Many Options Available for Small-Business Financing
Executive Roundtable is a weekly column by TEC Worldwide, an international organization of more than 7,000 business owners, company presidents and chief executives. TEC members meet in small peer groups to share their business experiences and help each other solve problems in a round-table session. The following questions and answers are summaries of discussions at recent TEC meetings in Southern California.
Question: I have some ambitious growth plans for my small manufacturing business, but it will take a lot of money to get us where I want to go. Other than a bank line of credit, I have no experience with the capital markets. What should I know before looking for some serious growth money?
Answer: Not too long ago, small companies had few borrowing options beyond their bankers and trade creditors. In today’s multifaceted financial markets, however, entrepreneurial firms have access to a variety of lending institutions and products. Given the complex nature of most capital transactions, it pays to know what you’re doing before borrowing large amounts of money or leveraging yourself to the hilt.
Gordon Tunstall, who runs Tunstall Consulting Inc. in Tampa, Fla., has been helping high-growth companies develop financial strategies and obtain capital funding for more than 20 years. He recommends the following:
* Research the capital markets. Current capital markets offer a variety of lending alternatives. In addition, today’s capital deals often combine several types of lending tools and techniques. Investing some time upfront to learn about the types of financing available and how to use them properly will enable you to get the best deal and avoid getting taken to the cleaners by sophisticated lenders.
* Match your financing needs with the correct lender and financing product. After determining the framework of your financing needs, identify the type of lender that fits your industry, your type of company and your specific financing needs. For example, don’t approach a bank or commercial lender if you need mezzanine financing, because you won’t have the collateral to support the loan. Similarly, borrowing from a venture capitalist when you could have used mezzanine financing may cause you to give away more equity than necessary. If you’re uncertain about which type of lender to use, hire a professional who knows the markets and can help you find the right type of financing for your borrowing needs.
* Write a world-class business plan. In order to get the most money at the best terms, create a business plan that lenders can’t resist. Make it clear so lenders can understand it and compelling so they believe you can get where you want to go.
“A well-documented business plan contains both narrative description and hard numbers,” Tunstall said. “The key is making sure that one supports the other. For example, every line item in the plan should have some narrative that describes the assumptions behind the numbers. However, the narrative must be credible or the lender won’t buy your plan. Above all, don’t think that a two-page summary will capture the attention of lenders. It takes more than a few pages to provide the raw data to support your projections and conclusions.”
* Minimize risk. Entrepreneurs often think they have to bet the farm in order to obtain financing. However, sound financing should involve less risk, not more. To minimize your exposure, look for lenders willing to structure flexible deals. Avoid agreements filled with restrictive covenants and warrants. Don’t take out a second lien on your house or give any kind of personal guarantees. Build a cushion into the deal in case things go wrong.
Before signing any financing agreement, always ask yourself, “Am I taking more risk to finance this growth than I did before I decided to grow the company?” If the answer is yes, don’t sign.
* Adjust your lending agreement for actual performance. When lending institutions create loan packages, they typically discount your performance projections and increase their compensation through additional fees or equity. In most cases, you can’t avoid this discounting because lenders need some way to protect themselves. However, you can negotiate a performance clause that adjusts the terms should you achieve your objectives in the agreement. If your lender refuses to consider this option, shop around for a different lender.
* Conduct a broad search of lending institutions. When looking for growth capital, start with about 100 lenders and work your way down to a final “short list.” In particular, look for lenders who specialize in your industry and the size and type of your company. If you’re looking to grow a chain of auto repair shops, for example, don’t approach a venture capitalist who specializes in lending to biotech companies. Once you have a small group of finalists, present your business plan to all of them at the same time. By creating competition among several lenders, you increase your chances of getting the best deal.
* Think big. Plan your borrowing based on your company’s potential, not on your current capital position. Project how much you would need to grow the company to its full potential and strive to get the best financing with the least risk, the least dilution and fairest transaction terms. “Also, make sure you like and respect the people you deal with at the lending institution,” Tunstall said. “Once you sign your name on the contract, you have to deal with those people for the life of the agreement.”
* Never give up control. You may have to relinquish some equity in order to obtain the capital, but if you have to give up control to grow your company, don’t do the deal. The best way to avoid giving up control is to create competition for your transaction.
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If there is a business issue you would like addressed in this column, contact TEC at (800) 274-2367, Ext. 3177. To learn more about TEC, visit www.teconline .com.
