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An Alternative to Franchise Finance – Private Investors

July 12, 2010 by Frank Goley, Business Consultant

With bank and franchise finance drying up in this economy, a smart entrepreneur came up with a solution. A platform to link investors with potential franchisees. FranEquity provides a platform where a potential franchisee in need of money can present an opportunity and accumulate investors into a group so the franchisee can qualify for bank or traditional finance. This platform also matches franchisors with investors.  

This type of system really opens the doors for many entrepreneurs seeking capital to start or grow a franchise. Here are some applications of this concept which may be helpful in your capital raising efforts:

Ø  If you want to fund a franchise start up but lack capital and expertise, then consider putting together a local private investor group to fund 40-50% of the funds necessary and then finance the rest with the bank. Use a good law firm to set up the investment group and define the rules.

Ø  Already a business owner and want to franchise your concept? Don’t have the funds? Consider forming a private investment group so you can develop the system and do some test franchises. Leverage your investment group into larger bank finance when ready to sell your franchise concept.

Ø  Already own a franchise but can’t get financed for more units? Consider forming a private investment group to help you qualify under the franchisor terms.

There are a ton of applications and advantages to this franchise finance concept. Namely, if a franchisee has the expertise to run a franchise unit, then he or she shouldn’t be disqualified for lack of funding. It is a win-win for both the franchisee and the franchisor during a period of tough business finance acquisition. Apply it to your circumstance and see what creative ways you can come up with to enter the franchise market.  

Disclaimer: ABC Business Consulting is not offering investment or finance, nor endorsing a particular company in this blog post. Please conduct your due diligence and utilize legal help when considering such a strategy.

Video Resource: Bank Franchise Finance

Posted in Business Finance. Comment

Should You Rollover Your IRA or 401(k) to Fund Your Business Start Up?

July 9, 2010 by Frank Goley, Business Consultant

I was a Financial Planner back in the day but no longer practice. More than likely as a financial planner I would advise not to do this if you are using all or a majority of your retirement funds to do so. Moreover, there are all the tax rules to consider – another big negative and potential risk.

But from the standpoint of a Business Consultant, it is my job to share ways to fund your business and present the positives and negatives of a Business Funding Strategy. It is up to you to decide, but if you are going to consider this funding strategy, be sure to meet with both a very qualified Tax Attorney and ERISA CPA to discuss the pros and cons.

Nearly 4,000 businesses in 2009 used this strategy to launch their businesses. Why so many? I will discuss why, but first let’s see how it is done.

The Mechanics of the Retirement Fund Rollover as a Business Funding Strategy

– Step 1 – Move Your 401(k) or IRA into an ERISA Profit Sharing Plan: This ERISA plan then becomes the retirement plan for your new company.

– Step 2 – The New Retirement Plan Buys Stock in the New Company (C Corp):  When the funds have transferred into the new company, it becomes Tax Free Capital. The idea is you are buying stock in your own company rather than the stock of another.

– Step 3 – Open a Business (Corp) Checking Account and Pay Yourself Back: You must offer the retirement plan to the employees and use it as a retirement plan.

The Risks

v  Your business may fail and there goes your retirement money.

v  You may violate the complicated ERISA rules and end up paying harsh penalties and taxes. Very complicated compliance rules. Be sure to read the IRS publications on this strategy, including: http://www.irs.gov/pub/irs-tege/rollover_guidelines.pdf

v  Fee up to $5,000 to set up the ERISA Plan, plus all the Attorney and CPA fees prior to assess it.

v  On going annual fees to maintain the ERISA Plan in compliance with the IRS, which can run up to $1,500 a year.

v  Some Tax Experts predict the IRS will crack down on these plans in the future.

The Advantages

v  Cash is King in business. You do not have to strap the cash flow of your business with this strategy.

v  Businesses not burdened by debt finance can become profitable much quicker.

v  Tax Free

v  Doesn’t require a credit score to acquire the capital. Bank finance is hard to find even for credit worthy applicants, let alone a start up.

v  Money is ready quickly. You don’t have to wait on banks or investors.

v  60,000 jobs and $8.3 Billion have been added to the Economy as a result of these Plan Rollovers.

v  You don’t have to secure a second mortgage on your house and adversely affect your personal cash flow to fund your business.

v  Great way to attract quality employees to your Start Up by offering a Company Retirement Plan right from the start.

v  If you only use a portion of your Retirement Funds to set up the Rollover Plan, then you don’t risk your future retirement funds in the event the business fails.

v  Combine the retirement funds with other Business Finance Sources to find the best mix of cash and debt finance for your business.

