Posts Tagged small business financing
One of the traits of a good entrepreneur is to stop people trying to take advantage of them by foretelling the future. So often I see people trying to sell their products and services telling the small business founder if he or she does not buy the product the sky will fall on them. Savvy entrepreneurs filter the predator soothsayers claims to conserve capital.
My advice to a new business founder is to buy goods and services as you need them only if they are absolutely necessary to the business’s plans. Predators will try to sell the small business founder everything under the sun. If the predator is so hungry, the small business founder should ask for a free trial with no strings attached to see if the product or service performs as intended. Before signing on, business founders should ask themselves if the product or service is absolutely necessary or if they can get by without it.
Capital preservation is critical when a business is in an embryonic stage. The small business founder should take great care to preserve capital. I have seen too many small businesses spend foolishly and eat the capital the company needs to survive. A savvy entrepreneur learns to make do with less. Learning to say no is a tough assignment, but pays dividends in the long-run. When in doubt, return to the business plan and only say yes to those items included in the business plan.
Are predator soothsayers knocking on your door? How do you deal with them? If you need help learning to say no I encourage you to get help now. Contact us for help.
One of the most often forgotten about benefits new business founders overlook is the ability to carry forward and carry back a net operating loss. Founders of new business struggle to find sources of cash flow available to bootstrap their way to sustainable profits. A new entrepreneur founding a business should consider the benefits of cash flow from the net operating loss.
A company has a net operating loss when its business expenses exceed it business income. Business expenses excludes any capital losses, personal exemptions, and 50% of the gain from the sale or exchange of a qualified business stock. Business expenses also exclude alimony paid, contributions to an individual retirement account or self-employed retirement plan, payments to a health savings account, and most itemized deductions with some exceptions.
A founder can carry back a loss two years before the year in which the company incurred the loss creating a refund of previously paid taxes. A company can carry forward any remaining losses for up to 20 years reducing future tax liabilities. When a new business struggles to make ends meet it should not lose sight of this important tax benefit.
Most new businesses take 3 to 5 years to achieve profitability, but meanwhile the company can preserve cash. Using the net operating loss deduction can produce cash from the refund of taxes paid previously. This refund produces cash a business owner can use in the business.
Have you built the net operating loss into your cash budget? If you want to take advantage of the net operating loss, but have not already done so I encourage you to get help now. Contact us.
I read a blog post today about how banks have started to lend to small business again. Considering the bad treatment banks have given their customers I wonder how they will treat small businesses after cutting off lines of credit and other lending to them during the financial crisis. I suggest considering the credit union as an alternative to a bank for small business lending. Personally, I like getting treated as a person instead of as a commodity and credit unions have many advantages. I just opened an account with a credit union and I found the I received much better treatment and the credit union valued not just my business, but me as a person.
I remember an SBA loan I had with a small bank that a larger bank later took over. For several years the bank and I had a good relationship. One day I received a notice the larger bank had bought the bank and the new bank no longer wanted SBA loans as part of its business. The new management made it difficult to preserve the good relationship by charging new fees for everything imaginable. A few years into the recent financial crisis I saw this bank on a list of the banks the Fed had shut down.
Because small business financing sources have evaporated during the global recession, small business should consider using credit unions. Credit union unlike small banks are cooperative nonprofit organizations. As nonprofit organizations credit unions have an exemption from tax resulting in lower costs allowing them more latitude in making loans. Credit unions also enjoy lower costs from volunteer labor and employer sponsorship giving them the ability to offer lower rates. Besides offering small business loans, credit unions also offer other products like credit cards and car loans (Feinberg & Rahman, 2006).
The trend is for large banks to buy smaller banks especially in larger markets. This trend has resulted in less lending to small businesses causing a need for alternative funding sources like credit unions to service small businesses. Consolidating small banks has created less of an interest in small business lending. The lack of interest stems from the difficulty large banks have dealing with soft data, the more hierarchical bank’s need for more approvals, and lower credit supplies by the larger organization (Ely & Robinson, 2009).
Oriz-Molina and Penas (2008) found one way to mitigate opaque risk from small business is to shorten loan terms to watch the progress of small businesses. The more conventional approach is to want greater collateral over a longer term. Credit unions also have the ability to gain a better understanding of owners’ personal wealth. Although credit unions can focus on better addressing opaque risks using these approaches, larger banks often rely on credit scoring to approve small business loans to achieve a competitive advantage (Immergluck & Smith, 2003).
