Wednesday, July 2, 2014

Investor Perspective on Small Business Financing

Show me the money! That's what you're thinking when you pursue investors for your business, right? "Step up and put your money where your mouth is." or "Put up or shut up." is what you secretly say in your mind when thinking about investors. Admit it.

When seeking funding from an investor, it's very important for you to see your business and its potential from the investor's perspective, essentially stepping into the investor's shoes. Why is this important? Taking the investor's perspective will help you really think of your business as a valuable asset separate from yourself and help you anticipate the questions and concerns an investor may have. Finally, this perspective can help you better prepare and package your company and, consequently, pull in more investment dollars.

 If you cannot return the money to me on a yearly basis and have no intention and strategy to get the company to a sale point in a few years where I could make multiples on my investment, then why would I invest. It's the same "what's in it for me" perspective that businesses must think of when crafting marketing material for prospective customers. An investor needs to know what she'll get out of it.

Your perspective changes depending on where you look from.
What do I mean by "small business financing from the other perspective"? This blog is dedicated to helping small business owners understand financing options and how to access those options as a vehicle to grow and strengthen your business. So "the other perspective" refers to those who would provide you or your business with financing. I think it's important to have a good grasp of what motivates those who may be interested in lending or investing in your business. With this knowledge you can target appropriately or, if rejected, adjust who you go after and what you provide them with, without taking the rejection personal.

Lenders and investors are very different, therefore I will discuss them separately. Look at past and future articles for more specifics regarding particular financing sources (i.e., differences between banks, commercial lenders, accounts receivable financing firms, merchant lenders, and more on the lending side and differences between angel investors, venture capitalists, strategic investors, private equity investors on the investing side).

Key for Lenders

What's key to seeking financing from lenders of all types are the following:
  1. Cash flow to support the pay back of the loan;
  2. Collateral for the lender to take if your company defaults; or
  3. Combination of the two.
In general, for lenders, the more cash your company generates and the longer the history of generating this cash, the lower the need for collateral. Think about it. If you were lending out $100,000 to a company for four years, what would make you feel reasonably comfortable that you would get your money back? A company that generated cash flow of $5,000 per month and so could easily cover the $2,500 monthly payment (I'm keeping it simple here!)? Or a company that had no idea what's its cash flow was? What about a company that barely generates $2,600 per month in cash but that provides you a two-page summary of how the funds you've loaned them will help them increase that cash flow to $6,000 per month over three years? Be honest.

What would make you comfortable lending?

Thoughts on Cash Flow

There are options for you, no matter your situation but you must be very clear on what you need, what you need the money for, and what financial position your company is in. Many small business owners confuse cash flow with net income. They are NOT the same. You can provide an income statement that shows that your company makes $5,000 in net income per month. But, if you created a cash flow statement, which the majority of small business owners do not, you would see that the cash flow may be negative.

This is why lenders typically ask for your aging - account receivables aging and account payables aging. They analyze how long it takes your customers to pay you and how long it takes you to pay your vendors and suppliers and compare it to your income statement to determine if your company has strong, positive cash flow or is really struggling. If you were lending to a company, wouldn’t you want to understand how that company would repay you? And wouldn’t you want to be sure that those were not empty promises but actually backed by cold, hard facts?

Thoughts on Collateral

Perhaps your company has high quality collateral, or needs funds to buy or lease high quality collateral. This is where asset-based lenders like equipment lenders or accounts receivable lenders come in. These companies often specialize in particular industries and understand that cash flow may be tight yet they believe in the quality of the collateral. This is not blind faith, mind you, but a receptiveness based on years of experience lending in certain industries against certain assets. Again, put yourself in the lenders' shoes.

Let's say someone in the construction industry approached you to purchase dump trucks and hydraulic lifts and you had significant knowledge of the construction industry. This knowledge includes the types of companies - financial strength, customer list, bonding capacity, etc. - that successfully repaid their equipment loans. Wouldn't you feel more comfortable lending to that company, as long as it met certain thresholds? Now what if a distribution company approached you to buy those same hydraulic lifts? How comfortable would you now feel?

Take This Perspective

If you do this analysis yourself (or, more likely, hire someone to do it), you can identify and find a lender that's a good fit for your situation. This process of putting yourself in the lender’s shoes will also help you identify areas for improvement so you can eventually expand your financing options.

In the next article I'll discuss investors.

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