Financing Your Business:  Friends and Family

Last week I talked a bit about the SBA loan.  This week I want to talk about one of the other early stage funding options – Friends and Family.  It is exactly what it says.  You get money from either Friends or Family or both.  Sometimes this can be Debt, but I want to talk about it as Equity.  This will give us a view into one of the biggest issues in Equity transactions:  Valuation.

Valuation is pretty simple.  How much is the company worth?  The younger the company is the less likely there are lots of good ways of determining Valuation.  But to start with there are 2 numbers that you need to understand: Pre-Money and Post-Money.  This is pretty simple.  A Pre-Money Valuation is the worth of the company before their is an investment.  A Post-Money Valuation is the value after the investment.  Think of it this way.  If you created a company with 1,000 shares of stock and had invested $1,000.  You then sell 100 shares of stock at $1 per share to a friend.  The Pre-Money Valuation is $1,000 and Post-Money is $1,100.  The Friend now own 100 out of 1,100 shares or about 9% of the company.

I hope you are beginning to see why Valuation is such a big deal.  How much a company is worth is subjective, especially early on.  That is because of what would be both Intangible Assets and Sweat Equity.  Intangible Assets are the Intellectual Property that the Founders have.  In other words, their brains.  Sweat Equity is the effort that they put into the company without compensation.  So a Founder will want to get value for all the work they have put in and the value of their Business ideas.  Most investors will not be so generous about what that is and thus there is a significant amount of conflict about this topic.  So, have your ducks in a row about Comparable Companies or Comps.  This helps set the market for businesses.

I have one last thing to say about this.  Put it in writing.  I can not tell you how many people have broken relationships over business disagreements.  It is not worth it.  Put things down in writing and make sure everybody is clear.

Have a great day!

Jim Sackman
Focal Point Business Coaching
Business Coaching, Leadership Training, Sales Training, Strategic Planning

Change Your Business – Change Your Life!

Financing Your Business: The SBA Loan

SBA Loans are a form of debt that is very common in the small business world.  SBA stands for the Small Business Administration and is an agency of the US Federal Government.  The SBA Loan is, in the most common form, a standard Business Loan from a Bank or similar Financial Institution.  What the SBA does is provide some level of risk reduction to the lender.  I don’t want to provide an exhaustive detail on getting an SBA Loan.  What I will do is provide some thoughts about why this is important and when to use it.

Just so we are clear, SBA support is not free.  Think of it like when you first purchase a house and have to have Mortgage Insurance on your home.  Once you can, refinance the loan (or point out to your lender that you no longer meet the criteria for needing Mortgate Insurance) to eliminate the charge.  SBA loans like Mortgage Insurance provide value directly to the lender not to the borrower.  These programs provide indirect support for borrowers.

So, what is this indirect support.  Well, I will be blunt.  You can’t get a business loan in so many cases, that the SBA guarantee is very important.  If you recall in last week’s post, I talked about Underwriting at a Bank.  The basics with Banks that I talk to is that they want to loan money to a firm that has had a stable organization for 3 years and can show a profit over that same period.  That is BEFORE we talk about the loan and what it might be used for and how it is intended to build the business.  By stable organization, I mean that it is in the same corporate structure over that time.  So, right now if you are reading this to head to your bank to get a loan to start your business…just turn around.  You won’t get a loan that way.

What the SBA does is provide air cover for the lender.  If they see that there is a good business plan with people to support it, they want to issue the loan.  The SBA guarantee allows them to get around those pesky Underwriting Guidelines to do so.  I want to be clear that I put the words “good business plan” in that sentence.  That means a narrative and 3 years of proposed financials.  If you are thinking you won’t need to know your numbers, you are not thinking about this properly.  The Bank wants to make sure that you understand how the operation of your business will end up paying the bills – including them.  So, they are likely to have questions about both the numbers and the business that you will need to answer.  Saying, “I don’t understand the numbers” will not be comforting to them and help you secure the loan.

An SBA loan is where many businesses have started.  Have a great day!

Jim Sackman
Focal Point Business Coaching
Business Coaching, Leadership Training, Sales Training, Strategic Planning

Change Your Business – Change Your Life!