Despite the ability of larger banks to gain a competitive advantage in lending to small business, credit unions are closer to small business customers and able to forge better relations. Large banks have shown poor behavior in recent years making them less attractive than more personal, smaller thrift institutions. For example, banks have added new fees and restricted lending to only the strongest small businesses. Improved relations with small businesses promotes long-term relations despite shorter lending terms.
Consolidating small community banks into larger banks has caused banks to become less personal and more selective. Credit unions fill a social gap in the market because of consolidation of these community banks and the cost advantage they have from the nonprofit status. Credit unions can expand from solely personal to more commercial lending to fill this gap.
What sources have you considered for your business in achieving financing? Are credit unions part of the mix? Do you want to know more about the value of commercial lending by credit unions? Find out more about how you can benefit.
Ely, D. P., & Robinson, K. J. (2009). Credit unions and small business lending. Journal of Financial Services Research, 35(1), 53-80. doi: 10.1007/s10693-008-0038-3
Feinberg, R. M., & Rahman, A. F. M. A. (2006). Are credit unions just small banks? Determinants of loan rates in local consumer lending markets Eastern Economic Journal, 32(4), 647-659. doi: 1241333261; 35361511; 11879; EEJ; INNNEEJ0000065491
Immergluck, D., & Smith, G. (2003). How changes in small business lending affect firms in low- and moderate-income neighborhoods. Journal of Developmental Entrepreneurship, 8(2), 153-175. doi: 502848551; 8351081; 38473; DVEN; INODDVEN0000469300
Ortiz-Molina, H., & Penas, M. F. (2008). Lending to small businesses: the role of loan maturity in addressing information problems. Small Business Economics, 30(4), 361-383. doi: 10.1007/s11187-007-9053-2
Finding financing for a small business is like playing Where’s Waldo. Where’s Waldo is a game in which a player looks for a funny guy in a red-striped shirt and stocking cap in a maze. Waldo blends into the crowd and is difficult to find.
Small businesses look to find a source of financing among a maze of potential financiers and hazards. Financing can include angel investors, venture capitalists, banks, and other sources of equity and debt. Ma and Gui (2010) classified direct small business financing in the United States into venture capital and securities financing. Ma and Gui explained indirect financing comes from commercial bank loans. Some commercial bank loans have a government guarantee from the Small Business Administration. Mezzanine financing is another hybrid source of financing valuable because a company can treat much of it as equity even though it combines features of debt and equity (Silbernagel, Vaitkunas, & Giddy, n. d.). The maze is difficult to navigate because the terms differ from one source to another. The small business should target equity financing whenever possible because debt financing is more risky. Micro financing and crowd funding are some new entries to the maze, but an old favorite is bootstrapping.
A person playing Where’s Waldo has to examine the maze with great scrutiny to find Waldo blending in to the crowd. Waldo is a friendly guy, but is crafty in making himself inconspicuous among the crowd. Waldo may have hidden motives in avoiding making himself obvious.
A small business needs to have an awareness of the hidden motives different financiers may have. Some financiers use convertible features to gain control of a company. The small business should have an awareness of these features to prevent a takeover. Small business founders work hard to find a working model for their business and should protect themselves from possible takeovers by reviewing the terms of the financing. Protecting a controlling interest in the firm is a critical role for a small business founder to keep control and avoid the board from firing him.
When one finds Waldo, the game is over and the player can start a new puzzle. A small business founder looking for the right financing locates it the search is over, but he must remember to make sure the terms allow for keeping control of the company.
What sources of financing have you considered? Want to learn more about small business financing and how to preserve a controlling interest? Learn more.
Ma, J., & Gui, J. (2010). Study on the small and middle enterprises financing mode in financial crisis. International Business Research, 3(1), 76-79. doi: 2225515451; 56706961; 137934; NBRS; INNNNBRS0000568443
Silbernagel, C., Vaitkunas, D., & Giddy, I. (n. d.). Mezzanine Finance, from http://pages.stern.nyu.edu/~igiddy/articles/Mezzanine_Finance_Explained.pdf
Once I took a position as the chief financial officer of an organization with a history of over 100 years. The institution in its early years thrived because of its location bordering a city nearly the size of Chicago with a booming coal mining industry. The location bordered on the one of the Great Lakes cutting off half the circumference of the target market.
