Finding Financing in an Economic Decline
Originally published: 04.01.09 by Chris Talis
Although the lending environment has tightened, you can still access the money you need to run your business if you get creative.
It seems that the economic crisis that we are facing today can be traced to the housing industry and the widespread interest in underwriting sub prime mortgages. It has, unfortunately, spread to more traditional industries including banking, investment, automotive, construction, manufacturing and retail to name a few. As a result, we have witnessed the failure of several of our large U.S. companies, most notably substantial financial institutions. We are also seeing its effects hit home as we read about unprecedented home foreclosure rates. This has brought fear throughout the marketplace which, in turn, creates further uncertainty. Government intervention has created some temporary relief but will its programs spur a rebound and will the effects be felt in the near future?
The result of this economic contraction has been a significant tightening in the lending environment. Whatever lending is going on today seems to be focused on larger firms. The lending problems, however, affect all businesses including the small business owner. The effect on small business has probably had more impact than most people realize. This is because entrepreneurs do
When the small business owner has the need to make required purchases, increase payrolls or invest in new equipment where does he turn to receive access to the funds he requires? This problem becomes even more magnified as the nation’s banks tighten their lending requirements. So in a difficult lending environment, such as the one we are experiencing today, where should a small business owner/entrepreneur go to find the financing to continue the growth of his business? This is an important issue because many believe success in the small business sector is paramount to a successful and swift economic turnaround.
For a turnaround to begin, banks will need to ease their lending requirements in order to help alleviate the credit crunch currently being felt. It is widely understood that entrepreneurs will likely play a critical role in the recovery our economy desperately needs. Because the small business owner will play a vital role in this recovery it is important that there is a concerted effort to boost consumer confidence & increase incentives for the entrepreneur. In a declining economy, an investor’s aversion to take on risk increases and, therefore, government policies must encourage entrepreneurship. These policies must promote innovation, provide capital and spur employment.
Until these government policies and programs are in full force it is important for entrepreneurs to be creative and seek every available source of financing to keep their business flush with cash during difficult times. Here are some of the options available:
1. Friends and Family. Many times the simplest way to raise capital is to go to friends and family and ask them for help. It may be a short-term loan, it may be to make an equity investment in your business. If you would like their dollars in the form of equity but would not like them to have any sort of voting power perhaps you can create a second layer of stock (preferred stock for example) which would give them preference should the company need to liquidate but no voting rights.
2. Existing Stockholders. If your business is owned by multiple stockholders or partners, you may be able to raise capital by going back to the original stockholders and requesting an equity raise. You may also create stockholder’s loans whereby the company would owe each individual stockholder principal payments plus interest (it is important to keep it arms length especially for IRS purposes).
3. Non-traditional bank financing.
(a) Factoring — you may be able to find lenders who will advance funds based on specific invoices. These lenders will try to understand your business and then figure out a way to give you up front cash on a newly generated invoice. They will generally advance you about 75% to 80% of the invoice amount and charge you anywhere from 1.5% to 3.0% per month in fees until it is collected. It generally has to be paid within 90 days.
(b) Asset based lending — some banks will lend you monies based on the company’s assets. Whether it be equipment, real estate, inventory, accounts receivable or vehicles, banks will lend using the company assets as collateral. The a d v a n c e rates will vary usually based on liquidity of the assets (accounts receivable & inventory being more liquid and therefore would have a greater advance rate), and the cost to this type of financing can be high, as well as the reporting requirements being somewhat cumbersome.
4. Borrowing from Personal Assets. Many times entrepreneurs in need of immediate capital will borrow from their home’s equity until traditional financing sources become available again. This can be a precarious choice in that you are risking the home to benefit your business but many times it is the only choice.
5. Credit Cards. This option is very costly, but in reality, credit cards are unsecured loans and should be used only for short-term credit purposes.
In conclusion, being creative and resourceful during economic hardship is vital to keep your small business flush with cash while the government attempts to create programs designed to ease lending and improve our economy’s conditions.
Articles by Chris Talis
Finding Financing in an Economic Decline
To keep your small business flush with cash while the government attempts to create programs designed to ease lending and improve our economy’s conditions, entrepreneurs should be creative and resourceful in finding financing during economic hardship.