Financing Your Business: Factoring

Factoring is a tool that a minority of Business Owners have heard of.  The ones that have are not enamored with it, but Factoring can be a good tool in a business that has issues with Cash Flow.
In particular, the best use of Factoring is covering the gap between expenses incurred on a project and being paid for a project.  Let me use Construction as an example.  Imagine you are going to do some renovations on a Commercial Office building.  In this case, let us say that the Building requires a new roof.  To get to the point where the job is complete, you need to buy and use materials.  On top of that you have one or more crews that need to get paid for their time.  After the job is complete, you send an invoice (maybe the net is due in 30 days or NET30).  But the business is a bit slow in paying and you get a check between 45 and 60 days.  Expenses for the project are likely to have started 90 – 120 days before you get paid.
Now, you will realize at this point that you are floating the customer a loan. Some industries (for example signage) often have down payments to cover materials but this is rarer than you might think.  Even if the roofing job is wildly profitable, you might run out of cash waiting to get paid.  So, how does factoring work and how does it help?
Well, factoring is a solution that is not a loan.  In fact, it is a form of selling an asset.  In this case, that asset is the Invoice that you are going to provide to the Customer.  A Factor buys that invoice from you at a price less than face value.  The Factor provides the cash to you up front and keeps a fee that represents the equivalent of Interest on the Invoice.  The good news is that the Business’ Credit Rating is not an issue, the customer’s is.  This means that a small company can get financing to deliver to a large customer.
In the long term, Factoring can be expensive.  But it is the lifeblood of many industries and companies and smooths over any Cash Flow gaps that exist.
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 Debt:  Early Stage Venture Debt

Venture Debt is a rather complex topic, so I need to break this down into two different parts.  This is the first of those parts and has to do with Valuation.  Now, as I have said the actual valuation of a startup is a problem.  There is little to no revenue and there will be ongoing losses for some time.  Uniqueness and IP Value are in the eye of the beholder, so one way out is a form of Venture Debt.  The point of this post is actually to help you get a handle on some other terms, so our financial example is going to be pretty simple.

Now let us imagine a company where you have been able to pull together a modest amount of Friends and Family money.  You are on your way, but struggle to raise Angel money because their is a disconnect on valuation.  If you don’t get some money pretty quick, you will need to stop or nearly stop the company.  This loss of momentum is bad and most times is unrecoverable.

Now if the company was more advanced you would go to a Venture Capitalist (VC) or 12 and raise what is called a Series A Round (aka an A Round).  The problem is that the company may not be mature enough for this to happen.  In today’s world, a software application needs to have a somewhat functional prototype to get this money.  It is different in hardware or bio technology, but all of them have some points to get started.

So, is there a solution to bridge this situation?  Well, yes there is.  It is a strange form of Convertible Debt with step-up preferences.  The notion here is that a lender provides some cash (in this case let us say this is $250,000).  There are two points going forward:  the company either gets to an A Round or it does not.  If the company does, then the Debt can be converted to equity or paid off in the A round with a Step Up.  This is a percentage that the loan gets as a fixed “interest” payment.  It works something like this.  Let us say you gave the lender a 10% Step Up.  That means that the investment is counted as $275,000 instead of $250,000 when the A round gets completed.  Remember the Creditor here is taking on significant risk.  The company may not reach an A Round, at which point all the money is lost.  So, you can expect these to have a significantly higher value to the Lender than a Bank Loan.

This Loan will also have a preference to it.  That means that it gets dealt with first over everybody else.  They provided funding when nobody else would so that is fair.  The other good news for the Lender is that he/she has a relatively early liquidity event.  They can get paid off if the company is successful in raising an A Round or they can get an extra bump to the money that they put in.  And this is true regardless of the Valuation of the company in the A Round.  Thus, they get significant risk reduction for providing very early stage capital.

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: Valuation

I have dabbled in this topic a bit.  But we need to talk about Business Valuation when we talk about Equity.  That is the key to understanding Equity Investments and Equity Investors.

There are 4 basic types of Investors in the Public Market:

1 – Value Investors:  These people look at the numbers associated with the Operational Part of the Business as well as other Financial Metrics.
2 – Growth Investors:  These people look at the Market and Market position of the company to evaluate the potential for future growth.
3 – Technical Investor:  These people study metrics around the stock price and recent price trends to look for positive and negative signs in the price of stock.
4 – Day Trader:  These people look to trade regularly for small variations in the stock price to be able to extract value.

These last two will not be part of our conversation today.  They require the public market and its open nature to work.  You can’t use these techniques to invest in private companies.

Everyone else is a combination of the other two.  Private Market transactions will have a significant weight on Financial Metrics of the company, especially for established businesses.  Startup businesses will depend more on the Growth that is envisioned and thus the future of improved Valuation to be able to establish a price.

For an established business, most of the time it will be pretty simple.  There is a multiple of cash flow and an addition for excess capital on the balance sheet.  The cash flow multiple is specific to certain industries and there will often be comparable transactions that can be used to set the multiple.  The biggest single issue is the state of the financials in most small companies.  Small businesses are captured financially to maximize the tax benefits to the owners.  In general, that means that the company is actually making more money than is stated by the P&L.  There are expenses that the company takes that are benefit to both the business and the business owner outside the business.  In a large, public company these expenses are not allowed, but often pollute the value of smaller companies.  What is required is that what is handed to investors are Generally Accepted Accounting Practice (GAAP) financials.  In the case of a private company transaction, there may need to be a reconciliation of the normal books to GAAP Books to ensure that things are clear.

