Revenue-Based Funding
January 29th, 2019

 

How does a company raise capital to grow or even to start a new business?  Raising investment capital is generally one of the most difficult and painful things an entrepreneur has to do.  Generally the default method is selling a percentage ownership in the company in return for investment.  One of the risks that come with this strategy is dilution of your ownership.  You no longer own 100% of your company, so if you are successful you get less of the rewards.  Still, selling equity is by far the most common way of raising investment.  But another risk might be that you are not as successful as you projected that you would be and what sold the investor on making the investment in the first place. 

Since the investor has only a minority interest in your company, and since there is no market for the stock assuming that it has not gone public, the investor is stuck if you cannot or will not buy back the stock or if he/she can’t find another buyer.  This could potentially cause a problem if the investor is unhappy enough.  The investor might file a lawsuit for misrepresentation for example.  This is probably highly unlikely because it would be extreme and costly for both sides, but an unhappy investor is not something you want to deal with because it could take you away from concentrating on your most important job, which is running the company.

Another way to raise capital that you could consider might be some sort of revenue-sharing arrangement – royalties.  Royalties have been used in industries such as oil and gas, coal etc. for decades.  Say an owner owns a piece of land under which there might be oil or coal.  A mining company comes along, wants to drill, and offers a royalty on each gallon of oil or ton of coal extracted.  The land owner still owns the land.  So coming back around to a startup or early-stage company, a royalty on revenues might be worth looking at.  There are no rules or guidelines on how to structure such investments.  Every deal is a snowflake.  One example might be a royalty of X percent until the investor receives some percentage above the original investment.  Another might be a note with a royalty attached.  Such a structure would give the investor a definite exit point which is something that is almost always required in the venture capital industry. 

With revenue-sharing the most critical factor of all is that you keep 100% ownership in your company.  This could be particularly important at some point in the future if you become a serious candidate for a larger venture capital investment.  You will still own all of your stock enabling you not to have to be as concerned about additional dilution, and it also means a cleaner deal for potential venture capital investors because there is only one class of stock – yours.

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I am a very strong supporter of SBA loans.  Over the years the SBA has guaranteed billions of dollars in loans to help small businesses.  But because of the government shutdown the SBA is one of the agencies shuttered (and not likely to be called back) which means that no loans submitted to SBA by banks for the guarantee are going to be dealt with and no loans approved and waiting for SBA approval will be processed..

SBA loans have two steps.  The first is the approval by the lender.  Banks underwrite requests for SBA loans almost exactly the way that they underwrite regular loan requests as though the SBA didn’t exist.  The only difference is that the SBA has broader credit guidelines – things like longer terms, lower debt or collateral coverage for example, so a bank, if they are interested in pursuing an SBA guarantee can be a little more aggressive – emphasize little because banks don’t want to get too far away from their regular (tight) credit guidelines.  SBA’s credit guidelines are not that different from banks.  They are just less restrictive.  So the first step in the process is to get the loan approved by the bank – a process that has its own seemingly never-ending time line SBA guarantee or not.

Then, if the bank approves the loan, it submits it to SBA for the guarantee.  Banks that do a lot of SBA loans can become Preferred Lenders (PLP) meaning that they can put the SBA guarantee on the loan themselves which saves a great deal of time.  Non-PLP lenders have to actually submit the loan to SBA for underwriting by SBA.  Here is where the process starts to slow down.  Even PLP lenders have to get a loan number, which means somebody has to look at it, but now there is nobody to look at it.  And once the number is attached, closing documents are sent to the lender.  No one in that department either. 

But longer term –  after the shutdown ends, the SBA is going to have to deal with the huge backlog of applications already in for approval, and that is even before the banks start submitting loans that are backed up in their pipeline.  It’s going to be a mess for a good many months.  So if you’re thinking about applying for an SBA loan or actually have one approved by the bank waiting for SBA approval, if it’s something you can’t or don’t want to put off but so long, you should probably start considering a Plan B.