The Bottom Line

Don’t risk all your retirement funds to try this strategy. Whether the business turns out successful or not, most smart entrepreneurs only use 20-30% of their retirement fund to set up the new company retirement plan. It depends on your financial security and if you have kids or not – in this sense, it is a personal financial planning decision as well. Understand the implications of all the IRS Rules and the possibility of future IRS scrutiny.

Disclaimer: Frank Goley or ABC Business Consulting is not offering tax, investment or legal advice. Consult an Attorney and CPA for tax and legal advice.

Video Resource: Why the Retirement Fund Rollover as a Business Funding Strategy May Not be a Good Idea…

Posted in Business Finance. Comment

What Venture Capital is Looking For in this Market

July 7, 2010 by Frank Goley, Business Consultant

If you think you require venture capital, then it pays to do your homework.

With the Recession, Venture Capital has shrunk 18% the first quarter of 2010, compared to 4^th quarter of ’09. Some say that is good, others say that is bad. Either way, you need to understand if you have a fundable business model for Venture Capital, what VC is looking for in an opportunity, how to find VC and what VC investments are hot now. So here is a Venture Capital checklist for you to help steer you through the competitive market of venture capital.  

The Venture Capital Checklist

ü  Is Venture Capital really appropriate for your business model? Will your company be fast Start Up, grow very big quickly, and have an Exit of a sale or IPO?

ü  Understand only 1 in 20 serious deals get funded

ü  Tap VC networks of professionals and advisors to get close to a viable VC firm.

ü  Get close with a VC’s group of funds relationships

ü  Up to 50% of VC inquiries can come from cold contacts but highly recommend you find a referral source

ü  Find the VC inner networks. These people are trusted by VCs and are great referral sources. This includes previously funded entrepreneurs.

ü  Find VC by researching online

ü  Find VC by using your personal networks and the social networks

ü  Use VC attorneys and accountants for an introduction

ü  Research the companies a particular VC firm has invested in

ü  Read very carefully what the VC principals say and write and make that personal, informed connection when contacting them via email. Make it a personalized email!

ü  Keep the introduction email short: how much looking for, why you are a good fit to the fund, comment on the principal’s writings and speeches and make a personal connection. In other words, do your homework on the VC and keep your initial contact short and too the point but very personalized.

ü  The lead Entrepreneur(s) is scrutinized for knowledge, credibility and experience around the business opportunity.

ü  The entrepreneur has real Passion.

ü  Entrepreneur has vision

ü  The entrepreneur isn’t too optimistic about potential problems and threats

ü  Company has a great Team in place.

ü  The management team is more important than the business idea. A great team can be profitable with a mediocre idea. A great idea with a mediocre team fails.

ü  A website that already has lots of Organic traffic

ü  A Web Model that makes profit sense

ü  Understand online marketing well

ü  A Product or Service Solution that will change the market or create a new market.

ü  Some Current Hot VC Areas: Wine, Food, Financial Services, Video Delivery, E-Business Infrastructure, Infrastructure around Cloud Computing, Media and Music. Solutions to save Consumers and Businesses money in this long Recession.

If you don’t qualify for Venture Capital, consider private investors. If you qualify for VC, use private investors to get you VC.

Resource: Here is a Video on How Venture Capital Works

Posted in Business Finance. Comment

Have You Considered Micro Lending, Community Banks and Credit Unions for Your Business Finance Needs?

July 2, 2010 by Frank Goley, Business Consultant

The business finance statistics are sobering: Commercial Loans by US Banks have decreased 21%. Wow! So how does a business get funding? Well, there are still a few ways left…

Micro Lending

Micro Loans have been out a while but now there is a new twist. There is now Micro Venture Funding. These Micro funders collectively gather funds from investors and spread the risk among different investments. You can get a loan or investment from a pool of investors, all managed by a Micro Fund. To qualify, it is more about business model and cash flow, verses credit score and traditional bank finance parameters.

Your Community Bank

Search for Community Banks that care and understand your business. Pair that up with an SBA guarantee and you will be surprised that you can still secure bank finance, even if things are not so good with your business in this recession. Find a banker that listens and is in tune with local businesses.

SBA backed loans increased this year due to an influx of $1 Billion in loan guarantees from the Recovery and Reinvestment Act. Hopefully the proposed $30 Billion from TARP will be approved and available soon through the Small Business Fund. Your local SBDC can provide you a list of local SBA lenders.

