A.
Startup
Small Businesses typically
face the greatest obstacles to obtaining financing because they lack
a performance record and a credit history.
Startup businesses often begin with only ideas
and enthusiasm. One of the many issues that every entrepreneur must
address in starting a small business is the financial reality involved
in deciding exactly what he or she wants to do, when it can be done,
and how it's going to be done.
New small businesses have trouble securing conventional
financing because they present a tremendous risk to lenders and investors.
The result is that nearly three-quarters of startup businesses are
funded through the owner's
own resources, such as personal savings, residential mortgages,
or consumer loans. Family
members, friends, and investments by private contacts or
"angels" provide most of the
remaining "seed" funds for new small businesses.
You
will find that some small business advisors preach that a "survivalist"
mentality is the only way to successfully fund a startup business
on a shoestring budget. For example, they may advocate borrowing as
much money as you can get, regardless of how much money you think
you are going to need for a particular purpose. They assume that it
will be easier for your business to manage debt (once you have cash)
than it will be for your business to obtain cash when it's really
needed. However, while this advice may sound savvy, the reality is
that most of your small business debt will also be your personal debt,
and any default may mean disaster to your personal finances. Moreover,
the more debt you assume, the harder it may be to obtain additional
funding, on much better terms, when you are in a better financial
position to obtain it. In short, advocating a limitless assumption
of risk and debt is easy when it's not your life savings, your house,
or your family's assets on the line.
The most common financial problem for startup
businesses is a shortage of short-term cash, and cash
flow problems during a potentially long initial period can
be fatal to the business. Any debt financing
(loans) that the business can secure from traditional lenders, e.g.,
banks, is likely to be expensive because of the high risks assumed
by the financier. Moreover, unless the business can boast a significant
owner investment and marketable collateral, the availability of conventional
debt financing is almost nonexistent.
This "cash crunch" puts a tremendous
focus upon inventory turnover, and the need for immediate revenue
often becomes a daily crisis that takes priority over financing for
sustained growth or development of new products. Perseverance and
a willingness to investigate all sources of financing — from angels
to government loan programs — are invaluable
at this stage.
The
financing pressures of a cash flow shortage has forced many small
business owners to take unwise, desperate measures to salvage their
business. For example, cash-strapped entrepreneurs may try to "borrow
against" payments of quarterly payroll taxes, hoping to repay
delinquent amounts as soon as business improves. Unfortunately, the
problem is rarely resolved and the entrepreneur not only ends up with
a failed business but personal tax liability for failure to withhold
payroll taxes.
B.
Acquired Businesses
face fewer obstacles than those being started from scratch,
and might have seller financing as an option.
In many respects, the financing options available
when you purchase an existing business are similar to the options
for raising capital in a growing business that you already own. Debt
and equity vehicles are typically more available to you than if you
were starting a similar business from scratch. Because the target
business has a credit history, existing assets, an established operating
cycle and business goodwill, lenders and investors can be approached
in the same manner as if you were seeking to expand a business you
already owned.
The major distinction between financing for
the purchase of an existing business and financing to raise funds
for your own growing business is that the former offers the opportunity
for seller-financing. Entrepreneurs who
are selling their small businesses usually realize that they may need
to participate in the buyer's financing of the business sale, and
they may be willing to negotiate a very favorable debt
or equity arrangement with you.
Potential advantages to seller-assisted financing
include:
- You may get a reasonable interest rate and
a less demanding credit review.
- The existing assets of the business are often
the exclusive collateral for the financing.
In contrast to the common practice of conventional lenders, additional
or personal assets of the buyer are rarely pledged as additional
collateral on a seller-financed loan. Moreover, a seller's valuation
of the business's assets (collateral) tends to be higher than that
of a conventional lender; a low valuation might appear inconsistent
with the asking price for the business.
- Personal guarantees
are less likely.