Financing Your Business:  Debt or Equity

This is such a wide ranging topic that it makes it hard to find a great starting point.  So I am going to begin by making sure that we are clear on Debt and Equity.  I am going to use an example later to show how they compare in a real situation.  In some businesses, it may be difficult to get one or the other or both.  And we will get to that.

Debt is pretty simple.  It is borrowing money.  Many people are clear on this today as Credit Cards, Auto Loans, Student Loans and Home Mortgages are commonly used and widely available.  Business Debt is available in a variety of forms such as Corporate Bonds, Business Loans, SBA Loans, and Lines of Credit.  Each of these has their different place in the life cycle and size of company.  But the basics are still the same.  The borrower gets an amount of money that will be paid back over time with interest.  Terms and Conditions on these loans vary widely and so have a lot to do with who can get what kind of loan.  In the Banking world, the process of evaluating the loan request is called Underwriting.  So when you hear of a Bank talk about their Underwriting Guidelines, they are talking about what they will need to have from the company to be able to give it a loan.  You should talk to a Banker before you apply for a loan and they will give you an idea of what they want.  This may be a lot more than you think it is.

Equity is also simple.  You are selling a portion of your Business to someone (or many someones).  You will know Equity transactions from the Stock Market where Public Companies are bought and sold (or at least parts of them are) every week.  But Private Companies have equity investments of many forms as well, where firms sell part or all of themselves.  The difference between a Public Company and Private Company is the availability of Stock for sale on the Public Markets.  There are some forms that need to be filed and a whole mechanism to distribute that Initial Public Offering (IPO) happens.  But at the time of an IPO, there is already Equity in the company and shareholders who own it.  All that is happening is that some percentage of the ownership is for sale in a public marketplace and average people can buy or sell that stock in a marketplace.

There are also mixed Debt and Equity Instruments like Convertible Debt that I will cover in the future.

My example is a company that has $250,000 ($250K) in profit and has an opportunity to expand by spending $500K to buy a competitor.  There are plenty of middle grounds here (and I will cover this a lot more in another post) but we are going to examine both scenarios at a very top level.  For a Loan, the company takes in the $500K and pays off the loan with the profit that it generates in the future.  For Equity, somebody gives the company $500K.  If we assume the company was worth $1M at the time (aka pre-money), then the company (after the Equity Sale) is now worth $1.5M (aka post-money).  This is shown on the Balance Sheet first with an increase in cash and then an increased Liability in Shareholder Equity.

The value of each of these is different as we have to look at how the Investment gets its Return.  For Debt, it is pretty simple.  It is the payback of the Principal ($500K) plus the value of all the Interest.  For Equity, it is more complex.  The Investor may want to be paid a percentage of the profits.  The reason is that the Investor will want to “get liquid” or get his money back from the Investment at some point.  So will the owner buy out this minority partner or will the investor sell his/her stock to a 3rd person?  You can see how this can make the Equity more expensive than the Debt.  But we will examine this throughout our series.

Have a great day!

Jim Sackman
FocalPoint Business Coaching
Business Coaching, Leadership Training, Sales Training, Strategic Planning

Change Your Business – Change Your Life!

Financing Your Business

Over the past 4 years, I have written on occasion about Funding and Financing Sources for a Business.  This will be a series about Financing and how to view it in your business.  The goal is to talk about various stages of funding for different kind of companies as well as the various types of players.  The thing is that this is so vast a topic that I will probably miss something.

The there are two issues that will be at the core of everything else: Your Business Plan and Return on the Investment.

There are people that will not want to understand Your Business Plan, but they are not going to fund most Businesses.  You need to be able to describe to people how you are going to make your Business work.  That is the point of the Business Plan.  But the part here that is front and center is the Financial Part of Your Business Plan.  People will expect at least 3 years of realistic Financials with some narrative with them that helps explain why your Financials will be that way.  Most people often don’t think through their Financial considerations in any detail.  For example, How many customers do you need to make your Business match the Financials that you have presented?  That question alone leads to a line of question involving Products, Marketing and Sales that help make a Business Plan tick.  So, there are several threads that you can follow through your Financials to make the narrative of Your Business Plan.

Now, the important part of the Return on the Investment is the addition of the word “the”.  I am not talking about how you are planning to improve your Business results.  I am talking about how your investors are going to make money.  When you talk to investors, that is what they actually care about.  The Business Plan is simply a vehicle to describe how your business will grow.  There is a difference in that translating to how the value of their investment will grow.  There is another difference in how that translates to the investor being able to exit their investment and get all their capital back and make a return on top of that.  You also need to ensure that you have the risk associated with the investment being comparable with the potential return on the investment.