Community represent 97% of all banks in the US. There are a lot of them. Go hunting in your backyard for one interested in your business and willing to help. Be sure to present the best picture possible to a bank with a well prepared Business Plan and Loan Package.

Credit Unions

While less than one third of all Credit Unions make business loans, it is worth the search! Business Loans are the fastest growing financial line for credit unions so you will find more and more starting to lend to local businesses. While Credit Unions may be a little more stringent, their average business loan is $200,000. So if you are looking for a loan in that range and qualify well, then compare the credit union to your bank finance. You may just find a better deal! Also most credit unions will find a way for you to join if you are a potential good customer.

Good luck and let us know about your business finance struggles and successes. We would love to share the experience and knowledge!

Resource: Video on Getting a Business Loan with a Credit Union

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How to Prepare a Business Loan Package for a Bank or Private Investor

June 28, 2010 by Frank Goley, Business Consultant

A Loan Package is typically used for Real Estate Development Projects and Acquisitions, but there are parts of the Loan Package which are applicable to the other types of Business and Commercial Loans.  If you are seeking a Loan from a Commercial Lender or Funding from a Venture Capital Firm, it is very important to present a well organized, detailed Loan Package.  The Loan Package gives the Loan Officer/ Venture Capitalist the necessary information to gauge the viability of your loan request, enabling them to provide you a specific loan term sheet and commitment.  All Lenders have different requirements, so customize your Loan Package to their parameters.

Organization Tips

Loan Packages are voluminous and paper intensive so it is very important that it is well organized with a detailed Table of Contents and alphabetical Tabs indicating different Sections, correlating to the Table of Contents.  This way the Loan Officer can easily find the necessary information in the Loan Package when analyzing and assessing your Loan Qualification and the resulting Terms. 

The Loan Package should be bound in paper form, as well as, scanned to a DVD Disk using Adobe Acrobat™  to suit the Lender’s particular preference.  Mail the Loan Officer a bound, paper copy along with the DVD.  This way the Lender can print out different sections for various Loan Committee members and decision makers.  The DVD should be well organized, with each Section of the Loan Package as a separate, labeled Folder, all presented in the order indicated in the Table of Contents.  The first Folder on the DVD should contain the Table of Contents indicating the Section Names with their applicable Tab Letter (the Alphabetical Tab Letter should appear in the name of the particular Section’s File).

Loan Summary

Preceding the Loan Package document is a Loan Summary, two to three pages in length, which summarizes the important parts of your Loan Request.  The Loan Summary is the first section in the Loan Package and can also be used as a stand alone document to generate and gauge interest in your project.  If used as a stand alone document, it should be accompanied by the Long Form Executive Summary.  The Loan Summary is to a Loan Package what an Executive Summary is to a Business Plan, a summary of the key aspects and facts of the overall Loan Package.  For this reason, the Loan Summary should be developed after the Loan Package is completed. 

Suggested Loan Summary Format

1.     Company Information

2.     Project Description

3.     Company / Project Principal’s Experience Summary

4.     Sources and Uses of Funds

5.     Requested Loan Terms

6.     Summary of Assets and Collateral

7.     Project Financial Summary

8.     Current Company / Project Financial Summary

Loan Package Format

1.     Table of Contents

2.     Loan Summary

3.     Company / Project Information, Contact Details and History

4.     Principals’ Backgrounds, Experience and Resumes

5.     Key Project Employees, Executives & Managers’ Experience and Responsibilities

6.     Company and Project Organizational Chart

7.     Company Registration

8.     Project Description

9.     Project Pictures and Renderings

10.   Key Roles & Relationships:  Company, Strategic Partners, Third Parties and Government

11.   Sources and Uses of Funds

12.   Company & Project Collateral, Assets, Liens and Loans

13.   Schedule of Real Estate

14.   Rent Roll

15.   Company and Principals’ Credit Standing and Credit Reports

16.   Principals’/ Company Financial Statements

17.   Company Balance Sheet

18.   Project Budget

19.   Company and Project Cash Flow Statements

20.   Pre-Sale Commitments

21.   Project Appraisals and Valuations

22.   Project Studies, Feasibility Studies, Business Plan, Consulting Studies and Engineering Studies

23.   Project Proposals and Contracts, Lease Agreements and Escrow Agreements

24.   Title Policies

25.   Annual Reports

26.   Tax Returns:  Personal and Business

27.   Project Strategic Plan and Time Line

28.   Project Construction Plans, Specifications, Drawings, Surveys and Maps

29.   Project Construction Cost Breakdown

30.   Construction Cash and Finance Disbursement Schedule

31.   Project Construction Cash Flow Statement

32.   Project and Company Advisors, Consultants, Contractors, Construction Team, Legal Firms, Accounting Firms and Engineering Firms

33.   Appendix

For more details on developing an effective Loan Package, please consult my Comprehensive Business Plan Guide and Workbook.

