Thinking Different About Alternative Financing Options

Transcription

1 Thinking Different Abut Alternative Financing Optins Christpher Mills Senir Business Develpment Officer Federal Natinal Cmmercial Credit This whitepaper will make yu think differently abut alternative financing ptins. It will highlight banking criteria fr lans, shw why many small business lans are declined and ffer insight int the pprtunities and risks inherent in alternative financing slutins. Small business Financing Needs In rder t find the best fit in a funding surce, it is imprtant t understand the reasns why financing is necessary. Examples f financing needs include: A funding gap: Imprve the cash flw frm accunts receivable and inventry t supprt payrll and perating expenses Capital Expenditure - the purchase f furnishings, equipment r sftware Finance Grwth Manage cllectin delays Acquisitin Financing Bank Financing Criteria Typically, a business first pursues bank financing, which engages strict credit criteria. Banks typically lk at the 5 C s f Credit: Credit: Analysis f business and/r persnal credit Character Cash Flw: Shws the capacity fr debt repayment 7315 Wiscnsin Avenue Suite 600W Bethesda, MD Cllateral: Prvides a secndary repayment surce shuld the brrwer becme unable t make payment n their lan. Capability: Management assessment Bankers are driven by the questins: Can the brrwer can repay the lan? Can the brrwer d s n time? and Can he can make the brrwer pay if necessary? FederalNatinal.cm Thinking Different Abut Alternative Financing Optins

2 Many entrepreneurs find it persnally ffensive when their lan request is turned dwn. Hwever, a declined lan request des nt mean anything is wrng with the business. It simply means it des nt fit within the bank s risk parameters at that time. The Discnnect 2012 Why Banks are saying N mre ften t Small Businesses 1995 thrugh 2006 was marked by unprecedented easing f small business lending standards. Sme Banks made lans with very limited dcumentatin requirements. The lan t value f the supprting cllateral (LTV) rse frm 60% t 80% in cnventinal lending times t as high as 100%. It all ended with the banking meltdwn in 2007, which resulted in a cry fr strnger banking regulatins and a retreat t mre cnservative credit standards. Simultaneusly, ver the past few decades small businesses in the U.S. mved away frm manufacturing tward the services sectr. Such service businesses d nt have as much hard, cmmn cllateral, as their manufacturing cunterparts. S when a service business applies fr a bank lan withut tangible cllateral, their applicatin is ften declined due t this mismatch. SBA Slutins T induce banks t lend mre, the SBA created several prgrams: 7(a) prgram: A small business may use the lan prceeds t establish a new business r t fund the acquisitin, peratin, r expansin f an existing business. 504 prgram: This prgram prvides a lng-term, fixed-rate financing slutin used t acquire fixed assets fr expansin r mdernizatin. CapLines prgram: This prgram is designed t help small businesses meet their shrt-term and cyclical wrking capital needs. The cntract lan prgram is used t finance material, labr, and verhead needs fr a specific cntract r cntracts. The seasnal line f credit is used t supprt buildup f inventry, accunts receivable r labr and materials abve nrmal usage fr seasnal inventry. Wrking capital line is a revlving line f credit that prvides shrt term wrking capital. These prgrams prvide access t capital t brrwers wh may have sme financial weaknesses and/r cllateral shrtfall. The SBA guarantees 75% t 90% f the lan, which makes banks mre cmfrtable extending credit t a cmpany that therwise wuld nt fit within their credit parameters.

3 Despite the lan guarantee, nt all banks participate in the prgram fferings. And even with the participating banks, brrwers still need t qualify n The 5 C s. When applying fr the SBA backed lans, brrwers need t prepare fr a lengthy lan prcess that typically lasts fur t six weeks. Sme prgrams have variable rates, which bear the ptential fr an interest rate increase. Often persnal assets can be required fr cllateral. If a business is unable t btain a bank lan, alternative financing may be a slutin. Alternative ptins can als help businesses that are nt willing r able t vercme the bstacles f the SBA prgrams. Alternative Financing Optins Family and Friends Smetimes an early stage entrepreneur may lk t a wealthy family member wh can prvide flexible financing ptins with terms n cmmercial surce can cmpete with. Family members typically d nt charge interest, may allw deferred payments and ften require n cllateral. A unique risk f this funding surce is that if things d nt wrk ut as planned, they may affect family dynamics. Hme Equity Hme equity lans are usually very cheap and allw fr flexible financing terms. They may be as lw as prime +/- 1%, have a 25 year term, and allw fr easy access t funds. These lans are based upn the hme equity and persnal incme, nt n the business financial strength. Hwever, in the current husing market nt many hmes have enugh equity available. They als bear the risk f persnal liability (including freclsure) if the business fails. Credit Cards Credit cards have the advantage f lw minimum payments. Mrever, persnal incme and credit scre are relevant fr their apprval, rather than business financials. Yet, a significant drawback t credit cards is that lines are nly available in relatively small amunts that successful businesses quickly utgrw. Quickly changing terms upn nn perfrmance may als pse a cst risk. It is crucial t read the small print t avid expensive surprises. Angel Investrs Angel investrs finance grwing small businesses in their early stages and take equity in the cmpany. Investrs usually lk fr a return n investment f 20% t 25% and tend t supprt lan

