Let’s Talk Lending and Debt Financing

From startups to large corporations, when a business wants to expand – whether it be new products or markets or increasing the volume of business transactions – capital is needed to fund that expansion. Expansions always occur in advance of the increased revenues and profits used to pay for the expansions. This brings us to two questions which are: Where and how does a business obtain the needed capital to enable it to expand?

Happily Stable

First, there is nothing wrong with owning and operating a lifestyle business. Having the business pay its bills, employ a few people, and give the owner / operator an income is a great thing. If it endures over several years, it can be a contributor to the community in tangible ways, which is also a great thing to accomplish. If the goal is to move the business from this maintenance level to one that not only generously compensates the owner for their work, but also generates a return on investment to the owner, then expansion will be needed for this to occur. This requires additional capital investment(s) into the business to scale it up.

Taking the plunge

Where would a small business (revenues < $2 million dollars annually) look for modest amounts of expansion capital? Depending on your company structure, your resources and availability of capital will vary. The first place to look is the current investor / ownership mix. Committed investors who understand your business are always the best bet. If there are partnership problems, then these need to be dealt with prior to a call for a round of increased funding. This is equity or ownership funding, separate from the debt financing we are discussing in this article.

Outside of your company, the best financing (debt) sources are your commercial bankers. Through business operations, you have established relationships that can be leveraged for funding purposes. You must qualify under the bank’s or credit union’s lending standards and amounts, but these institutions are in business for this purpose. The Small Business Administration (SBA) might be brought in as a financial backer to the lending institution so that the risk to the lender is reduced to enable the deal to happen. All of the documentation, collateral, cash inputs and personal guarantees from the company’s ownership are needed in order to seal the deal. The business must demonstrate, through projections, that the cash flow of the increased-sized operation will suffice to be available to pay the loan. Know that both fixed and variable rates are commonly available and up-front fees are also assessed during the application process.

If your bank turns you down, all is not lost as other sources of financing become available. 

These are either private investors, state or federal funding opportunities, regional economic development funds, or a combination of these sources.  In general, these sources will require all the documentation you would give a commercial bank, oftentimes carry a little higher interest rate, but are allowed to take on a little more risk than a commercial source might be able to accept.

Failing to acquire funding at this level can oftentimes end the hunt for finding monetary resources. There may still be options available at high cost or with difficult repayment options, so if you are in this situation, it will pay for you to work with a trusted adviser for obtaining funds when you reach the near-desperation area emotionally.

Preparing for the Journey Towards Debt Financing

General principles apply to business operations regardless of what stage a business is currently operating in. The best businesses are run on systems that are repeatable, predictable, efficient and minimize the waste of time and other resources.

As business needs change, for example making an initial hire or staging your business for sale, even preparing financials for a corporate Board, all have attributes in common. One overriding question to focus on this is:  Are you maximizing your Value Proposition? If you are, the great! You have a better chance of obtaining the capital you need in order to continue building and expanding your business. Many kinds of business metrics are measured and compared against peer businesses to help make that determination. 

The banking and lending communities are well aware of these benchmarks and use them to rate your business risk and the chances it will create the revenues needed to service increased debt. This all happens before a lending decision is made.

As businesses grow, what was a large workload for an individual becomes impossible with a small crew. Additional hiring of employees with specialized skills are needed to properly scale a business. Cash flow monitoring and projecting become critical success areas to pay attention to. Systems and systems integration are driving forces to maintain and increase the value drivers in the company. 

A need for increased and diverse markets emerge that need to be successfully developed for business continuity. Commercial banking relationships are especially critical to be maintained and enhanced to keep reserve capital balances healthy and productive. 

It is typical in this stage of business development that the commercial banking relationships that have been established over time are one of the top reasons businesses continue and not fail during this stage of growth.

There are businesses that reach several million dollars in sales and are able to survive without elaborate systems. 

The Good ‘Old flying-by-the-seat-of-the-pants approach has worked for a select few. For a while perhaps. Then it is not unusual to hear of a disaster or legal problem elevate to wipe out substantial value in that business. 

On occasion, an issue will envelop an established business and wipe it out right before an entrepreneur wants to retire and cash out. 

Even at the end stage of a business’s lifecycle, keeping an eye as to what the financials tell you, and keeping the banking relationships secure will enable the transfer of the business at the end to be successful, and return the value of the many years of investments into expansions back to the owners.

By Marshall Doak, SOU SBDC Director