Posted in Business Finance. Comment

How to Prepare An Investment Overview to Obtain Venture Capital or Private Investment for Your Business

June 25, 2010 by Frank Goley, Business Consultant

The Investment Overview is used in conjunction with your Long Form Executive Summary to not just solicit interest from an Investor or Venture Capital Firm about your Business Opportunity, but also to give the Investor the necessary facts about your opportunity so it can be quickly qualified and vetted.  The Venture Capital Process can be lengthy, but by providing the right documentation (already prepared prior to your Funding Initiative) from the get-go, you will significantly shorten the VC process and garner the attention your deal deserves.  The Investment Overview should accompany your Long Version Executive Summary (basically a mini- business plan) so the Investment Group can gather more in depth information about your Company, Product, People and Competitive Edge.

An Investment Overview is very detailed, yet it should be brief and concise.  Your Executive Summary and Business Plan will provide the next levels of detail the Venture Capitalist requires.  You will find a suggested Investment Overview Template in this article, and we recommend you customize it to meet the specific terms, objectives and requirements of the Investment Firm you are targeting.  Venture Capital Firms readily provide their investment Criteria and Requirements so that prospective entrepreneurs can provide them the information necessary to determine the deal’s qualifications in view of their investment parameters.  This is probably the single most important document you will send to prospective investors, so ensure it is targeted, concise, complete and accurate, with no mistakes or sloppiness.  Develop the Investment Overview last, after you have completed your Business Plan, Executive Summary, and Loan Package.

Suggested Investment Overview Format    

  I.        Company

A.    Company Name

B.    Location

C.    Business Type and Industry

D.    Business Stage

E.    Business Form

F.    Business Formation Date

G.    Company and Venture Overview   

II.        Product and Service

A.    Product and Service Description

B.    How the Product and Service is Unique

C.    Proprietary Characteristics

D.    Patents, Trademarks and Service Marks  

III.        Experience

A.    Business History Summary

B.    Founders, Directors and Principals

C.    Managers and Key People

D.    Track Record

E.    Previous Venture Capital and Investment Deals

F.    Key Experience  

 IV.        Market and Competitive Edge

A.    Current and Projected Market Penetration

B.    Market Niche

C.    Competitive Edge   

V.        Financial Overview

A.    Investment to Date

B.    Principals’ Equity Contribution

C.    Company Net Worth

D.    Principals’ Net Worth

E.    Investment Required

F.    Terms

G.    Proposed Structure

H.    Exit Strategy

I.      Investment Stage

J.     Liquidity Options

K.    Valuation Pre and Post Investment

L.     Current and Projected Debt to Equity Ratio

M.   Current Ratio

N.    Acid Test Ratio

O.    Collateral

P.    Current Liens, Loans and Terms

Q.    Year to Date Profit (Loss)

R.    Projected 1^st to 3^rd Year Profit (Loss)

S.    Current and Projected Net Profit Margin (%)

T.     Appraised Values (and Methods)

U.    Return on Equity

V.    Return on Investment

W.   Management, Market, Technological and Investment  Risks

X.    Funds Disbursement Schedule  

VI.        Due Diligence Synopsis

A.    Litigation

B.    References 

VII.        Five Key Questions and Answers on this Deal

A.    Why is this a viable opportunity?

B.    Why I am doing this venture?

C.    Who I talked to in similar businesses?

D.    Have I tried out the Product or Service in the market?

E.    Has my Plan been reviewed and critiqued by Accountants, Attorneys, Bankers, Mentors, Consultants and other Professionals?

For more information on Venture Capital and Private Equity Finance Strategies, Funding Business Plans, Business Financials, Financial Projections, Financial Formats, and Financial Formulas and Calculation, please consult my Comprehensive Business Plan Guide and Workbook.

