This educational guide will be separated into two sections. And although it is mostly directed towards our distributor base, there are ideas that may assist suppliers. In this first section I will address sources of debt and equity, the benefits and costs of each. Our second section will help you prepare presentations for these sources of financing.
Many of us came into this industry by accident. We did not say in high school, “I want to sell promotional products for a living!” (Apologies to those legacies who started as children in our industry and hung on.)
And it was relatively easy for distributors to get started as long as they had an “in.” In finance we say that there are very few barriers to entry. As a result, many are undercapitalized having brought insufficient liquid equity (net worth) into the business.
Debt is “borrowed” money. It has a specific repayment term. Trade payables, when a supplier offers you terms to pay, is also considered as debt. Traditional sources of debt are banks, finance companies, personal or family dollars, trade payables, some types of investor arrangements, and credit cards. Not only is the repayment term set, so is the cost or interest rate.
Equity is ownership of one form or another. Generally there is no set rate of interest, but the owner has a say in the managing of the business. And typically there is some concept of repayment through the sale of his/her ownership interest. There rarely is no free lunch.
As banks are the least expensive, it is not difficult to find the right bank. Meeting with your local community banker and discussing yourplans is a good start. Getting a referral from fellow small business owners, your accountant, your lawyer, even your insurance or real estate agent, is an excellent beginning. Sometimes the local community bank may be a much larger bank with local decision making.
The bank’s decision will depend a great deal on your personal credit. If you have a high credit score, you have a strong position. The bank looks at the 4 C’s – character, capital, cash flow and collateral. Do not be surprised if the bank wants some hard collateral to back up the debt, such as a second or third mortgage on a personal residence.
Please understand what the creditor wants – its rate of return and repayment within the specified term. No more, no less.
Be careful when presenting your request. It might be helpful to review with an advisor of some sort in advance. We had a saying in banking, “Open up a window and they will climb out.” Do not give them reasons to say no.
Also, ask for lines of credit when you do not need it. Have it in place for when you do need it. On a sunny day it is easy to borrow an umbrella. On a rainy day, it is more difficult.
Bank debt comes in various forms – unsecured, secured with business assets, or secured with personal assets. Interest rates depend upon the type of loan/line of credit. Similarly, the bank may require some financial reporting. It could be limited to periodic financial statements, or it can include more detailed reporting, such as A/R and A/P agings.
Finance companies take a legal interest in certain business collateral. Typically accounts receivable, inventory, real estate and intangibles, this collateral bolsters their repayment in the event of a default. Remember, they just want to be repaid.
If the financing is dependent upon accounts receivable, there are specific reporting requirements. It can be costly to comply. Factors (the companies that purchase receivables with or without recourse) are the most expensive form of debt. Understand the financing terms.
Borrowing from family may be the least onerous in terms of reporting and hard costs, but it can make family gatherings uncomfortable if you are not performing as expected.
There is a lot of self-help besides debt in improving your cash flow. Offer discounted terms on your A/R to your accounts. For example, 2 percent 10 net 30 costs 24 percent per year. It may be high, but you get your money quickly if they take the discount. More expensive than traditional bank debt, but less expensive and onerous than factoring. Just asking for a prepayment of some sort the right way can free up funds. Utilizing a merchant charge card to collect gets your money quickly at similar costs. Being more aggressive and proactive in collecting your A/R is also helpful.
On the A/P side, ask your vendor for dating (common with calendar orders) or special negotiated terms. Allowing a vendor to invoice your client the retail amount directly and remitting your mark up to you is a “free” way of easing cash flow. For larger transactions you can also work with the client and bank for transferable letters of credit.
Another way to free up cash is to finance all of your capital expenditures. There are leasing companies that offer financing on almost anything, including leasehold improvements. This allows you to keep your cash and pay as you reap the benefits of the purchase. The vendor of that product will have a list of leasing companies with whom they work. Same with your insurance premiums and car purchases. The idea is to preserve cash, only paying as you use the benefit.
Credit card financing is a time honored Inc. 500 tradition. Many small start ups began with personal credit card debt. Although more expensive, it is easy to access. Provided that you repay according to terms, there is no future “decision maker.” You control your destiny. And if you just have it as a back up and do not use it, the cost is nothing.
Besides credit card financing, the Inc. 500 used family dollars to get started. Approximately one-third of them went that route.
How do you approach your future creditor? Keep in mind that repayment is the only thing desired. Have a business plan. Develop a personal relationship with the potential creditor to create trust. Demonstrate how you will repay. Included in this topic is a business plan (this is for another column, and do not overlook the significance of this topic). You have an idea of where you are headed, but the credit grantor needs to see it concisely.
After graduating from the Wharton School at the University of Pennsylvania, Harvey Macklet enjoyed a 20-plus year career in commercial banking, exercising his “golden parachute” in 1996. He was executive vice president and COO of our commercial finance subsidiary in Manhattan and chairman of the Small Business Banking Unit of the American Banker’s Association. He has served on the board of the acclaimed George Street Playhouse in New Jersey and chair of the Easter Seal Society of New Jersey for two years as well as a captain on his local emergency rescue squad. He acquired GWI Corp in February, 1997 and transformed it to focus on the Supplier/Distributor/End-buyer model, growing the company's sales by 500 percent. He is past chair of the SAAGNY Foundation, current Co-Chair of the PPAF EXPO and past Chair of the Supplier Committee of PPAI.