Financing Your Company in 2012
Bank Funding
Banks are generally the cheapest way to finance your company other than with your personal cash flow. There are different types of bank loans: lines of credit, equipment loans, business purchase, inventory or flooring lines. If you can call it collateral and take a loan out on it, banks will lend versus it.
Loans for business purchase and owner occupied real estate may need additional guarantees on them depending upon the health of the borrower and the amount of the collateral available. If needed, the Small Business Administration (SBA) or US Department of Agriculture (USDA) are two government agencies that will add their guaranty to improve the borrower’s credit strength- with an additional fee of up to 2.5% of the loan amount.
Alternative Lenders
Sometimes, your company is not at a place where a bank would fund it. At those times there are a number of different alternatives based on where your company is in its life cycle:
1) Young high growth company: there are lenders that will fund the growth of newer companies in different ways. Most are these lenders are funded themselves by private investors. The rates and fees are higher than banks and they will do creative types of financing and security, sometimes using warrants (options to buy shares in the company at a set price) as part of the security pool. These lenders either pool the funds of various investors or assign one investor’s funds to a particular company’s debt through a promissory note.
2) Companies that are somewhat out of compliance with bank ratios but have available accounts receivable or inventory fit into another tier of lending- asset based lending. These lenders will loan at varying percent of AR and inventory value depending upon the quality of the overall balance sheet and the quality of the company’s receivables and inventory. These lenders will sometimes do equipment loans as well but only as an adjunct to a line of credit.
3) One tier below ABL is factoring, where the lender purchases the company’s invoices at a discount to the amount. Rates for these are even higher than ABL lines and are for companies that are a bit more out of compliance than ABL will accept. These lenders will loan only on accounts receivable and care mostly about the viability of the customer not the borrower. Some ABL lenders will also do factoring.
4) Hard money lenders tend to congregate in the real estate area, loaning a certain percentage on commercial or residential property (the latter usually only for investors) for 3 years or less at a time. These are used a lot by contractors, house flippers, and those businesses that can’t qualify for regular commercial mortgages. There are a few private lenders that are doing other forms but these tend to be for super high interest, high risk lending.
5) Companies that need small amounts of funding or alternative types of funding that may not quite fit into a bank’s niche can also get funding from some alternative lenders often called community capital development groups. These are nonbank lenders that receive a combination of funds from various government agencies and at times receive funds from banks that invest in these groups to meet their Community Reinvestment Act requirements. These loans are often guaranteed and/or the funding is shared by government agencies (SBA, USDA for example). Rates tend to be between those at the banks and those of other alternative lenders.
Equity Investments
Equity investments can come during different times of a company’s existence. Early stage, growth, recapitalization, and sale are all times where different types of equity investments fit the bill.
Angel investors generally use their funds to invest in very early stage companies that are just starting to produce revenue or may not even be at the revenue stage yet. These investors pay a very low price per share and tend to invest only in companies where the return is well over 10x their initial investment, as this is the highest risk investing one can do. The dollar amounts invested can be very low- often these can be friends and family at the low end of the investment range. These are usually individuals or small groups of investors rather than the larger pools with very large sums seen with the next group.
Venture capital groups are the next stage, although they can be fairly early in the revenue phase, the company is generally still not cash flow positive. These are usually groups of investors that pool their funds into partnerships that then spread those funds over several investments. Investments here tend to be a minimum of $5 million versus $25,000 for the angel investors (I’ve even seen $5,000 for one investment option.)
Equity partners make up two groups: those that do recapitalization without a majority interest and those that take over the majority of the company. There are two distinct subgroups- those that work with small companies and those that work with mid to large companies. The difference is generally that the former is in the less than $5 million range for investment while the latter is usually $10 million or more (mostly a lot more.) Equity investors include both local and international investors (through the EB-5 program for example.) We work with several different companies and partnerships that bring together pools of investors as well as a few individuals that work with the foreign investment program.
The first option is a recapitalization of its balance sheet. This can be due to one- time events such a recession that used up cash during a down cycle, the opening of a new division that used a lot of retained earnings as it was ramping up, or other unusual events that created a balance sheet that may be highly leveraged. There might also be a need based on an anticipated growth period that will put a strain on current cash flow. The equity partnership will negotiate with the owner for a percentage of the company as well as a time frame for exit- often 5 years- where the company will then have the financial strength to refinance the investment and take out the equity investor or pay out of cash reserves, sometimes a combination of both.
The second option is to have an equity partnership purchase the majority of the company. This is more often done when the company is in a lot of financial hardship or the owner is working on an exit strategy for retirement but is not quite ready to retire fully. Think of the multiple banks that have had equity investors come in with large amounts of cash to save them from a FDIC seizure or in some cases those that have been healthy but have used the equity infusion to fund an acquisition strategy of a number of those troubled banks.
There are many permutations of all of these forms of lending- I have given you only a synopsis. Especially as banks have been more reluctant to lend, other options have started to spring up. This allows those companies that are not of the highest credit quality but are still going concerns to still access funding for day to day operations as well as growth. Biz Loan Link can help you sift through the many options to find those that are most appropriate for you.
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