Some of my Business Finance Articles which you may find helpful…

Small Business FinanceBusiness Funding Sources

Business Funding Strategies

What Investors look for in a Business Investment

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How to be Prepared for Investor Questions When you Present your Business Investment Opportunity

June 24, 2010 by Frank Goley, Business Consultant

By understanding what investors are looking for in a business opportunity and what their potential questions about an opportunity can be, will help you tremendously when looking to raise private equity finance and venture capital. I was in the private equity business for several years and learned a few things along the way in attracting private capital. Here are some of those crucial things I learned about investors along with some suggestions from a venture capitalist, which I agree to 100%.

Review your original Business Plan Questions for possible Investors Questions (please see my Business Plan Workbook for a list of Business Plan Questions).

Know your Product Development Plan, Marketing Plan and Strategic Plan cold.

Answer these Five Key Questions about the opportunity before the meeting:

§  Why is this a viable opportunity?

§  Why I am doing this venture?

§  Who I talked to in a similar business?

§  Have I tried out the Product or Service in the Market?

§  Has my Plan been critiqued by Accountants, Attorneys, Bankers, Consultants, Key Business Influences, Business Mentors and other Professionals?

From the VC Insider Section of the January ’09 Entrepreneur Magazine, Venture Capitalist, Brad Feld, has an Article, “Perfect your Pitch”, which lists eight common mistakes entrepreneurs make when pitching for Venture Capital:

§  Not Knowing Your Audience:  Understand the Venture Capitalist’ niche areas of investment.

§  Asking the VC to Sign an NDA:  And we quote Brad Feld directly on this one:  a Non-Disclosure Agreement “is a stupid idea perpetuated by lawyers.”  Most VCs won’t sign an NDA so why try? Present your Business Plan and supporting materials in a way that protects your interests. If a VC gets serious, then you can discuss Confidentiality issues at that time.

§  Sending a 74 page Business Plan in the mail:  Instead send a short email directly to the Venture Capitalist, personalized to him and his firm, introducing yourself and your Company.  Send him a 3 page Executive Summary and a 2 page Investment Overview if the VC shows an interest to your initial email.  The VC will let you know the steps and info needed from that point on.  For a detailed information on VC Funding, please see these articles:

·         Funding Sources for Your Business

·         How to Analyze Business Funding Sources and Strategies

§  Spamming 150 Venture Capitalists with a “Dear Sir” Email:  This is the kiss of death.  Don’t shop your deal; personalize your email; and do proper research, only targeting 1-3 strongly matched VCs at a time. 

§  Name-Dropping other Venture Capitalists:  This will result in an unsuccessful contact.  Let the VC lead, and he / she will ask you who else has looked at your deal, and who else maybe potentially interested.  VCs by their nature aren’t impressed with name dropping or pressure tactics.  However, it is good business to use other Venture Capital Firms to refer you to a VC which they feel will fit well with your opportunity.  The best referral you can get is VC to VC.  Please refer to my Business Planning Guide for tips on how to leverage a “no” from one VC into a “yes” from another.

§  Listing 27 Advisors but only one Co-Founder:  And I quote Mr. Feld again, “advisory boards, especially at the very early stages of a company, are generally useless”.  I can’t argue this point.  Strategically placed, highly engaged Advisors, numbering 3 to 5, is much more credible than having a bunch of well-known names that have little to do with your business.

§  Using the Wrong Materials at the Wrong Stages:  As a Business Consultant, I preach this to clients all the time.  It is important to have an “arsenal of presentation materials to go.  However, dumping it all on the Venture Capitalist with one big thud is rarely effective”, says Mr. Feld.  I completely agree. I suggest you have ready:

·         Executive Summary (one long version of 5-7 pages; one short version of 3 pages max)

·         Investment Overview 

·         Funding and Comprehensive Business Plans

·         Due Diligence Package

·         Product  / Service Demo

·         Power Point Presentation

·         Marketing Plan

·         Strategic Plan

·         Loan Package

§  While it is important to have all these before mentioned documents prepared and ready to go, you should always proceed slowly and provide the VC what he/she wants, when asked.  VC likes to have access initially (upon request) to a Demo or Power Point Presentation, reviewing it at his option and talking with the Entrepreneur, rather than being aggressively pitched. 

It is important to keep two key things in mind when sending VC information on your Company:

·         Let the VC lead and tell you what he or she prefers.

·         Customize all your materials to the particular VC’s objectives, background, history, track record, current portfolio, outlook, etc.

§  Thinking There are Rules that Apply to all Situations:  As Venture Capitalist, Brad Feld, says “…tune your approach to each Venture Capitalist.”  Research and a well developed Financial Strategy customized for each VC is critically important.

