Business advisor: November 2010
October 25, 2010 By Jonas Cohen
For many business owners, looking for financing can be overwhelming at
any time. Throw in unpredictable economic times and it suddenly seems
next to impossible. But savvy business owners present themselves and
their financing requests in a way that gets noticed.
In-the-know business owners know how to pitch their ideas right to get the financing they need
For many business owners, looking for financing can be overwhelming at any time. Throw in unpredictable economic times and it suddenly seems next to impossible. But savvy business owners present themselves and their financing requests in a way that gets noticed. There is no cookie-cutter approach, or a “one size fits all” checklist, but here are four sound strategies to help business owners acquire the financing they need to reach their business goals.
- First, understand why you need the financing. What’s your objective? What do you need the money for? What will it enable you to do? Here are some examples:
- Meet current and planned working capital and capital expenditure requirements.
- Scale to meet the changing requirements of the company as it pursues its growth strategies, which may include acquisitions or an expansion of existing product lines, new products or services.
Second, understand the financing requirements, including type and amount, which meet the business objectives you identified earlier.
Third, consider a variety of financing options. Here is a brief overview of some of the more popular types of financing choices.
- Borrowing amount is tied to specific assets, typically inventory and receivables, with standard advance rates of 85 per cent and 50 per cent, respectively.
- Lending decisions and credit limits are based largely on the size and composition of the assets being advanced against, rather than on the business owner’s personal credit history.
Advantages: Determining the amount to be borrowed is relatively straightforward. The advance rate formulas provide a mechanism for the available loan to grow with your business, less restrictive covenants (covenants are part of the conditions of a loan agreement whereby the company agrees to adhere to limits in the firm’s operations (e.g., maintaining a minimum working capital level); and there is typically greater margining availability (amount that can be borrowed against the assets).
Disadvantages: Asset-based loans typically require slightly higher interest rates, and there are ongoing fees associated with the lender monitoring the company’s assets.
- The amount of senior term debt provided to a company usually depends on the type and quality of its collateral and the stability of its cash flows.
- Lenders also consider a company’s ability to service its loans given its cash flow. If a company has stable cash flows, the lender may provide additional funds above the collateral coverage.
Advantages: This is the most economical financing option because it has first priority on cash flow and is secured by the borrower’s assets. Payments are designed to match cash flow generated from operations so servicing the debt is not cumbersome, and it does not involve relinquishing any equity as may be involved in subordinated debt financing (described below).
Disadvantages: Stringent covenants and pre-payment may be expensive.
- Funds are loaned based on the amount and predictability of cash flow exceeding that required to service senior debt. Senior debt refers to debt that is secured by assets and takes priority over other debt issued by the company.
- Subordinated debt usually has little collateral protection and it is almost always granted with warrants (also known as an equity kicker, which provides equity participation to the lender).
Advantages: Repayment terms can be structured around cash flows. Transaction costs are generally lower than for equity issues. Terms can be tailored and can be structured as quasi-equity.
Disadvantages: This is an expensive form of financing, usually involving a high interest rate, and it can place additional burden on cash flow.
Finally, it is important to find the right lender, as your lender can provide a significant amount of value added through a strong partnership arrangement. For example, seek to find lenders/investors with a focus or specialization in your industry. They are more likely to understand your business and risks associated with it. Also, look for a solution that minimizes reporting requirements and investor/lender involvement in the day-to-day activities of your company. This will enable management to stay focused on operating activities and not be distracted by reporting requirements.
Jonas Cohen is the managing director of Fuller Landau Consulting Inc., a member of the Fuller Landau LLP group of companies. For more information, visit www.fullerlandau.com .
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