Positioning Your Company for Debt Financing
There was a time in the old days when going to the bank was the
only way to get outside capital for your business. These days with
the explosion of raising equity investment, many of the guidelines
for running a company have been revolutionized. Unfortunately this
new phenomenon is only true for companies with super "star power",
because these companies have potential to create sky-rocket return
For everyone else, sticking to fundamentals is where it's at.
Building your company incrementally, following a pre-prepared
business plan, watching expenses, and increasing sales. When your
company moves beyond its launch, it begins to operate much like a
bank. On the financial side you will be making credit decisions
involving your customers. Some will have to pay C.O.D., some you
will extend net 30 day terms. In this sense you are now becoming a
banker for your customers.
Without getting into how inexpensive debt financing ultimately is
compared to equity (try 20% annualized interest versus 20% ownership
lock stock and barrel), in certain situations the time honored
tradition of borrowing money can be the best solution for increasing
growth or starting a company.
By knowing what commercial finance companies look for, you will
become a much more attractive prospect.
- Concentration – This means putting all your eggs in one
basket. Avoid going out and making a large sale to a customer and
then not continuing your sales effort to find more customers. The
risk of a problem developing with your main customer, or for
whatever reason they are no longer buying from you can obviously
be detrimental to your success. Finance companies look for
incoming revenue to be spread evenly over a number of customers.
- Creditworthiness - Who are you lending your hard earned
assets to? What kind of due diligence do you perform on new
customers? The challenge here is whether to accept a lucrative
sale with a company that could never get credit from any type of
finance company. You are essentially telling yourself that you
know better than the banker about loaning money. Finance companies
will respect a business owner that has a thorough credit checking
process and a number of stable credit worthy customers.
- Book keeping – While some businesses send out all their
accounting to outside agencies, it is helpful to have a qualified
book keeper on staff. When it comes time to seek financing, being
able to produce an instant fiscal snapshot of your company will
show the sophistication of your operation. Finance companies
appreciate businesses that keep a close eye on their books.
- Taxes – Pay them. Using the Internal Revenue Service as
your funder becomes expensive. Whenever you work with a finance
company, you will be pledging assets as collateral, thus the
nature of debt financing. When you fail to make tax payments, the
government steps in and places a lien against those same assets
essentially stepping into first position. This leaves the finance
company with money outstanding to your business and no collateral
to back it up. This places your entire relationship in default.
When going to closing on financing expect to sign a form that
allows the finance company to receive duplicate correspondence
from the IRS. This is standard procedure to track tax problems.
Owing taxes does not mean you cannot get financing. It is entirely
possible to receive a subordinated debt agreement from the IRS
which allows the finance company to work with you unencumbered.
- Bankruptcy – If you have ever entered into a bankruptcy
proceeding whether personal or business, own up to it right away.
It will come out, and being up front about the circumstances will
enhance the necessity to overlook the past difficulties.
- Applications – Finance companies ask for a variety of
information when performing their due diligence. Do not be
alarmed, they are not trying to steal your secrets. They need to
feel comfortable with you and your company. Each company has its
own threshold for fact checking. Invariably the finance companies
that do the most thorough job are the most reliable and safest to
do business with. Finance companies like working with a business
that takes the time to put a loan package together in advance of
asking for financing. Typically you can start with; Interim
Balance & Income Statement, Interim Profit & Loss
Statement, Last Year End Statements, Accounts Payables Aging
Report, Accounts Receivables Aging Report, and of course Tax
- Contracts – Be prepared for onerous language. Finance
companies cannot sugar coat the reality that if something goes
wrong they need to exercise their rights. They have to go into the
relationship always thinking that the absolute worst case scenario
will unfold. Once a finance company finds itself being defrauded,
stolen from or payments not made without explanation, it's too
late to insert stronger language for protection. By and large the
language is standardized and walking from a deal to start shopping
for less demanding legalisms won't produce much. Remember this, a
contract is just paper in a file cabinet until you default on your
agreement. Stay within what you agreed upon and all the tough
language won't matter. Even if you start having financial
difficulties, get in touch with your finance company immediately.
You can greatly reduce the chance of default by showing that you
are pro-active with your situation.
- Using the money for the right reasons – This sounds
obvious but in certain cases it can be highly relevant. You hear a
lot about going to the right Venture Capital Firm that would
handle your type of investment. In some ways that holds true for
debt finance companies. They tend to work within industries that
they feel comfortable. Additionally the type of financing company
will depend on your plans for the money. If you are trying to set
up a new business infrastructure, then a working capital line of
credit is not your best option. You will probably do better with a
term style loan that will allow you to amortize the expense over a
period of years.
- Management Integrity – Also like equity investment, get a
good team together and hold onto them. Finance companies raise red
flags when a long time Financial Officer who has been the contact
person at the company since the inception of the relationship all
of a sudden leaves without explanation. Again, always fearing the
worst, the finance company could unjustly feel that something
untoward was afoot and begin to scrutinize your account more
closely. Even though finance companies are not part owners of your
business, they are partners in your success just like your good
customers. Keep them abreast of breaking news.
- Be Professional - Answer calls and messages
expeditiously, be prepared with information, show up on time. When
its crunch time and you need an extra fifty thousand dollars for a
week to get a better deal from a vendor, you would be surprised
how much mileage you can get by being a courteous and thoughtful
customer to your finance company.
-from a speech given at SmartStart 2000 Albany Law School Science
& Technology Center