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When and how to expand your business is the most important decision you will make in your entrepreneurial life. When access to cash is vital for growth, an analysis of your options is essential. One choice is when to sell equity and accept the resulting dilution of ownership. The extent of dilution resulting from the sale of equity depends on your company?s valuation. If you do not have to be the first to market or do not need the connections that appropriate venture capital investors often contribute, than consider delaying the use of equity until your company is further along in achieving its goals and has a higher valuation.
Avoid dilution by first bootstrapping the company with founders money, then family and friends, and then potential suppliers and customers. Ask yourself, “who needs my company”. For example, I know of a deal where a supplier provided material in exchange for stock based on a very high valuation of the company and therefore little dilution occurred. That supplier wanted to get a new customer to diversify its customer base and was willing to take the risk because diversifying its customer base was strategically important. Once there is a business that is operating, there is an opportunity for loans, from banks or alternative lenders. The latter may provide very expensive loans, but the founders retain their equity.
When seeking financing, small businesses start with basic handicaps. Small business are generally run for the benefit of the owners, not to produce attractive financial statements or taxable income. In addition, lenders are concerned about both management?s ability and (if one founder is dominant,) succession issues. How will a company survive a leadership transition? Lenders want to know that the partners or successors are capable; they want to know that there has been succession and estate planning, with buy-sell agreements, proper valuation formulas, and affordable (or insured), buyout programs. In short, the lender wants to minimize the risk of a business failure due to succession problems.
Lenders are comfortable with viable business plans. The lenders? world consists of voluminous files with carefully recorded analyses. You have to speak their language. Be precise in stating your company?s goals and as equally precise in outlining how you intend to achieve them. A good plan is your key to success. It describes your company, its history, and its future. Include the details of how much cash is needed, when it is needed, and how long it will be needed. It is vital to describe how the cash to repay the loan will be generated.
The plan should be prepared in-house, with input from your key people. You should ask outside experts to review the document and test your assumptions. The final draft should be written by you, not by a lawyer or an accountant. You must understand the assumptions behind the plan and where the numbers came from. Your lender will not be impressed if you are forced to reply to questions by saying, “My accountant understands that,” or “Only my lawyer knows that answer.” Such responses suggest that you are not in full control of your business.
A loan officer will be assigned to shepherd your loan application through the bureaucratic procedures and make a formal presentation to a loan committee. Before that takes place, two or three officers will usually have had to sign off on the loan. Lenders usually divide their customers into industry or loan groups according to sales volume, the size of the loan requested, or both. For example, a lender may consider applications in various categories: those with revenues under five million dollars, those with revenues over five million dollars, those whose loan request is under two million dollars, those whose request is over two million dollars or any combination of these or other criteria. In looking at each application, the lender will compare a company?s performance with the overall industry?s performance. They will also examine the quality of the collateral for the loan. Then they may assign a numerical score to the application, which represents the degree of risk involved in the loan.
Generally, loan officers prefer to handle larger loans, which, if they succeed in steering through the approval process, can help them earn bonuses or promotions. If the size of your requested loan is at the low end, you can expect the process to take longer.
The lender representative who made the cold call at your office may be charming, but often does not have much clout in the loan process. Find out who your contact reports to and what they think of your industry. Look into who sits on the loan committee. Maybe you have worked with one of them before and you can ask them to vouch for you and your company?s reputation.
The loan should not be negotiated by the company controller or an outside CPA or lawyer. The owner who is borrowing the money should deal directly with the loan officer using the assistance of the outside advisors. When lenders make loans they want to assess the quality of the management as well as the character of the borrower. Employees or outside experts can handle the preparation of the loan application and other details, but the owners must develop relationships with lenders.
Try to avoid giving personal guarantees. Lenders ask for personal guarantees because it is one way to ensure you will stay with the business no matter how tough it gets. The truth is, that it is easier to sell off your personal stock portfolio or apply your savings account to the loan than it is to step in and run your business. If you have to guarantee the loan, make sure the agreement requires the lender to go after the business assets first. You may be able to give only a partial guarantee ? that is, the lenders may agree to a ceiling on the amount of your personal liability that is significant to you, but not everything you have.
A trap that many entrepreneurs fall into is the belief that “I can get it cheaper somewhere else.” When you borrow, it is more important to get as much as you need and to be able to keep it as long as you will need it, than it is to get it at the lowest rate. As in many other business negotiations, the terms are more important than the price.
Believe it or not, smaller business customers provide higher yields, higher deposit-to-loan ratios, and far lower loan losses than all those big deals that lenders are always chasing.
Negotiating with a lender requires understanding the institution?s culture and procedures. In the end, lenders simply want to feel confident that your company has the ability to repay the loan and that an equity buffer is in place in case your loan goes bad. If you can present a good business plan, demonstrate management ability and find a supportive loan officer, getting the loan may allow you to ultimately keep more equity in your company.
Jay W. Trien is senior partner in the accounting firm of Trien Rosenberg Rosenberg Weinberg Ciullo & Fazzari, LLP in Morristown, New Jersey and New York City. Trien frequently consults on troubled loans for lenders and is president of the Venture Association New Jersey. Telephone 212-619-0525 or 973-267-4200, Ext. 123, E-Mail jay@trienrosenberg.com |