- A seller may be willing to take a subordinate
(secondary) security interest. The
seller may be amenable to taking a subordinate interest to allow
you to obtain conventional financing. The incentive for the seller
is that the more money you can obtain from other sources, the more
money the seller gets upfront. A conventional lender will require
a priority claim on business assets and so the only way you may
be able to qualify for the loan is to subordinate other creditor
claims.
- The buyer's assumption of the existing debts
or liabilities of the business may
be a means of reducing the purchase price. Typically, much of the
downpayment or initial cash price of a business sale goes toward
a reduction of existing business debt. However, rather than pay
off existing creditors, those debts may be assumable by the buyer
in exchange for a set-off on the purchase price of the business.
The business creditors essentially become financiers for the acquisition.
- The use of a gradual buyout
may be acceptable to the seller. For instance, the business name
and goodwill, and perhaps some tangible assets, could be sold upfront;
other equipment or property could be leased by the buyer with a
optional or mandatory buyout at a future time. The seller may be
willing to accept an earnout arrangement,
where a portion of the purchase price is depending on the future
success of the business.
Work
Smart
As a seller, the biggest obstacle to a buyer's
assumption of business debts is that the seller may remain personally
liable on those debts. If the seller signed the contracts in his or
her own name, committed to personal guarantees, or operated in a business
form that created personal liability (e.g., sole proprietorship or
partnership), the seller cannot escape these liabilities merely by
selling the business; the seller remains personally responsible on
the preexisting debts. Unless the creditors agreed to a subordination
contract — in which the creditor agrees to substitute the new owner
or entity for the former owner — the seller is unlikely to allow a
buyer's assumption of debt to reduce the business's purchase price
if the seller remains personally liable for a large amount of debt.
C.
Growing or Mature Businesses
generally have more financing options because as
a business matures, it establishes creditworthiness and operating
success.
A growing or mature business usually has sufficient
stability in its operations so that cash flow
problems are not a constant crisis. If the business is successful,
internally generated funds from sales and investments can fund many
of the business's needs.
Typically, growing and mature businesses have
more financing options available to them because of their operating
history, established value, credit history, and availability of inventory
and accounts receivable financing. In
addition, the advantages of having established customers and suppliers,
efficient internal operating procedures, more sophisticated marketing
and advertising, realistic long-term business plans, and the company's
emerging goodwill help improve the creditworthiness and investor appeal
of the business.
Debt financing
becomes increasingly available to a business as its track record supports
creditworthiness. If the business has been profitable, debt financing
is generally the preferred form of raising new capital for existing
businesses.
Nonetheless, a growing business may be stifled
by inadequate capital for expansion that stems from the reluctance
of an entrepreneur to dilute his or her ownership through equity
financing. Sometimes the decision simply comes down to whether
you want a profitable, growing business in which you share control
or will cash out your interest at a given time, or whether you own
a business that fails because you could not raise sufficient capital
for the business to grow. Growing businesses can consider raising
equity capital through private transfers of ownership interests, by
using venture capital firms, or by selling
ownership interests through formal limited private
offerings or an initial public offering.
Dangers to the financial health of a growing
business are often attributable to the business overextending itself
or to poor decision-making. If you rush expansion or acquisitions,
purchase too many expensive fixed assets, or form unwise associations
with other businesses, you may find yourself throwing good money after
bad money. Even very "street-wise" entrepreneurs may be
better served by engaging professionals to assist in legal and business
matters, and by employing experienced management to handle the growing
complexities of the daily operations.
D.
Aging Businesses tend
to be cash-rich because new investment is not taking place. Owners
are often searching for the best way to sell out.
Many businesses never reach this stage of the
business life cycle because they either fail at an earlier stage or
they remain healthy, growing entities. An aging business is characterized
by a conservative philosophy aimed at maintaining the business's internal
bureaucracy and its market status quo.
Some companies reach the point where innovation
and creativity are limited to tinkering with current products and
existing markets. Investment into new product lines and emerging markets
represents a financial risk that a complacent ownership is unwilling
to assume. Aging businesses tend to be cash-rich because less investment
is being undertaken.
The financial concerns for owners of aging businesses
often involve selling the business and
retirement planning.