 

 

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Fast Cash
January 15th, 2019

Fast Cash

Cash for car titles; payday loans; quick cash; fast money….  So how does this relate to small business ownership?  Cash.  Lack of adequate cash is one of the biggest causes of small business failure.  There are multiple causes for cash flow problems, but two often stand out.  The first, and arguably the most important, is not knowing your cash position each day.  Things can often happen so fast that all of a sudden a particular event can create a cash flow problem.  Say you have to purchase new inventory; even if you have terms from the supplier the inventory may not be turned into cash fast enough and suddenly you are short on cash.  This is not at all an uncommon occurrence but if you haven’t planned for it you could suddenly be in trouble.  And one of the results of such an occurrence is that you may have to forego a paycheck or take less until you sell that inventory.  And let’s say you do sell that inventory at a profit, but then you may be thinking I’m making a profit so why don’t I have any more cash?  Profit is not cash, and if you’re not regularly paying attention to your cash position you might not see the problem coming and be able to do something about it.

The other thing that stands out as mentioned above is failure to plan for it.  If you know that there are going to be periods where there might be a shortfall due to the normal business cycle or even some unforeseen event, know what the most likely sources of working capital are.  The most obvious place to start is your own bank.  Bank financing is generally the cheapest form of debt financing there is.  But generally banks don’t like providing lines of credit or working capital loans to startups or early-stage companies with limited earnings history – even if it’s your own bank.

 So if you haven’t done it already, the first thing you should do as soon as possible is to go to your bank and find out what if anything they will do or if they will even consider it.  If not, it may be worth checking other banks – like getting a second medical opinion.  In Richmond, Virginia for example, there is one place where there are four banks in two blocks.  And they are not long blocks.  There are also two more several blocks away.  So if you get a “We don’t consider working capital lines of credit….” from your own bank, don’t stop.  Remember, banks are always after new accounts.  You could say something to another bank like “As we grow we are going to be running a lot of cash through your bank.  We are going to be a good customer for somebody. Your bank could be it.”

Whoever you talk to at your or another bank, find out exactly what they would need if you apply and have it ready almost like emergency supplies that you can grab and go like up-to-date P&L and balance sheet and personal financial statements and most recent tax returns if you have them.  Also you should probably check out some of the multitude of online lenders that have appeared in the last few years to fill that void of banks not lending to small businesses.  Their loans are frequently more expensive, but if you are in a bind and can get it fast it could be worth the extra cost.  It could save your company. 

And your car.

 

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Student Loan Debt
January 8th, 2019

Long-range weather forecast – possible strong storms on the horizon.  Federal student loan debt is the only consumer debt segment that has continued to grow since the last recession, also leading to a rising default rate.  Over the last eleven years student loan debt has grown almost 157%.   According to the Federal Reserve there was $1.5 trillion in student loans outstanding through the second quarter of 2018, and the number continues to grow.  At the same time student loan debt currently has the highest 90+ day delinquency rate of all household debt, and these delinquency rates are within about a percentage point of their all-time high in 2012.  Couple that with the fact that interest rates are continuing to slowly increase and you have the possibility for those severe storms on the horizon to do some serious damage.  One of the most severe effects of the student loan crisis is the potential negative impact on the broader economy which is continuing to slow down, albeit slowly.  But it is definitely slowing.

One segment of the economy potentially affected by defaults on student loan debt is small business.  Debt financing of many kinds such as working capital loans, equipment purchases and real estate acquisition is often critical to a business, but if there has been a default it can have a serious negative effect on a credit rating making getting loans more difficult or even impossible to get.  An unpaid student loan on a credit report is close to the kiss of death.  I had a borrower turned down for a loan because of an old – very old, unpaid student loan payment.  The number was almost tiny; the business owner had been trying to pay it off but could never get a response from the servicer. The borrower was very strong including a high credit score, but that unpaid student loan killed the chance to get a loan.

As young adults struggle to keep up with student loan payments they are forced to make financial concessions such as delaying starting families or buying a house – two things that generate substantial economic activity.  It is a serious problem that is only going to get worse before it gets better and could also have a negative effect on the formation of new small businesses.

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