When researching Venture Capital Firms, be sure to find one that will bring valuable connections, experience and resources in your Industry.  Venture Capital isn’t just about investment of monies in your Company, but also a potential, valuable resource to tap for your Company’s Future Success.

Need help with your Funding Business Plan? Please see our Business Plan Packages…

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What Private Investors Look For in a Business Investment Opportunity

June 23, 2010 by Frank Goley, Business Consultant

You have developed your Business Plan and Investment Overview, and now you are ready to approach Investors about funding your Company.  But before doing so, it is important to know what the Investor is looking for and understand the Investor’s perspective.  This post lists a host of variables an Investor considers when looking at a business investment opportunity, as well as, ways to make your investment opportunity more attractive.

Market Driven Company:  Market, Sales and Profits are more important than the Technical and Technological aspects.

·         Short payback Period.

·         User’s Benefit more important than Product Innovation.

·         More importance placed on Market-Driven verses Technology-Driven.

·         Market Penetration:  If an Investor is convinced by your Marketing Research and Penetration Strategy then he or she sees your Financial Projections as Realistic and Achievable.

Your Business Plan should show How and When Investors can Cash In (Exit Strategy).

Investors are typically satisfied when Ventures reach 50% of their Financial Goals.

In general, Investors are looking for a Return on Investment in the 40-60% range, dependent on Risk and other variable determinants.

Investors manage Risk by looking at the Management Team and Product Status.

·         A fully developed Product and proven Management Team should yield a Return on Investment in the 35-40% range.

·         Incomplete Products and Unproven Management Team should yield a Return on Investment of about 60%.

Investors calculate the Value of a Business at the Five Year Mark to determine what equity stake percentage will yield their expected Return.

·         Example Scenario:  Developed Company

o    Developed Company projected to yield a 35% Return on Investment per year.

o    Investors want 4.5 times their investment over five years.

o    In Five Years the Company has $20 Million in Revenue with a Net Profit of $1.5 Million.

o    Assume 10 times earnings:  Company would be worth $15 Million in Five Years.

o    Company wants $1 Million in Venture Capital, so the Company should grow to 4.5 Million in Five Years to satisfy Investors.

o    Company is worth $15 Million in Five Years, so Investors would require an Equity Stake of 33%, before Inflation.

·         Example Scenario:  Undeveloped Company

o    Return on Investment Outlook of 60%, you will need a Net Profit of $15 Million in Five Years.

Companies with an Accepted Product, in a Proven Market, with Competent and Experienced Management, win the Investment Funds at the Lowest Cost.

Traditionally, Investors Gauge Performance by looking at Financial Projections compared to Performance, but they more often look at Management’s Milestones (Strategic Plan), Achievement Success and Adaption as the Process to determine whether and how much to fund the next stage in a Company’s Growth.

The Entrepreneur (Founders) must be Reliable and Driven.  Entrepreneur has a Successful Track Record. Experience is Key.

The Entrepreneur should know his or her Money Needs at specific time intervals.  Set up a schedule to track Progress with the Venture Capitalist so it will coincide with your Funding Needs.

Entrepreneur needs to look at ways to Reduce and Mitigate an Investor’s Risk.

Demonstrate Credibility to an Investor by using a Network of Influential Mentors and Contacts.

Use a Combination of Debt & Equity Finance (see my Article on Financing a Small Business) with Investors.

·         Venture Capital Firm receives part of their funds in interest payments, which are Tax Deductible to them.

o    VC recovers Tax-Free Cash when the Loan Principal is repaid.

·         Convertible & Preferred Debt provides easy Liquidation.

Posted in Business Finance. Comment

How To Mix Business Capital Sources in a Cohesive Business Funding Strategy

June 22, 2010 by Frank Goley, Business Consultant

Understanding how to mix equity and debt, as well as, combine various business funding sources and capital is necessary in determining an effective business funding strategy. Putting together a cohesive funding strategy prior to your capital campaign is absolutely essential toward finding the right amount and type of business capital necessary to reach your business goals.

I.  The Relationship between Debt and Equity

Concept of Leverage:  Utilizing a Low Rate of Interest Debt Structure to leveraging into Investing the Loan Proceeds into an opportunity at a projected higher Rate of Return. Compare the relationship of using Debt verses Equity.  Variables would be the Interest on the Debt, the Effect of Taxes and the Economic Reality.  Equity and Debt should not be an either/ or proposition but a proper mix to meet your Financial Modeling Scenarios Goals.