If that is too much text, then let’s make it simple.  You need to tell people what they are getting and how you are going to grow the value of their investment by executing your business.  Remember, you are competing in a market for this funding.  You will find that investors have choice.  And it is your job to align with them to get their investment.

Have a great day!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Leadership Training, Sales Training, Strategic Planning

Change Your Business – Change Your Life!

Fear of Funding

I have had some conversations lately about capital to help a business grow. The conversations have not gone well and I am trying to post here to help people be a bit more thoughtful as it relates to raising capital for their business. We have talked about all kinds of investors whether they are Financial, Strategic, or Angels. But the thing that I think people want are Unicorns. Investors who don’t actually exist.

Let me take a step back and outline the fundamental problem. I think this came from Kickstarter and the like where people give you money with really no expectation of a rate of return. This kind of funding works for a very small slice of businesses. An Electrician or a Clothing Store is unlikely to have a viable Kickstarter. They basically work for Product Development Projects that have some meaning to a Millennial Audience. Most businesses can not use that kind of vehicle to raise money.

This leaves us with our two traditional funding mechanisms: Equity and Debt. Yes, there are hybrid vehicles but most Small Businesses don’t have the infrastructure to deal with Warrants or Preferred Stock. So, let’s just stay the course and focus on our two mechanisms. Debt is a loan of some type. There is interest to be paid on a loan as well as eventually paying back the principal. This means that many people are interested in Equity investments. This way the money comes in and there is no direct obligation to pay this money back. That makes things attractive for people. The downside is that Equity likely comes with some interference with how the business is operated. This can be troubling for some owners.

But we need to talk about two things that need to be included in any request for funding: A plan for Return and Use of Proceeds. The former creates a whole set of problems as Owners are often unclear on how they are going to make the money up that they are taking in. Think about an investor. If you are unclear or uncertain, why would they give you money to use on your business. That kind of clarity is paramount. With Equity, there is an additional challenge. They are not concerned with getting interest but at some point being able to sell their portion of the business at a higher number than they put in (with some thought to a reasonable return on their investment). Does that mean you have a plan to sell the business or take it public? If not, how are they selling their stake? The Use of Proceeds asks how the money is going to be spent. Often times, owners know they need capital to grow but don’t have clarity in planning how they are going to use the money and what alternative uses their might be. Investors will evaluate the Use of Proceeds to see if the plan makes sense. If it doesn’t they are unlikely to give you capital.

All of these things cause people to be adverse to raising capital to properly execute their business. But all of this is well within the Owners thinking and is easy enough to write down in a clear manner. It can help a business prioritize how it is spending its money even without additional investment. If you know a business that is struggling with raising capital or is unsure what that would mean have them contact me. Would be happy to talk to them to see what their options are.
Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

Change Your Business – Change Your Life!

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Know Your Numbers: A Real Life Example

Last Monday, I finished what I had planned to do in this series. Wednesday, I reviewed Enphase’s earnings. On that post Wednesday, I promised to use the numbers from Enphase’s earnings to help people understand the Way to Wealth Formula. Before I do that, I want to say that Brian Tracy coined that phrase. Brian published 2 books: The Way to Wealth and The Way to Wealth Workbook. Both are fantastic and I highly recommend them.

What I wanted to cover today was the announcement on Wednesday that Enphase was adjusting its pricing and therefore can expect lowered Gross Margins. They also “adjusted” Operating Expenses and I want to take a look at how this runs through a set of numbers based on what they do and show the impact. In case you don’t know Enphase, they are a publicly traded Solar Power Company that focuses on power conversion and storage. They are relatively young as a company and have been really successful. Recently the stock has had issues, culminating in problems last quarter and going forward. Note, all the information I use here is public and available on the Internet.

In a typical quarter, Enphase has about (and I plan on using nice round numbers where I can) $100M in Revenue. Traditionally, they have had Gross Margins (GM) in the 30% range. This means that 70% of the money goes for Cost of Goods Sold (COGS). In real money this equates to $70M in COGS and $30M in GM.

