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GET FINANCING NOW
How to navigate through bankers, investors, and alternative sources for the capital your business needs
By CHARLES H. GREEN
The McGraw-Hill Companies, Inc.Copyright © 2012Charles H. Green
All rights reserved.
WHY DO YOU NEED BUSINESS CAPITAL?
"Sorry, we can't help you." "Your expectations are out of line with our guidelines." "It's unlikely you are going to find that much money at this stage of your business."
All funders have uttered one of these three sentences on a majority of all the proposals they have ever considered, although maybe they delivered the message with gentler phrasing. Financing is strange territory for many upstart entrepreneurs, who expect that they can ask for and receive the entire sum of money they think they need for their big idea or fledgling enterprise.
Business owners frequently ask investors or lenders for an obviously inappropriate sum of capital based on either a lack of acumen to determine their real capital costs or failure to recognize the financial risk any funder is going to require that the owner share. Closing the information gap about this financing reality will advance the owners' capital search faster than any other exercise in the early business stages.
As in most of life's transactions, there's a distinct difference in business financing between what we want and what we can get. We all want world peace but often settle for a cease-fire. We want to win the big Lotto but are happy to get just a few bucks with a scratch-off card. In business it's great to imagine someone would put up all the money to pay for the pursuit of a terrific idea, but the reality is that that probably won't happen.
Capital owners employ funding within established risk parameters with the expectation of a specified return on investment. Risk is determined within stringent guidelines that are intended to avoid expensive losses of capital. The capital owners generally have the experience of previous disasters or the aversion to taking chances beyond a defined boundary with the funds they manage. These experiences and boundaries will define their appetite for risk and, as we have learned from the Golden Rule: "Those with the gold make the rules."
Business owners must recognize that the ultimate financial risk of any financing transaction is always going to be borne by them. Likewise, most of the financial rewards of a very successful enterprise will flow to the business owner as well. It's a risk vs. reward world.
Once business owners reconcile themselves to the idea that they must acclimate their capital needs to someone else's standards and accept the brunt of transaction risk for the enterprise and the capital provider, then they come around to asking themselves: Why do I really need capital?
The quick answer to that question might be "because I don't have it." More often than not, that answer is not entirely true.
Many business owners initiate efforts to acquire capital from a third party because it is perceived to be simpler and less risky than using their own resources. Depending on one's financial position, appetite for risk, and general business optimism, the personal risk is generally inversely related to the ease of accessing third-party capital.
If business owners are laden with significant cash resources relative to their capital request, the pursuit may be effortless but certainly with significant risks. If the search is a complicated process with many roadblocks to navigate, it's because the request reflects that the capital source is evaluating more risk.
Entrepreneurs often seek to use third-party capital because it seems easier to make spending decisions with someone else's money. Compare that to situations where they may have been tempted to purchase something frivolous with a credit card that they would have immediately dismissed if the purchase required payment in cash.
People seem to consider risk as a matter of possession. Spending another's money while maintaining control of one's own seems to invoke a sense of immunity from the possibility of adversity.
This pseudo immunity may be encouraged by the false presumption of reasonableness on the part of capital owners if things don't turn out as planned. Others have misperceptions or blind faith in the murky protection offered in bankruptcy and falsely believe that the courts will provide them with a universal get-out-of-jail-free card in the event of financial catastrophe. Sometimes that faith is disappointed.
Anyone operating within the reasoning described in the previous paragraph needs to do some serious soul searching before seeking business capital. The personal risks are very real, and the failure to make judicious choices can have a long-term impact on one's lifestyle, economic future, and even family.
Self-discipline, good business sense, and patience are the best attributes to exercise in order to build a successful business enterprise. Hopefully those attributes will help owners recognize the wisdom in employing their own resources where possible to avoid handing over control of their futures to third-party funders.
Tempering the amount of external funding acquired should be one of the primary goals of all small business owners. Doing so would mean that business achievements would be created with internally generated funding that ultimately eliminates external debt. Only then can businesses realize their greatest sustainability and owners truly control their own destinies.
Obviously, many businesses could not organize or function without external capital financing, and there are many good, necessary reasons to employ it for expansion and growth. However, business owners should understand the negative attributes of third-party funding and seek it only with full recognition of the potential consequences.