– Calculate Return on Equity:   Earnings divided by Equity. Consider the effect of Harvesting the Asset in an upside & Downside market. So while a Debt structure, allows you to leverage Equity, in an Economic Downturn, the Loan Interest can cause the Equity Investment to lose money.

The Cost of Debt Finance:  Cost of Debt = Interest Rate x (1.00 – the Effective Income Tax Rate).

The Cost of Equity Capital:  Cost of Equity = Earnings Participation divided by Investment or Earnings per Share divided by Selling Prize per Share.

Comparing Equity and Debt Capital:

– Cost:  Equity Capital is more costly than Debt Capital, as the Investor is exposed to much Higher Risks than the Lender, and to justify the Risk, the Investor seeks a High Return.

– Investor Risk verses Lender Risk

·         Interest deducted from earnings prior to distribution to Investors.

·         Legal requirement to repay debt, not equity.

·         Lender has greater access to collateral and liquidity availability.

·         In the event of business failure, Lenders are paid before Investors.

– Risk:  Equity risk lies with the Investor, yet, Debt Capital Risks are high to the Company:

·         Interest penalties.

·         Repayment demand during low Cash Flow Period.

·         Collateral Claims.

·         Personal Guarantees.

·         Unsuccessful Re-Finance or Expensive Re-Finance Terms.

– Flexibility:

·         Equity Capital much more flexible and efficient.

·         Alternative Debt Sources (Hard Money, Bridge Loans, Factoring, etc.) are Expensive but offer Flexible Debt on a short term acquisition schedule for a short term period (i.e. Rent Money).

·         Equity can limit Debt and vice versa depending on Covenants and Agreement Terms.

·         When combining Equity and Debt, Equity can make Debt much more Flexible, Attainable and Economical.

– Control:

·         Equity has Board Seat and Share Ownership.

·         Hybrid Debt Products (Hard Money, Mezzanine Finance) can have an Ownership Component.

·         Debt can control a business with a high Loan to Value/ Cost, high interest rate and steep penalty/ default terms.

·         The proper Mix of Debt and Equity is the answer.

II.  Combining Capital Sources

Typical Mix Considerations

·         Internal Cash Generation:  Retained Earnings Maximization, Good Asset Management, Solid Cost Control, etc.

·         Trade Credit / Supplier Credit

·         Matching Principle:  Short-Term Debt for short term needs and Long-Term Debt for long-term needs.  Utilize the Current Ratio Formula.

·         Debt to Equity Mix:o    Founder and Angel Investor Contribution = 20%o    Long- Term Debt = 40%o    Short- Term Debt = 10%o    Equity Capital = 30%

o    Other successful mixes:

§  10-50-10-30

§  10-60-10-20

·         Debt Capacity = Acceptable Debt to Equity Ratio x Equity

o    A typical Acceptable Debt to Equity Ratio is 1.00.

o    The above Formula measures the proper level of Debt to Equity with the injection of additional Equity.

III.  Pulling It All Together in An Effective Business Funding Strategy

How to Develop an Effective Business Funding Strategy

·         Good Communication with Lenders and Investors:

o    Realistic, Well- Developed Facts and Figures.

o    Bridge the Gap with a Well Developed, Presented and Packaged:

§  Business Plan 

§  Loan Package

§  Executive Summary

§  Investment Overview

·         Understanding Business Plan Development Relationships:  Company Experience & Track Record = > Product Development => Marketing Analysis & Plan => Strategic & Sales Plan = REALISTIC Financial Projections & Forecasts.

·         Integrate your Funding Structure & Strategy into your Cash Flow Statement, showing the effects of different Capital Structures based upon your Strategic Plan Findings. The Cash Flow Statement shows the Banker how your Loan will be repaid and the Investor how much and when Investment Proceeds will be accumulated and disbursed, all based on Realistic, Believable numbers via a solid Business Plan Development Process (see above Flow Chart).

·         An Effective Funding Strategy begins with an effective Business Plan Process which incorporates excellent Financial Analysis and runs various Financial Model outcomes via Cash Flow Statement Development and Analysis.

·         Understanding the right mix of Financial Instruments, is key when modeling your Cash Flow Scenarios.

