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Small Business Financing When Credit is Tight

Keeping Your Bank Happy

When serving as CFO for literally 100’s of companies over my career, I have had my share of bank meetings. Whether it is the weakness of the credit market or the lack of adequate business performance, this has recently become an unpleasant chore. Today I met with a lender that is in the process of transferring one of my clients to workout (the department of the bank that extracts unwanted loans from their portfolio). Two years ago the bank would beg to give this client more money. But today is a very different story. The bank wants out. And they are going to make me and my client miserable until they achieve that goal. This includes increased reporting requirements, oppressive interest rates, forbearance fees, appraisals, field audits, etc. These are all costs and distractions that my client would prefer to avoid.

Banks are looking for excuses to get out of loans. This is especially true when the borrower negotiated a great deal. Now that credit is tight and the market is much less competitive, banks can often alter the terms of a loan with little risk of losing a client (after all, where can you go?) Here are some tips to help you avoid these problems and keep your bank happy:

1. Produce timely and accurate financial data: Banks will assume the worst until you prove otherwise. The proof is in timely and accurate financial data.
2. Use additional services: You are going to incur these costs anyway, why not enhance your banking relationship? Whether it is merchant services (credit card processing), financial planning, or deposit relationship, additional services make you more profitable to a bank. This also gives you additional relationships with the bank. You never know when you may need leverage these relationships.
3. Over-communicate: Banks don’t like surprises. In most circumstances, the earlier you notify the bank of extraordinary events the better. Events that may warrant a conversation with your bank include large capital expenditure projects, late payments, acquisition/divestiture activity.
4. Report good numbers: Performing businesses makes everyone happy. From the banking perspective, it validates the business plan and management team.
   

You can’t control the credit market. However, you can control your relationship with your bank. The better the relationship, the more likely the bank will be willing to help you when times are tough.

Financing – Is it really worth it?

When I was in business school, I was under the delusion that entrepreneurs used other people’s money to get rich. Now I would argue that this is the exception as opposed to the norm. When most of my friends and I started our businesses, we had very little financing. For me, it isn’t because I lacked potential sources of financing (e.g. credit cards). Rather it is because of a simple truth that seems to escape a large portion of the population. You are expected to pay loans back! Whether it is a legal requirement or a moral obligation, most lenders expect you to repay your debt at some point.

For me, entrepreneurship is about freedom and flexibility. The ability to do whatever you want, whenever you want to do it is awesome. Obviously this freedom and flexibility also gives you the freedom not to have any customers and the flexibility not to make any money, but you have to take the good with the bad. The point being debt inhibits this freedom and flexibility. I have a client that is essentially being forced to work for the bank. Their business was fully leveraged. Now they are in default with the bank. The bank wants their money back. My client doesn’t have it. My client is helping the bank collect as much cash as possible before they close their doors. We hope the bank won’t enforce the personal guarantees. Although my client still “owns” the “business”, it doesn’t feel very entrepreneurial to me.

Don’t get me wrong, I understand that not every business has the luxury of avoiding outside financing. And sure, MAYBE you could accelerate your ten year plan to five years. But ultimately you must evaluate whether debt is really worth it to you (e.g. personal guarantees, debt covenants, interest costs). In my opinion, there are only a few reasons to incur debt. These include:

1. Working Capital: Financing used to help manage the Cash Conversion Cycle (or Cash-to-Cash Cycle). This is financing the purchase of a widget today for the ability to sell it at a later date (hopefully for a profit). The proceeds from these sales should be used to pay off the corresponding debt.
2. Income Producing Furniture, Equipment, Building, and Land: Essentially anything you NEED in your business to make money. Income-producing means it will either increase revenue or decrease cost. The income generated from these purchases should be used to pay down the debt in a reasonable amount of time.
3. Income Producing Acquisitions: Identifying situations where 1+1=3. When done properly, acquisitions should earn additional income through elimination of redundant headcount/overhead, cross-selling product/services, etc. Again, the income benefit generated from the acquisition should be used to pay down the debt in a reasonable amount of time.

All other costs else should be funded by equity. This can be equity from your personal net worth, retained earnings, friends, family, or outside investors.

I realize that a lot of entrepreneurs will disagree with my opinions (especially highly leveraged ones). But when credit markets tighten, businesses that practice these fundamentals will ultimately have the upper hand. Banks are still lending new money to companies that adhere to these practices. If your business is highly leveraged you are likely in trouble. A key to sustainability is to avoid getting yourself into that position to begin with.

