years of working in this business, there is virtually no such thing as an easy deal. Easy deals or easy flowing money falls into the 1% probability category slightly ahead of your odds for winning the lottery.
The take away message here is not that is all gloom and doom and that you’re not going to get the capital you require.
No, that’s definitely not what I’m saying.
What I continuously tell business owners is to get committed to the process as early on as possible and then stay invested in it as long as required and provide the resources and time necessary to increase the probability of a positive result.
In many cases, the business financing process is grossly over simplified and under estimated by entrepreneurs who would rather stick needles in their eyes than have to develop a detailed financial knowledge about any financing request they need to make. Money is a necessary evil that shouldn’t be that hard to come by, or so the thought process goes.
Unfortunately, this thought process eventually leads to failure in many cases in that money that gets secured tends to come from the path of least resistance which is typically not the most ideal form of funding available which can start the business into a death spiral it may never recover from as it continually takes on poorly suited forms of capital that will only reduce the probability of profitable results.
And when I say you need to commit to the “process”, the process is whatever is required and however long it takes to get the right match of money and opportunity.
If you say you don’t have the time for what’s required, then start the process earlier, get farther ahead of when capital is required, avoid being backed into a corner and forced to take what you can get.
Finding easy money that fits your requirements when you need it is always possible. But is it probable?
Click Here To Speak With Business Financing Specialist Brent Finlay
Equity Financing Exit Strategy
“Equity Financing Considerations Are Similar To Marriage With Some Added Twists”
When business owners are looking to raise capital through equity financing, they are planning to sell off a portion of the ownership of their business to someone else in exchange for a cash payment. This sale of ownership can be of a controlling or non controlling nature, but unlike debt financing where you pay back the money borrowed, ownership can have very long term connotations.
That’s one of the reasons why many people equate equity investing to marriage in that you’ve got to plan whether you want to be in the relationship for an extended period of time and under what conditions.
And while marriage agreements can be made going into the relationship in the form of prenuptial agreements, business financing scenarios involving equity capital should go one step further and have both an entry and exit agreement in place.
Especially for small businesses, it makes very little sense to take on an equity partner with no clear exit strategy for either partner. Many businesses get trapped in a situation where either a owner wants to leave the ownership group or the owners can’t get along anymore and someone needs to buy out the other.
Without an upfront agreement as to how an owner can exit, the process can be grueling to complete and financially damaging to both parties, but particular to the trusting and naive that get taken advantage of by the remaining owner or owners.
While any equity investment will clearly outline what you get for the cash you’re paying, it also should have its own form of prenuptial agreement and states exactly how things ARE going to end. There is no misconception here that everyone’s in it until death do us part, and even if that was the case, what happens to the ownership shares on passing? Failure to plan out the end right at the beginning is a bad idea in virtually any situation I’ve come across.
But in the hast to secure financing and the excitement of getting going or getting things back on track, the exit strategy is many times over looked or over simplified.
And the exit strategy you’re prepared to consider will also better align you with sources of financing that are better fits for what you’re looking for. For instance, there are many equity investors out there that want to double their money in three to five years and then get all their money back along with the required gain. This speaks to a very specific exit strategy that has to work for both sides at the outset of discussing the deal.
For investors that want to ride the wave of opportunity there should still be an exit plan to really protect both sides as the longer the relationship goes on the more likely something is going to happen with respect to ownership and ownership objectives.
The other part to keep in mind is that the more sophisticated the investor or investor group, the more the exit plan is going to be stacked in their favor, taking advantage of the entrepreneurs financial ignorance or sheer desperation.
So, yes equity financing is very much like marriage, but with a contract going in and one going out with the divorce or funnel preplanned.
Click Here To Speak With Business Financing Specialist Brent Finlay
Debt Lender Requirements
“Here Are The Three Debt Lender Requirements That Will Apply For Any Request For Business Financing”
I don’t want to over simply things as business financing applications can become fairly complex and involved, depending on the amount of funding a business owner is looking for and its application.
That being said, regardless of the level of complexity attached to not only getting an approval in place, but getting funds advanced, virtually all lenders are going to focus on these three main areas:
- Debt Servicing
- Loan Security
- Borrower Guarantees
Each category of lender is going to put different weights on each of these areas as well, but as one institutional lender who provides low cost financing put it to me the other day, “in the first 10 questions we ask, 9 are about debt service”.
So it goes without saying that if you’re in search of low cost financing, the proof and support for debt service are going to be the most important element being reviewed.
As the cost of financing goes up due to perceived higher risk, which is usually associated with less predictable or supportable debt service, the shift in attention moves to the other two areas as there is a greater possibility of a loan default which would require the lender to realize on securities and guarantees.
This is not to say that debt service is not going to be very important to the asset based lenders of the word. It just means that at least half of their top ten questions are going to be directed to security and guarantees pledged.
And when I speak of guarantees, this does not automatically include personal guarantees. If a business has accumulated enough retained earnings over time and non pledge asset value to provide the comfort the lender is looking for, then a business guarantee may be all that’s required. In situations where there are multiple business entities within a business group for tax purposes, its not unusual to see corporate guarantees from each entity to support a loan issued to one business in the group of companies.
These three areas are basically the 80/20 of business financing for most lenders. If the 500 page business plan or elaborate financial projections don’t adequately cover off these three areas in accordance to the lender category and risk category they are trying to get funding from, then the loan application is likely going to be a non starter.
Sharing Business Financing Risk
“Business Financing Risk Typically Needs To Be Shared”
Its not uncommon that business owners and managers in search of capital, especially those from businesses with sales under $1,000,000, seek a source of debt financing for their business that doesn’t require them to take any personal risk beyond their investment in the business.
While every business owner would prefer to minimize risk as much as possible, its unrealistic for new or developing businesses to expect lenders and sources of debt financing to take a disproportionate amount of the risk associated with a particular funding request.
In an attempt to avoid risk, owners can spend a lot of time looking for something that may not exist…that being debt financing without any form of a personal guarantee. And while personal guarantees are not always required, they will most likely will be for cheaper sources of debt financing.
And from a lender’s point of view, its not that they are necessarily gaining a great deal of additional security from a personal guarantee, but what they are gaining (at least in their mind) is 150% commitment from the business owner to do whatever it takes to make the business work, versus throwing in the towel when things get tough and letting the lender take a bath.
As businesses grow in size and increase their financial stability through the accumulation of retained earnings, there will be less of a need for personal guarantees to balance off the risk scale.
Personal guarantees or covenants are also closely linked to the type of lender you’re dealing with as well. When there is security pledged, lenders that are either good at liquidating assets or controlling them will be less concerned with personal guarantees compared with a lender taking an unsecured position or accepting security that they aren’t very adept or experienced at liquidating.
The key here is that the risk needs to be somewhat proportionate. If a business owner is asking a lender to take 80%+ of the risk, then it stands to reason that a personal guarantee is going to be required. In situations where there is more risk sharing between the business and the debt financing source then its more likely that a personal guarantee will not be required or at least a partial guarantee may be considered.
As I mentioned earlier, guarantees tend to be linked to the cheaper sources of money which relates to low risk positions for the lender. Higher lender risk will almost always mean a higher cost of financing to offset the risk if the lender is going to be interested in extending funding at all.
While the goal should always be to reduce risk wherever possible, you also have to realistic in terms of taking on a reasonable share of the lending and borrowing risk being entered into.
Click Here To Speak to Business Financing Specialist Brent Finlay