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Business Trade Credit and Debt Finance

June 21, 2010 by Frank Goley, Business Consultant

Trade credit can be an excellent way to generate quick, flexible business capital, yet it can be costly. Understanding debt finance is crucial so you can determine what you can qualify for and if your debt ratios are acceptable. If you use trade credit and debt finance together, you can highly leverage your business capital, but you must be careful not to over extend yourself. This blog post explores both areas of business finance so you fully understand how they work, what the risks involved are, and how to effectively use them.  

I. Trade Credit and Supplier Finance

Trade credit and supplier finance is great for meeting short-term capital needs quickly and with less red tape than other short term finance instruments.

– Cost:  Can be high cost. Supplier Terms of 2% Cash Discount within 10 days, net 30 days.  By not taking advantage of the Discount, the Company is allowing use of its money for an additional 20 days at 2%.  On an Annualized basis, this is equivalent to a 36% Interest Rate. Late Payments can run 1-1.5%, monthly basis, which annualized is the equivalent of 12-18% Interest Rate. If used effectively for short-term needs, the higher costs associated with Trade Credit can be justified.  Over-reliance on Supplier Credit and using it as an intermediate or longer term finance need will significantly hamper Cash Flows and Growth

– Risk:  Suppliers can cut off credit at any time or demand upfront cash payments during difficult business periods. A solution could be adopting your Key Supplier as a small Equity Investor, which promotes more flexible finance terms during cash strapped periods.  The Supplier has a better understanding of your potential upside as an Equity Investor.

– Flexibility: Be careful of Suppliers offering Extended Payment Terms as you can get locked in or over committed to these suppliers, overshadowing other Suppliers who offer lower prices, a better product and more reliable delivery.

– Control:  Can lose effective Control of Company Operations if Trade Credit was over-extended to such a level where your Suppliers take Legal Action, which can result in attaching Assets and forcing the Company into Receivership.

– Availability:  This is a short-term need and your short-term Strategic and Cash Management must be up to the task. Can be significantly curtailed during Economic downturns; therefore, having a backup Line of Credit is mandatory.

– Short-Term Needs: Best utilized for small, short-term needs. Necessary to have excellent Planning in place to avoid unnecessary costs, such as forfeiting Cash Discounts or incurrence of Delinquency Fees.

II. Debt

– Timing:  The money market may be tight so having a well developed Business Plan is essential toward obtaining Debt. Banking relationships are Key when times are tight in the lending markets. Having a well prepared Loan Package is also essential.

Resource: Please see my Article on Funding Sources for your Business, for more information on establishing good Banking relationships.

– Financial Condition: A strong Equity Component in your Company’s Financial Structure will promote a Debt Ratio which is amendable to a Bank or Commercial Lender

– Stability:  A company’s capacity to withstand periods of lower earnings or losses without defaulting on Debt Obligations. A Company’s ability to carry more Debt.

Ratio Analysis:

·         Debt-Equity Ratio = Total Liabilities divided by Total Equity.  Compare to Industry’s Average to determine an Acceptable Threshold.

·         Debt Capacity = Acceptable Debt to Equity Ratio x Equity.  Estimate the amount of Debt that a Company can carry based on its Equity Strength. 

– Liquidity: Company’s ability to meet short-term obligations. Relationship between Current Assets & Current Liabilities.

Ratio Analysis:

·         Working Capital = Current Assets – Current Liabilities.

·         Current Ratio = Current Assets divided by Current Liabilities.

·         Acid Test = Quick Assets divided by current Liabilities. Can be converted to cash in 30 days. Indicates the adequacy of a Company’s Short-Term Capital position.

– Long Term verses Short Term Debt:  Liquidity Analysis can indicate whether a Company should obtain Short Term or Long Term Debt. Short Term Loan reduces the Current Ratio, while Long Term Finance often improves the Current Ratio. The trick is to find the right mix between Short-Term and Long-Term Debt to meet Stability and Liquidity thresholds.

– Collateral:  The Quality and Quantity of Collateral both matter equally. Free and Clear Collateral, not encumbered by excessive Liens. Understand how to Package Collateral Classes and leverage Cross- Collateralized Assets.Receivables Factors:  Aging, Customers’ Credit Standing and Bad Debt History.Inventory Factors:  Market Value Determination, Sales Track Record and Turnover.Equipment, Machinery and Real Estate Factors:  Market Valuation, Repayment Ability and Disposability of Assets.

Resource:  For a detailed explanation of Financial Formulas and Ratios, please refer to my Comprehensive Business Planning Guide and Workbook.

Posted in Business Finance. 2 Comments