The question that is on the mind of owners of small business everywhere: How do I grow my business (and make more money)?
There are a lot of elements that are critical to growing small business: bringing good value to the marketplace, quality people, the right amount of business structure for the position in the life-cycle curve, etc. The list goes on. It seems that one impediment that is consistently dogging businesses across industries is access to cash. It takes cash to purchase inventory and pay payroll while one waits to collect receivables. This article will touch upon the most common financing methods that businesses use to accomplish their growth goals. Feel free to contact us to discuss your situation and the choices that may make sense for your business.
Many businesses are formed with injections of cash. Frankly, financiers want to see that the owner has skin in the game. Often the initial capitalization is from personal reserves, friends & family, the sale of other businesses, or through home equity loans on the principal’s residences. Capitalization from outside investors is discussed later under Angel Investors / Venture Capital. Banks in particular, like to see that a company is capitalized at least to the level that is common in the businesses’ industry.
Suppliers typically offer terms for their regular customers. Some specialty industries offer extended terms (called dating or invoice dating). Some suppliers offer discounts for quick payment. It is common to see 2/10 net 30 as offered terms. That means the supplier will accept a 2% discount if paid in 10 days, but the invoice is due in 30 days nevertheless. Banks want to see that the balance on trade credit does not exceed the balance in inventory. Otherwise they think that the business has diverted sales proceeds from paying the payables that supported the inventory from the sale. They also look at the ratio “payable days” as compared to industry averages to see if the business is overly relying on trade credit. If one does not have a bank and suppliers are patient, some businesses grow via stretching the trade credit.
Lines of Credit:
Traditional bank lines of credit are at the forefront of most business owners’ thoughts. Business owners tend to get frustrated when they are declined for a line. Banks tend to charge Prime + X, with X being 0-5%. Lines are typically granted when there are both primary and secondary sources of repayment; collateral is available (whether or not taken); and debt to worth ratios fall within industry guidelines. Secondary sources of repayment means that there is a reasonable back up plan if something goes wrong the original plan. This can include collateral, financially supported guaranties, or multiple distinctly separate sources of repayment. Non-bank asset based lines of credit fall into this category.
Many businesses want to grow faster than their sustainable growth rate. Often the businesses’ debt is out of proportion to their net worth. Factoring solves these problems. Factoring is the process of selling the businesses’ accounts receivable. Typically a receivable can be sold once goods or services become verifiable with the buyer of the goods or services. This can provide cash to meet payroll and cover inventory purchased on short terms. Factoring is a good choice for high growth companies. It tends to be a poor choice for companies with very small gross profit margins.
Letters of Credit:
Sight Letters of Credit are very common with international transactions and are sometimes used domestically with large transactions. A bank, supporting the buyer of the goods provides a letter of credit that stipulates the terms of the purchase. The bank’s credit supports the transaction, not the buyer. Upon presentation (sight) of certain documents as specified in the letter of credit, the bank pays. Occasionally a letter of credit is drawn for sight plus a number of days, perhaps 90 days. That means that the bank pays 90 days after valid paperwork is presented. In such cases the buyer gets terms. The seller may have the option of selling the approved but not paid letter of credit in the Banker’s Acceptance market thereby getting cash earlier than the 90 days.
Some companies are equipment heavy. Term loans and leasing tend to be very good choices. Basically, banks and leasing companies see equipment as good collateral (secondary sources of repayment) therefore they tend to have very good rates for leasing. Since the leasing company owns the equipment and you are renting it, they have an edge on other lenders in a businesses’ bankruptcy. This allows leasing companies to be a bit more liberal that equipment lending institutions.
Vendor financing is a choice that many businesses fail to properly consider. Vendors often make arraignments with a lender to finance their sales on a more liberal basis than they would otherwise do. Lenders may ask the vendor to guaranty a re-purchase of the items sold if the bank were to have to repossess an item. The vendor may also subsidize the interest rate. Often the bank will witness a very low loss ratio with respect to a particular type of equipment, thereby allowing them to justify more liberal lending criteria.
Sale Leaseback of assets:
Some established companies with equity in the equipment have an opportunity to grow. It may make sense for them to sale their equipment to a leasing company and lease the equipment back. This strategy allows the company to receive cash for other purposes (payroll, inventory or even other equipment purchases).
Government assisted programs/grants:
A variety of programs exist by industry and location. Some programs are sponsored at the National level, some at the State level and some at a local level. Programs include farm subsidies, SBA guaranties, micro loan programs and rarely locally distributed community development block grants. The more common national grants support specific types of innovation. Private industry has been known to issue grants, though these are hard to find. Google search will be your friend when trying to find grants.
Extend/Offset payroll periods:
Some businesses pay their employees every two weeks, or even monthly, instead of weekly. Doing so enables the business to stretch their cash. Generally speaking, employees would rather be paid more frequently. This technique is used less frequently and tends to be industry specific.
Some businesses grow their businesses by failing to fund payroll taxes to the government. This is a bad idea and I do not suggest that this strategy be followed. The potential result is tax liens, seizure of assets and disqualification for other types of credit. There is even personal liability for failure to forward the trust fund portion (employee withholding) of the taxes.
Angels are high net worth individuals that typically have other successes in business. Angels take risks for the potential of large returns. Angels often bring other Angels to the table to share the risk. They may inject capital for common stock (direct ownership). They may take a preferred stock position through a private placement, or participate through notes or warrants. Banks typically see Angel’s investment as equity and tend to allow the investment to be leveraged by a bank line of credit. Often Angels’ exit strategy is to be taken out by Venture Capital.
Venture Capital (VC) is somewhat similar to Angel investing in the form of the investments and their desired return on investment. VCs tend to make larger investments and want the company to be a bit further in their product development/sales cycle, whereas Angels tend to become involved at earlier stages.
Bob Stackhouse, President, Asset Commercial Credit
© Bob Stackhouse – All rights reserved – June 2016