Define Funding Needs in Concise Terms
Once a business owner has pondered all the reasons to acquire business capital from other sources, the owner must communicate those needs to the capital source in concise terms. The definition of what is needed and why is the most important information the funder initially seeks in order to qualify interest in a deal.
Business capital is distributed by a large number of sources that individually address only a narrow set of market needs. There are investors and lenders for every purpose, including those that exclusively fund to real estate, equipment, business acquisitions, working capital, and numerous other commercial purposes. But even these broad categories are subdivided into many niche markets that continue to be defined as the economy evolves. Some niches expand due to the creation of new funding sources or to the newly developed expertise of the financiers.
For example, there are some real estate funders that choose to invest funds only in residential property mortgages. Other funders focus only on home-equity lines of credit, owner-occupied commercial properties, investor-owned properties, industrial properties, condominiums, vacation properties, restaurant properties, undeveloped land, land developments, construction projects, foreclosed properties, and even properties obtained through tax foreclosures.
Obviously it's necessary for the owner to thoughtfully define the purpose for which money is needed in as much detail as possible in order to determine the appropriate funding source. As important is the requirement to provide the funder a thorough explanation and justification as to where and when the capital needs to be disbursed.
Clearly a business seeking funding to buy a new building has an obvious business purpose needing less explanation. But additional clarity is required to define each party's expectations of the extent that funding will be injected by each participant. If both parties assume such details based only on their preferences or self-interests, there will be some confusion at the closing table when one party is surprised to learn of its greater-than-expected obligations in the transaction.
For example, do the owner and funder agree that the closing costs are to be considered part of the acquisition cost? The answer will directly impact the size of the loan from the money source and equity contribution from the owner.
Detail Every Dollar Requested
When obtaining business capital from a third party, sometimes owners have difficulty acclimating to the fact that the funder will assert restrictions as to how the funds will be used. In fact, the proceeds from most term debt financings will be spent via direct payments from closing to the agreed expenditure.
When preparing a loan proposal the owner should carefully consider the entire capital requirement to ensure that the external funding request reflects an accurate sum of the money needed. Under- or overestimating true enterprise needs can present problems for both the business and funder.
Chiefly, an inaccurate proposal signals to the funder that there could be a management issue to consider. If the owner can't get a handle on the cost of business needs, how can the funder hope to meet those needs?
Intentionally overestimating the project costs leads the lender to suspect that the business is either building a funding cushion in the transaction or not actually injecting the owner's agreed-upon portion of the funding. Either would increase the funder's risk and raise questions about the owner's projections or character.
Underestimating the cost might lead the funder to conclude that the owner is incapable of assessing the required capital budget and hence will also disappoint the funder with estimates of other deal components, such as revenues, expenses, and profits.
It's very important to carefully evaluate the true costs that need external financing and ensure the funding proposal closely mirrors these needs. Best management practices dictate that every prospective cost and expense be identified to assure all parties that the comprehensive costs of the transaction and operation have been projected as accurately as possible.
For example, purchasing a $500,000 building cannot be viewed as merely a capital cost of $500,000. The business will incur additional costs to perform due diligence and the closing transaction according to the contract conditions or financing qualifications. Hopefully all of these costs are identified not only ahead of entering into the purchase contract but definitely before seeking third-party financing.
Due diligence and real estate closings cost money. All of these expenses must be accounted for as the owner assesses the cost of owning the building before the property is actually purchased.
And what about the building costs after the acquisition? What will the business have spent to prepare the property for occupancy? Will there be architectural fees, builder's fees, or painter's fees? Certainly there will be utility deposits, telephone system installations, new stationery, movers, network designs, signage, public relations, and many other direct costs associated with relocating to the new site.
Recognizing the full costs of such a business decision on the front end enables the business owner to make better decisions and execute a strategy with more success. Providing the funder with a detailed explanation of these impact costs and how they will be covered will assure the funder that management has the acumen to plan a safe course for business operations.
This level of planning also protects the business by considering the full effect of such a decision ahead of commitment, which allows for reconsideration if financing capacity is insufficient or the business cost is too great.
A very detailed cost examination is vital, even for the most routine business strategies, to ensure the funder that management is in command of the financial impact of implementation, that the business is capable of managing operations or expansion successfully with adequate resources (subject to funding), and that the project has a strong potential to contribute to the business's success.