4 needs in the range frm $100 thusand t $2 millin. They may als prvide strategic cnsulting t the small business. Hwever, it can be difficult t find the right partnership. Venture Capitalists Venture capitalists help small business get access t funds and prvide management expertise in exchange fr part f the wnership f the cmpany. They ften fcus n specific industry niches and prvide small businesses with much needed market intelligence. In sme cases the mney cmes in easily, which tends t create a lack f urgency with the business wner. Fr example, this was happening in many businesses during the Dt-Cm bubble. This is equity financing, which means the funders wnership is diluted by the venture investrs wnership, s in the lng run, this can be very expensive financing. Pr perfrmance can cause entrepreneurs t lse cntrl r even their wnership f the business. Venture capitalists typically have a three t five year timeline t return their investment. Equipment Leasing Equipment leasing typically finances up t 120% f the needed lan, including sft csts. Usually n dwn payment is required. The entire lease payment may be tax deductible. Yet, this frm f financing can be expensive cmpared t purchasing the equipment. Even thugh the brrwer has n wnership f the equipment, he remains respnsible fr maintenance and upkeep f the equipment. Asset Based Lending Asset based lending is a specialized lan that prvides funding limited by a brrwing base, which is cmprmised f advance rates applied t the accunts receivable and the liquidatin value f inventry. This frm f financing prvides wrking capital fr businesses which therwise culd nt qualify fr a line f credit. Asset based lending allws the line t increase as the cmpany s wrking capital needs rise. Asset based lenders extensively scrutinize the assets thrugh independent appraisals and cllateral audits supprted by strng reprting systems. Additinally, cllectins and sales are reprted n a daily r weekly basis. Interest rates n asset based lending facilities typically run frm prime plus 1% t 4%. Additinal fees, ften as much as r greater than the interest, are als necessary t secure assets and manage cllateral (e.g. cllateral mnitring fees, field exams).

5 Factring Factring is a methd f generating cash fr yur business by selling yur accunts receivable fr 75 % t 90% f their face value t a finance cmpany. It is nt a lan. Instead, it is a purchase f an asset (the invice) by an investr r finance cmpany. Factrs fcus n the quality f the receivables, rather than the credit wrthiness f the brrwer. This funding surce allws quick access t funds and allws brrwings t increase rapidly with business grwth. The brrwer s clients are ntified t make payment t the factring cmpany. With respnsible and reasnable ntificatin and verificatin practices, this des nt harm custmer relatinships. The finance cmpany even assumes many f the tasks assciated with the cllectin, allwing the business wner t fcus n their wrklad rather than chasing after payments. Hwever, if the accunt debtr (the brrwer s client) neglects t pay their invice by a predetermined date r fails t pay altgether, the brrwer will we the factr fr the balance. Csts vary widely but are cmparable t pricing fr nn-bank asset based lending services. Psitining Yur Cmpany fr (Credit) Success N matter what ptin a business wner chses, they need t psitin their cmpany fr credit success befre the lan need arises. T get prepared a business wner shuld: Speak t several lending prfessinals well befre the lan is needed Invest in the cmpany s accunting infrastructure Prvide a cmplete lan package: This will raise yur credibility and speed up the prcess. Be upfrnt regarding any issues with yur financials: Remember, character is an imprtant part in the lending decisin prcess Understand the lan decisin and if declined, stay in tuch with the banker Chse trusted advisers with an understanding f yur Industry and yur target market Cnclusin It is imprtant t select the right frm f financing that fits yur business type and needs. Alternative financing ptins, thugh mre expensive than bank financing, may be available t a small business despite a lack f cllateral r weak financials. Start the lan prcess early t psitin yur cmpany fr success..