This is also true for the Balance Sheet.  I often look at Internet Service Providers in my Consulting Business.  These companies tend to have extensive Capital Investment where a normal business may own its building.  These investments are great on the Balance Sheet and are depreciated over the life cycle of the asset.  Here too there are tax accounting considerations.  Small Capital Investments are often expensed as Cost of Goods Sold (COGS) and not depreciated.  This accelerates their tax benefit, by lowering earnings.  But since we are looking at a multiple of Cash Flow, this needs to be dealt with properly.

There can be additional issues with expenses, particularly the use of cash versus accrued accounting.  In most smaller business, this will tend to have a smaller impact but can be important.  As can the amortization of expenses over the year.  The important part of both styles is that expenses are taken in the same year that they are used and that they are smoothed so that Cash Flow is as consistent as possible over the year.

Now let’s take a look at the Growth side of the equation.  Here what we are really talking about is setting a floor for value or a higher than normal multiple of cash flow based on what business you are in.  Alternately, this can be also a strategic set of customers that the business has.  The challenge for most smaller businesses is that they are small.  Most strategies involve larger moves…things that move the financial needle.  So, here what you need to think about is what is so invaluable that a competitor would have to spend a lot of money to get at.  This is a lot less deterministic and thus there are a lot more disagreements on this front.  This is particularly true for Startup businesses.  So next week we will talk about a solution to this called Venture Debt.

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: Venture Capital

Venture Capitalists are both very popular and very unpopular.  They get to be popular because they have money to invest and are looking to do so.  They are unpopular because they often ask for terms that the Owners do not like nor do they want to agree to.

But let us start at the beginning.  A Venture Capitalist (VC) generally works for a VC Firm that has one or more funds.  These funds are raised prior to their usage and have some notion of what kind of companies that will be invested in and when the investment will occur.  I want the reader to take two points from this.  First, a VC will not be a generalist.  They have restrictions on the kinds of firms that they can invest in.  This can be either by geography, stage of company, industry or any combination of all of these.  Second, there is a time frame in effect.  The fund investors expect to be able to get a return (or not) within a specific window of time.  It would be rare for anyone to have a fund that was open for a very long time.  The idea would be to complete the investment, return the proceeds to the investors and move on to the next.

There is also the notion of an Investment Committee.  This will be typical of larger, more professional organizations in investing.  In this case, a VC will bring the idea of the investment to the Investment Committee, who will ask a number of questions and approve, change or dissaprove the deal.  In general, the individual VC will not make a decision.

I expect to cover Valuation as a topic next week, but as I have said that is an issue.  Generally, the VC is going to want the Owner to lose control of his firm to the new investors.  They want to have a level of control over what they consider (in most cases) a less educated and experienced professional.  But you can also expect these new investors to want to have a number of Board of Directors seats and to be compensated for being on the Board.  Management can expect to report out regularly (often monthly) to the Board with metrics that show the company progress against the plan.  These can often be problematic as most Entrepreneurs are inherently optimistic.  Thus most plans fall behind and increasing pressure is asserted to meet the original deadline.

But the reality is that Venture Capitalists are all about the Exit or the Liquidity Event.  This is when the company makes the shares that the VC holds turn into cash in some form.  This is generally through a buy-out by a bigger firm or the company entering the Public Markets through an Initial Public Offering.  This Liquidity Event is supposed to put profits from the investment back into the Venture Fund, so that when the Fund expires that the original investors make a profit.  Along the way, the VC takes a percentage of the fund to run the VC firm and pay the employees.

Well that is the basics of the Venture Capital World.  Next time, we talk about Valuation.  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: Angels

Just like anything else, Media attention gives a view to something that is simpler and more interesting than it is in real life.  In this case, I mean the program Shark Tank.  What we see are very cute face to face presentations and immediate answers from the investors.  If you think this will work in the real world, you are about to be in for a rude shock.  Remember, Shark Tank is a TV show.  It is Entertainment set up to get ratings.  For real investments to happen, a whole lot more information is required than is exchanged.

For most people, Angel Investors are the first group they might consider after Friends and Family.  In most cases, these are High Net Worth Accredited Investors.  In other words, they have lots of money.  The US Government is greatly concerned about scams and hustlers taking advantage of people so there is a minimum level of sophistication that is desired.  This means that you are not facing celebrities as on Shark Tank, but you are facing experienced investors who want details.  Just as in my last post, it will often turn out that Valuation will be the biggest issue.  I want to get to that in some more detail in a later post.  Today, I want to talk about the process of addressing Angels.

There are often groups of Angel investors who meet as a group to review possible investments, have live presentations, and question and answer with the principals of the company.  The presentation consists really of two parts.  The first part is a business review.  This is an outline of the business plan and the idea behind the company.  One very important part of this will be a biography of the principals involved.  Remember, the investors are going to be interested in both what the idea is as well as who will be executing it.  Investors will be greatly impressed if you have a background in the field you are investing in and management experience within it.  They will be more impressed if you can show a successful sale of a previous company.

The second part of the presentation will be the request for investment.  In most presentations, this will be pretty simple from the legal documents to come later.  But you need to have a specific request for money and tell the investors what it will be used for.  On top of that, the percentage of the company that is up for sale as well as the pre-money and post-money valuations involved.  If there are multiple owners, they will also need to know the capitalization structure or who owns what.

Decisions can take weeks or months and are not likely to be the full amount required.  For example, I know of a company that raised $5M from Angels and it required around 75 investors.  This is an average investment of about $65K per investor.  In general, you need to expect $100K or less from each investor.  They know that most new ventures fail so they are expecting a high risk/high reward situation.  So, they are not going to give anyone a large amount of their Net Worth.  It is a a great way to lose that money.

So, that is the starting point with Angels!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Leadership Training, Sales Training, Strategic Planning

Change Your Business – Change Your Life!

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!