Now let’s change the pricing. Enphase announced that Gross Margins would be in the mid-20s. I will use 25% as the number for my calculations. However, I am going to hold COGS constant in this exercise. This means I am recalculating if they sell the same number of units built at the same cost. We know that GM will be 25% and COGS is thus 75%. If that $70M is COGS (from the earlier calculation), this means that revenue is now $93.3M. Let’s get back to GM and see that it is only $23.3M. That means a 5% Price Reduction leads in a drop of $7M in GM. This is a drop in excess in 20%.

Wait, why is that such a bigger percentage change? The reason is that a Price Reduction without a Cost Reduction flows dollar for dollar into a reduction in profits. That is why the company will attempt to compensate with a reduction in Operating Expenses (OPEX). According to filings, this reduction in OPEX will be about 7%. Enphase was run as just about a break even company. This means that OPEX spent just about every dollar that GM gave. So, let’s call OPEX $30M. A 7% reduction is $2.1M or a new OPEX of just about $28M – I will use $27M to account for my rounding of numbers.

This implies that Enphase, in its new model, should expect to lose between $3.5M and $4M per quarter (GM of $23.3M and OPEX of $27M). What can they do? Either sell more stuff or cut costs more. How much stuff will they need to sell? Well, they need to generate $3.5M in GM that means that implies an new Revenue Number of $14M or a total Revenue of about $107M. This is about a 15% increase. Not a huge stretch, but that is just to get back to where they are today.

All of these factors of Prices and Costs factor into each business everyday. The kind of “What-If” scenarios are easy to do and something a Business Owner should be comfortable doing.

Have a great week!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

Change Your Business – Change Your Life!

Sonoma County: News and Notes

I really hate to post about Earnings this week as I will need to talk about Enphase. The stock reported last week and has been getting crushed since then. This is an extension of an ongoing decline for the last 6 months. The decline over the last 6 months has flown in the face of the results posted by the company, but it has all come to roost at this point.

The Q3 numbers were not bad. Revenue was $102M up slightly from last year. The company continued its tradition of spending what it makes and Enphase was about break-even again. The slight Revenue Growth is the first issue. Enphase had been a growth story, particularly around the spectacular top line growth. But Q3 2015 was different, it was essentially flat with Q3 2014. If the growth has slowed, then people will not want to price the company very strongly. This is a problem with Growth Investing (also called Momentum Investing). Once the growth inevitably slows, then there is a dramatic stock drop.

But there is a second problem with the stock which was the projection of only around $65M of Revenue in Q4. This was noted because of extra inventory at Enphase’s distributors. This means that there was a slow down in Sales at the Distributors but they had already placed orders and those got filled before the slowdown was noticed. This is a bad sign for the future and will have to be watched. One other number that you can look at that makes me pause is the Accounts Receivable. This number was up $30M Year over Year, which means that Enphase might have shipped a significant amount of product at the end of the quarter. I don’t like these kinds of shifts as one can make some rather suspicious comments about managing Revenue to make it all happen in one bad quarter.

Then there is a third problem at Enphase. Price pressure has gotten too much and Enphase has lowered its Gross Margin forecast for the future. This is a drop of about 5% and looks to be a relatively long term drop. Because of this, Enphase has had a 7% layoff. This signifies to me that this is not a 1 quarter issue, but that the company is serious in changing its cost structure. This presents a problem in efficiency because Enphase will need to return to its former Revenue levels with 7% fewer employees. That can be a challenge, unless those were unproductive employees anyway. If they were, then one would question why they were still employed. This Gross Margin change is a great example of how to use the Way to Wealth Formula that I have been posting about. Because of this, I am extending my series on that one more week and I want to run through the consequences of these changes to a company.

Finally, there are the unstated uncertainties in the future. As many of you may be aware the vast bulk of the Tax Credits for Solar from the US Federal Government expire next year. This will put further price pressure into the market. On top of that, Oil Prices have dropped significantly over the past year. This also looks to be a long term trend. These two taken together mean that Energy Prices are likely to decline. This means the Return On Investment (ROI) for a Solar Installation will be tougher for people to make.

So, we will have to see if Enphase’s expansion Internationally and into the Storage Business will help. Right now the Market Cap of Enphase is under $100M. This means it is about 1/4th of Sales. Management will be under extreme pressure to change this.

Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

Change Your Business – Change Your Life!