Getting Your Business Ready for Debt Financing:
In the past, the only way to obtain outside capital for your business was to visit the bank. Many of the rules for running a business have changed since the explosion of equity investment fundraising. Sadly, this new phenomenon only applies to businesses with super “star power,” as these businesses have the potential to generate sky-high return earnings.
The most important thing for everyone else is to stick to the fundamentals. Building your business incrementally, adhering to a pre-written business plan, controlling costs, and increasing sales are all important aspects. When your business grows beyond its initial stage, it begins to function similarly to a bank. You will be deciding credit decisions for your customers on the financial side. Some will have to pay cash on delivery, while others will get net 30-day terms. In this way, you are now taking on the role of customer banker.
Without going into how much cheaper debt financing is in the end when compared to equity (try 20% ownership lock stock and barrel versus 20% annualized interest), borrowing money can sometimes be the best way to grow a business or start one.
You’ll be a much more appealing candidate if you know what commercial finance companies look for.
1. Concentration entails placing all of your hopes and dreams in one basket. You shouldn’t go out and make a big sale to a customer and then stop trying to sell to more people. Your success could clearly suffer if a problem arises with your most important client or if, for whatever reason, they stop buying from you. Incoming revenue should be distributed evenly among a number of customers, according to financial institutions.
2. Who are you lending your hard-earned assets to based on your creditworthiness? What kind of investigation do you carry out on prospective clients? The question at hand is whether or not to agree to a lucrative transaction with a company that is incapable of receiving credit from any financial institution. You are basically telling yourself that you are more knowledgeable about loaning money than the banker is. A business owner who conducts thorough credit checks and has a number of dependable customers who are creditworthy will be respected by finance companies.
3. Bookkeeping: Although some companies outsource all of their accounting, having a qualified bookkeeper on staff is helpful. Being able to quickly produce a financial snapshot of your business will demonstrate the sophistication of your operation when it comes time to seek financing. Companies that pay close attention to their books are valued by finance companies.
4. Pay your taxes. It gets expensive to use the Internal Revenue Service as your funding source. Due to the nature of debt financing, you will be pledging assets as collateral whenever you work with a finance company. The government takes over and puts a lien on the same assets when you don’t pay your taxes, effectively taking over first. As a result, the finance company has no collateral to back up the money it owes your company. Your entire relationship becomes dependent on this. Expect to sign a form allowing the finance company to receive IRS correspondence in duplicate at financing closing. This is how problems with taxes are usually tracked. Even if you owe taxes, you can still get financing. The IRS may issue a subordinated debt agreement that grants the finance company free reign to collaborate with you.
5. Bankruptcy: If you’ve ever filed for personal or business bankruptcy, you should admit it right away. It will come out, and being open about the circumstances will make it even more important to forget about the problems in the past.
6. Applications: When conducting due diligence, financial institutions request a wide range of information. They are not attempting to steal your secrets, so do not be alarmed. They need to be at ease with you and your business. Fact checking thresholds vary from company to company. The finance companies that carry out the most thorough work are always the most trustworthy and secure to deal with. A company that takes the time to put together a loan package before applying for financing is preferred by finance companies. In most cases, you can begin with; Last year’s end statements, interim balance and income statements, interim profit and loss statements, and, of course, tax returns are all included in this set.
7. Contracts: Be ready for complicated language. Finance companies cannot hide the fact that they must exercise their rights in the event of a problem. They must always anticipate the worst-case scenario when they enter the relationship. It is too late to include stronger language for protection once a finance company discovers that it has been defrauded, stolen from, or that payments have not been made without explanation. Most of the time, the language is the same, so walking away from a deal to start looking for less complicated legalisms won’t do much. Keep in mind that a contract is just paper in a file cabinet until you break it. All of the harsh language won’t matter as long as you stick to what you agreed upon. Contact your finance company right away even if you start having financial issues. If you show that you are proactive about your situation, you can greatly reduce the likelihood of default.
8. Putting the money to good use: This may sound obvious, but it can be crucial in some situations. You frequently hear advice about selecting the appropriate venture capital firm to handle your type of investment. That is true in some ways for businesses that finance debt. They usually work in fields where they feel at home. Additionally, the kind of financing company you choose will be determined by your financial objectives. A working capital line of credit is not the best choice if you are attempting to establish a brand-new business infrastructure. If you can spread the cost out over a number of years and take out a loan with a term structure, you probably will do better.
9. Management Integrity: As with equity investment, form a strong team and keep them. When a long-term Financial Officer, who has been the company’s point of contact since the beginning of the relationship, suddenly leaves without giving an explanation, finance companies raise red flags. Again, the finance company might mistakenly believe that something untoward was going on and begin to look more closely at your account because they always feared the worst. Finance companies are partners in your success, just like your loyal customers, even though they are not part owners of your company. Inform them of recent events.
10. Be professional by promptly returning calls and messages, coming prepared with information, and arriving on time. You would be surprised at how much mileage you can get by being a courteous and thoughtful customer to your finance company when it’s crunch time and you need an additional $50,000 for a week to get a better deal from a vendor.