Overcoming The 5 C’s of Credit During a Recession

I met with a prospect last week that is in serious trouble. Due to increased competition and reduced demand, they have sustained significant losses over the past few years. They have a turn-around plan. They have a good team of employees. They have the inventory to sell. They have clients to sell to. There is only one thing they don’t have, cash.

I would argue that running out of cash is the most common reason businesses fail, regardless of the size or industry of the company. Securing financing during this recession has become increasingly difficult. However, it is not impossible. In order to play the game, you need to understand the rules. The rules are the 5 C’s of Credit (Collateral, Capacity, Capital, Conditions, and Character). If you are reading this article, chances are your business is struggling in one or more of these areas. Here are three techniques we use to overcome problems with The 5 C’s of Credit.

Compelling Story

When you are looking for financing, a good story goes a long way (especially when you are trying to obtain financing for a less-than-perfect business). What has changed that is going to make the future better than the past? Who have you hired/fired? What have you learned? Although most financiers will not ignore the numbers entirely, a good story can make the difference when your business is a somewhat risky investment. When I say good story, I mean a story rooted in believable facts (e.g. solid projections, defendable assumptions, strong business plan). I have seen a good story make up for every one of The 5 Cs of Credit.

Partnering

When your business lacks Character, Collateral, or Capital, it may make sense to secure a strong financial partner. Financial partners come in many forms (private investor/lender, guarantor, etc.). Our clients have used friends, family, vendors, government, and even competitors to help secure financing. Make sure you consult with your trusted advisors before entering a financial partnering arrangement. I have seen businesses inadvertently given away due to cleverly drafted legal documents!

Acquisition

Buying a business? In this environment? Without cash? It may seem crazy at first, but think about it. If you are hurting, what do you think is happening to your competition? The trick is to identify situations where 1+1=3. For example, we have structured deals where our client paid nothing out of pocket, folded the competitor into their operation, and all of the equity stakeholders made more money (including the sellers). In this circumstance, a good portion of the income benefit came from the elimination of redundant overhead (e.g. now they only needed one phone system, one computer network, etc.) The end result was a much more viable, bankable company.

These are just some of the innovative ways we are getting financing deals done. Hopefully these ideas will help you secure the cash your business needs. Without cash, there is no business.

Government Programs to Assist With Home Mortgages

Below is a link to a website that describes the government plan to help homeowners refinance or modify their mortgages.

Refinancing: Many homeowners pay their mortgages on time but are unable to refinance. This prevents certain homeowner from taking advantage of today’s lower mortgage rates (perhaps due to a decrease in the value of their home). A Home Affordable Refinance will help borrowers whose loans are held by Fannie Mae or Freddie Mac refinance into a more affordable mortgage.

Modification: Many homeowners are struggling to make their monthly mortgage payments either because their interest rate has increased or they have less income. A Home Affordable Modification will provide them with mortgage payments they can afford.

Learn more on their website:

www.financialstability.gov/makinghomeaffordable

Launch of Business Reality Blog

After taking a few months off to work on my book, I have decided to launch the Business Reality Blog. My mission is to entertain readers, while helping aspiring entrepreneurs and business owners reach their entrepreneurial goals. This posting is dedicated to updating everyone on what has happened over the past few months.

I have made tremendous progress with my book. The working title is “PROFITPRENEUR, How Your Business Can Thrive in Any Economy” © 2009. It is an instructional book that teaches businesses how to thrive despite less-than perfect products/services, economic conditions, culture, and leadership. The book is currently around 30,000 words (approximately 80% complete). I am currently in the process of obtaining a publisher (without an agent). If I am unsuccessful in finding a publisher (or a good literary agent) within the next three months I will self-publish the book. I will continue to update you on our progress.

The re-launch of the radio program has been challenging. Although I have secured a non-exclusive agency relationship (Unicorn Consulting, New York), we have not been successful in obtaining a mutually beneficial syndication arrangement. We recently had some interesting discussions with City FM 89 in Pakistan. Again, I will keep you posted on our progress.

Dynamic Advisory Solutions is still going strong. We have a great team with a very beneficial service (especially during these challenging times). We have committed to launching a low-cost crisis management division. This division is focusing on revenue enhancement, cost reduction, and cash-flow improvement for an extremely affordable monthly fee (for any size business). Our goal is to help as many businesses as possible to survive financial crisis (even if they cannot afford our normal fees). We are also offering a money-back guaranty to take the risk out of using our new crisis management service. Feel free to contact me if you are interested in learning more about the program.

I hope you have enjoyed the update. Going forward, the blog will be very similar to my radio program “Business Reality Network”. Feel free to email me your questions or comments: rcarlton@daspc.com . I look forward to hearing from you.

Keep fighting the fight!