Sometimes, the best way to recapitalize your business is to attract third party investors (not relatives or senior employees). This could be the case when the chartered banks show no interest in lending to you and internal cash flows are just not sufficient to finance that next step in your expansion or acquisition.
The last few years, the chartered banks have lost interest in small business financing, except of course that they will loan you $250,000 if you can give them a mortgage on your home. If you are trying to obtain an operating line or money for acquisition in a greater amount, good luck!
There are the special purpose lenders like Business Development Bank and RoyNat, and if they like your particular industry or business (equipment leasing, a building purchase, tenant improvements), financing at premium interest rates may be available. Interest rates are high (mid-teens), and so are their add-ons like stand-by fees, monthly administration fees, and equity kickers (giving up equity in your corporation as additional compensation to the lender).
There is also factoring, being the de facto sale of your receivables to a factor, who then advances you a percentage of the amount of the receivables. The effective interest rate for such loans can be +20% – even 35%, all in, and should only be used as a temporary bridge to obtaining more reasonably borrowing. Borrowing at 30% means losing a big chunk of your margin to interest cost.
In my snack bracket, which is $500,000 to +$5,000,000, the most active lenders lately are so-called private equity or alternative lenders. They are somewhat like a low tier of venture capitalists, and will consider putting patient (will wait a few years for payback) equity capital or making loans to businesses that the other lenders won’t talk to. Many of these lenders are regional, not national, though some are U.S. based. They tend to be more flexible and charge interest in the double-prime rate to low teens area. The deals are more creative, not just filling in the blanks in standard bank forms, but this does create higher transaction fees.
I would like to return to the avowed purpose of this article, to suggest behaviours which will make your business attractive to an investor or lender. Some may seem obvious, yet I very often see owners acting contrary to their own interests in attempting to attract financing.
First, consider if you can handle this exercise, with or without the help of your accountant and lawyer. Should you hire a consultant to source funding? My experience is that the owner/operator is rarely capable, and moreover, their time is better spent in keeping the business humming along. A good consultant will save you more money is lower interest and other fees negotiated with the lender or investor.
Second, have a written plan showing how the extra funds will be used to make more money from the business. This plan need not be a business plan per se: a four or five page narrative with some spreadsheets will often be enough at the outset.
Next, get your financial house in order. Do you have a good accounting system? Are your financial statements up to date? Are your books under control?
Is your corporation in reasonable legal order? Is the minute book up to date? A corporate clerk can do an update and rectify deficiencies in short order for a few hundred dollars. Do you have copies of major contracts?
Above all, what are your expectations for the financing? Are you prepared to disclose confidential information about your business at the outset, and continuing? Will you give the lender or investor regular financial and operational information on a regular and timely basis?
All too often, the owner shuts down the information flow to the investor or lender once the closing occurs. Requests for information from the financier are sometimes met with minimal responses, or worse, a stonewall, from the owner. This is dangerous at worst, and at least, short-sighted. It is strategically smart to keep your investor or lender happy and well-informed about your business: you will get more patience when business goes bad and you will have a better chance of getting more money from that party later on if you need it.
I must tell you that my experience, invariably, is that the business operator does not respect the value of the money brought to the business by a third party investor or lender who is not involved in day to day operations. This goes for ‘silent investors’, as well as for professional financiers. This is very unfortunate, and leads to a lot of unnecessary problems. An ideal partnership is where the owner/operator party respects the contribution of the funding party, and of course, vice versa.
My observation is that entrepreneurs who value their financiers are better able to grow and protect their businesses.