Do Your Homework (Your Funder Will)
Once the business owner identifies the various costs facing the business plan, it is necessary to tie down the actual figures with exact detail. Mostly for the owner's own benefit but particularly before presenting to a funder, it is important to extend the costs to know to the penny what the total costs will be.
To protect the integrity of the calculations, it is important for the owner to obtain cost quotes in writing from the various vendors, professionals, or other parties to whom such expenses will be paid. Inclusion of this kind of documentation in the financing proposal gives weight to the projections and builds others' confidence in the due diligence the owner performed.
This process is labor intensive for sure but will save much frustration once spending starts, since there is a commitment in hand. A written estimate removes ambiguity and shows the extended costs, including add-ons such as sales tax, delivery, and installation. Such hidden costs can increase the final expense 5 to 15 percent, which is disruptive if unexpected, particularly on larger cost categories.
Minimize Where Possible, Maximize When Necessary
When seeking financing, there is a tendency among business owners to ask for as much money as they can with a straight face, under the auspices of "get it while the getting is good." Other business people may challenge that notion.
Owners should start and end with the amount of funding that they alone have determined is actually needed. They should resist the temptation to accept all the money that may be thrown at them, since it may cause them to fall prey to other businesses (other funders) achieving their own objectives at the owner's expense.
Too often business owners start with "what can we get" rather than "what do we need?" There is a huge difference. One the one hand, they have a plan, and it may be more conservative to grow the enterprise deliberately with internally generated funding. Accepting external funds may (or may not) accelerate that pace, may (or may not) drive the enterprise to greater results, or may (or may not) cause owners to lose everything for a shot at faster or higher results.
Think about the different views of the word affordable. Depending on one's risk appetite and financial discipline, one party may believe something is affordable only if there is cash on hand to pay for it today. Another may take a more conservative view that affordability requires more analysis of a larger financial scope, which may assess the investment value and what return will be gained from the expense.
Still others may assess affordable as just being able to make financing payments today.
Affordability should be assessed on enterprise liquidity over and above a defined contingency reserve and the retention of earnings over time. When considering financing strategies, the financial payoff should be tangibly higher and obvious to predict.
Spending everything one earns is not a wise financial strategy. The accumulation of some portion of past success provides the financial footings for future expansion. The constant commitment of future earnings through payment obligations is management by the next dollar. This strategy leads to a crisis when the next dollar is delayed or never appears.
While fancy expenditures may impress others, unless they contribute to long-term profitability, growth, or sustainability, they are frivolous. These three attributes are essential to long-term success of any business enterprise.
Business owners should view any decision to leverage funds carefully and ensure that other resources are considered before jumping into a loan. Utilization of internal resources where possible is much less expensive and lowers the risks considerably to the future of the enterprise.
To maintain discipline and focus on the prospects for long-term business success, it is important to minimize external funding to the greatest extent possible.
* * *
Sometimes a business will need capital financing for reasons that do not represent an extravagant expansion but rather a wise financial strategy. Sometimes decisions must be made fast in order to take advantage of a changing market or sudden opportunity. Sometimes a business needs more money than it may normally have an appetite to acquire.
In those circumstances where the right reasons exist to fund strategies that serve the business well and move the company's purpose forward, seeking to maximize such opportunities with third-party financing may make sense. While prudence should be maintained, financing the business is certainly not taboo.
Seeking the maximum funding leverage should be done responsibly, weighing the internal need and opportunity against the external terms and cost. Management must be comfortable with the business strategy and move forward without reservation that success is likely. Internal resources should still be utilized in a prudent proportion to the external funds. If the business risk is in an acceptable range, external funding can enable it to accelerate its success.
Because You Can, Doesn't Mean You Should
Have you ever concluded a search for business financing by "losing the battle but winning the war"? You are offered some funding that basically meets your goal, but something isn't right. Maybe the terms are too short or there's too much collateral required, or perhaps the loan covenants are overbearing. Maybe you think the funder is squeezing too hard and setting you up to fail? It happens.
Sometimes in their zeal to lower their risk, funders impose unreasonable terms, like requiring too much security or pricing the deal too high or setting repayment terms too short. Owners could be offered funding that they may be unable to repay. They shouldn't take it.
Excerpted from GET FINANCING NOW by CHARLES H. GREEN. Copyright © 2012 by Charles H. Green. Excerpted by permission of The McGraw-Hill Companies, Inc..
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