Eventually, the coal mining industry declined and the city bordering the organization dwindled in population because of lack of other industry in the area. Recreation supplied the next biggest industry in the area because of ideal conditions for snowmobiling, cross-country skiing, and other winter sports. In the summer, the area provided ideal conditions for hunting and fishing. These industries failed to provide enough jobs and opportunities to keep the city alive.
The organization I worked for had its numbers drop by nearly 70% because the organization depended on people within a hundred mile radius of it. When I arrived I found the finances in a shambles and an accumulated deficit resulting in a negative net worth. At first, this condition alarmed me, but I knew I had a calling to turn this ship around.
A turnaround of this magnitude is like starting a new business because it needs a radical transformation. Fortunately, the executive team committed to a radical transformation of finding a new model for the organization that would turn around the organization and create positive cash flows. Weekly we explored new ideas and acted on cutting drains on the organization’s cash flows. In this way, the turnaround is more difficult than starting a new business because a new business does not have to deal with getting rid of existing programs causing a drain on cash flows.
The result of these efforts balanced the organization’s budget and identified new programs capable of producing positive cash flows. When I did my doctoral research I discovered that many companies that go public have accumulated deficits of the same magnitude and about 70% of them eventually fail. This revelation surprised me and I thought about how many companies can use the same help a turnaround expert provides. Big and small companies have similar failure rates. ‘
Although the cause is different, the need to identify a working model is the same. Without transforming an organization by finding a working model that produces positive results any organization will subject itself to failure. This revelation also caused me to think about the benefits of going public versus remaining private. Often, companies go public far before they rightfully should and prematurely remove the founder whose role it is to find a working model.
Public companies start to create more bureaucratic settings, while the organization needs to stay nimble enough to allow the working model to develop and meet consumer needs. Bureaucratization adds costs and reduces flexibility to adapt to make the model work. I believe many companies act too fast to go public because they believe it provides a safety net for raising capital. I believe a slower more deliberate growth may benefit many companies and allow the founders to keep their company and learn how to manage it instead of getting shown the door. Founders work hard and if they are serious should hold on to their creation and learn how to improve it.
I believe other consultants place too much emphasis on getting big too fast. Companies might do well to slow down and grow organically than fall prey to seeking the safety net of a public company. Slowing down allows the founder to start to see the forest from the trees and build a sustainable model without risking the founder’s position.
My company works to build organic growth by building on gaining the experience and education needed to grow organically. I believe a serious entrepreneur has an attachment to his or her creation and needs a different focus to preserve an identity with the company the founder creates.
What is your goal in founding a company? Would you prefer to stay involved in the company you create or do you want to exit and put the company in someone else’s hands? Please leave a comment to let me know your view.
If you are serious about preserving your identity with the company you want to create I urge you to try the services of my company by signing on now.
I often see bankers trying to lure small business owners into letting them help manage their cash flows. Although managing cash flows is critical for the small business owner, I question the value of going to a banker for help. In my experience, many bankers only have banking experience and little other tangible business experience. Banks concern themselves with cash flows mainly to ensure customers produce enough funds to pay the bank back. Is this approach enough to create enough cash to run your business?
Banks do not provide services without some form of compensation and may charge fees for managing cash flows. Banks often have no understanding of your business and what it takes to increase cash because all they understand is that you must sell more without understanding the tactics it takes to make more sales. Many times banks simply focus on cutting costs without considering new ways to raise revenues. Is this the approach you need?
My advice to the small business owner is to look at your own cash flows daily. Looking at your own cash flows will help understand where to increase revenues and where to cut costs. The business owner is the person who needs to decide how to increase cash and how to cut it not some outside party with little experience in your business. A business owner can look at the environment in which the company works and do some scanning to see what best fits the company’s model.
A company that does need help should employ a coach or an analyst to help design a procedure for the owner to make his own daily evaluation of cash flows. A coach or an analyst can also help the small business owner asked the right questions about what to add to improve revenues and what to cut to decrease costs. Experience and education are key ingredients in deciding what revenues to improve and what costs to cut. A good consultant is worth his or her weight in gold in helping the small business understand how to produce enough cash flows to keep a profitable business.
In my view, a good coach or consultant is there to guide you and help you develop the experience you need to make intelligent cash flow decisions. Yes a good coach or consultant comes with a cost, but the cost pays for itself because the small business owner benefits from learning how to manage his or her own cash flow. Do you want to learn more? Do you think you can get the same service from your banker?