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Challenges and Opportunities For Raising Capital
Start by viewing your company as an investor would
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Business New Haven
10/6/1997
By: John Hyde and Richard Pearce
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The decision of whether, and how, to obtain financing for your business should reflect the results of a self-assessment of your company's history and direction. You should attempt to define and quantify your company's financing requirements and anticipate the effect that financing will have on the company under various scenarios. Business owners often skip the planning process and begin by calling lenders; however, even if the business “needed the money yesterday,” you should step back and evaluate the company with the same critical scrutiny as a financing source.
Start the process by reviewing key areas of the financial statements: Is the business profitable and, if not, is there a feasible plan to achieve profitability within a reasonable time frame? What are the trends on sales and gross margins? Are there any unusual events that distort the company's financial picture? How quickly is the company collecting its receivables and paying its suppliers? What are the values of the company's assets? How much personal capital does the owner have invested in the business? To what extent is the business leveraged? Can the business make changes that are alternatives to raising capital, such as offering cash discounts to quick-paying customers?
The financial analysis should include quantifying infrastructure requirements including personnel, real estate and equipment. The sales forecast should reflect both historical information and future expectations. Many owners express concern over preparing sales projections; however, financing sources will gain comfort if you offer financial projections that logically relate to historic performance. Written assumptions should accompany the projections so that the materials can speak for themselves as they are circulated within the financial institution.
You can greatly elevate the likelihood of obtaining capital by retaining an objective consultant to help identify and resolve financing impediments. The consultant can design an appropriate financing strategy that reflects an understanding of the company's strengths and weaknesses in light of the marketplace for capital. The consultant
may also contribute creative thinking by offering solutions that have nothing to do with financing.
Owners examining their own companies sometimes incorrectly believe that they need financing when the root of the problem has other origins. For example, financing would not necessarily be the correct remedy for cash flow problems caused by declining gross margins due to industry consolidation.
Sources for business capital include banks, finance companies, government programs, investment banking firms, venture capital firms, private lenders, working partners, family members, merger partners and existing creditors.
Banks provide the least expensive form of capital, and although today's banking climate is more borrower-friendly than in the early 1990s, business owners should recognize what banks are looking for. Banks are particularly interested in lending as much money as possible to creditworthy, established businesses. You must demonstrate historical and future cash flow and sufficient collateral to support the company's total debt, not just the amount of the funding request.
Borderline borrowers may get approved if government enhancement programs are applicable to the candidate. Start-ups and companies with operating losses
have less chance for approval due to the higher risk of failure.
Bank mergers have accented the trend toward fill-in-the-blanks underwriting practices for small-business loans. Some banks have loan programs that are hybrids between business and consumer lending. You should pay attention not only to the cost of funds but to the restrictions that banks may place on the business.
A knowledgeable professional can help the owner negotiate the “financial covenants” and should guide the owner in the selection of which banks to approach, given the distinctions between local, regional and money-center banks. You should avoid going to more than three banks so as to avoid the negative stigma attached to bank-shopping.
The finance company niche of providing asset-based financing to non-bankable companies has eroded as the lines between commercial financing and asset-based lending have blurred. Many banks have their own asset-based lending divisions that compete with the finance companies. Asset-based financing is most effective for companies that are rapidly growing, downsizing or reorganizing, or as a transition until they can obtain conventional financing.
Finance companies continue to offer the best alternatives for equipment leasing and accounts-receiveable financing (factoring). The high cost of factoring makes it appropriate only for specific circumstances such as to finance a large contract or to provide a bridge until traditional financing is available.
Government programs typically reduce a bank's risk by guaranteeing a portion of the loan. They require carefully prepared presentations to address the specific criteria inherent to those programs.
Investment banking firms and venture-capital firms can provide additional equity capital to companies that have significant growth prospects. The process of “going public” is very expensive and time-consuming, and events on Wall Street can affect the timetable for obtaining financing.
An active private capital market fills gaps in the financing marketplace. Examples include “angel” investors (who offer equity capital, contacts and know-how, often to young high-tech companies), “vulture” investors (who seek high-yield investments among troubled companies), family members (who remain the single most likely source for start-up capital), and working partners (who can be brought in to provide management expertise and equity capital). Private capital sources often require an equity position in the business and negotiate certain controls to protect their investments.
A sale or merger of the company may result in a loss of control for the owner, but a merger partner or acquiring company can contribute capital, management and critical mass to take the business to the next level. A wide range of transaction structures including stock, options, employment contracts, and royalty or commission arrangements can be crafted to ensure that you participate in the future success of the business.
Reorganizing the company's finances may result in the creation of equity capital to the extent that creditors forgive collection of old debts. You should consider financial restructuring if you are repositioning, downsizing or exiting your business. Whether or not the process requires bankruptcy, an experienced professional is essential to help business owners manage this process. BNH
John Hyde and Richard Pearce are principals of Rampart Financial Group LLC, a Westport-based firm that offers specialized financial advisory services for entrepreneurial and family-owned businesses (800-575-0006).
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