Moving from Prototype to Production

By Mike Semanco, President, Hennessey Capital

 

In our world of lending money to small and midsized companies for working capital purposes, we get calls all the time about how to commercialize a concept or product.  Most of the time, these conversations are very difficult.  Entrepreneur’s are passionate about their product and know it inside and out.  The challenge comes in the form of addressing the following unknowns:

1) is there a market?
2) how is the initial launch funded?
3) how do you scale the business if the product takes off?
 

Setting the stage to address the above questions was a recent dinner conversation with a budding entrepreneur.  She developed a clothing product for both kids and adults to use in the winter months.  Even though there are similar products in the market, hers has a few twists which makes it very unique.  I proceed to ask the questions stated above and hear the following. 

1) Of course there is a market, I gave it to friends and family to try out and they loved it. I think it could be a big hit in the retail market.

2) I hear commercials all the time from banks that they will lend money to small businesses so I will ask my bank for the money.

3)  I have no idea.

Interesting answers.  We proceed with dinner and I put on my coaching hat and do my best.

A market test with family and friends is a good start but if you truly want to build a business and not just a hobby, don’t think small.  First, have you determined if the product can be patented in order to protect your idea before you begin approaching specialty retailers and distributors?  As for financing the initial launch, I am sure sweat equity was poured into making the first few hundred products.  Since the business has been no sales outside of friends and family, the first round of financing will come from the entrepreneur’s savings account, possibly from family members or friends of friends who believe in the idea enough to take the risk.  Banks like to lend money to companies with a track record, typically 2 years or more and a history of some earnings.  Lenders who specialize in purchase order financing and receivable financing may be able to help but they will require the business to have sales or a purchase order from a reputable buyer. 

What happens if the product does take off?  Has the business owner considered which suppliers to approach for raw material as well as manufacturing, packaging and distribution sources? 

The process of moving from prototype to production can be a daunting task.  A task that an entrepreneur should not take on alone.  Remember the business plan that was written a few years back when you thought it was not needed.  Time to dust it off and use it as a framework to tackle the next stage in your business.  Your CPA, attorney, friends and fellow business owners should be leveraged to help you think through the details of moving from prototype to production.  This is an exciting time in an entrepreneur’s life but it can also be one of the most stressful.     

Understanding the Financial Spectrum

By Toby Dahm, Senior Vice President, Hennessey Capital

For most small to mid sized businesses, when they think of financing, they think of a bank loan.  Frequently, however, a bank loan is not available or is not sufficient to meet the financing needs of these companies.  What, then, are the options for a company that finds itself in this situation?

As you would expect, the answer depends on a number of factors.  The first, is the stage in the life cycle of the business. 

A company that has not yet launched its product or service into the marketplace is in need of seed capital. Sources of seed capital financing include:  Owner equity, family and friends, seed investment funds, grants (which is very specialized), and micro loans, or a combination of these sources.

The next life cycle stage is “post revenue but pre bankable.”  Companies in this category have not yet developed a favorable enough financial history to qualify for a bank loan, but have sales.  The sources of financing that fit this stage include:  Asset based loans including factoring, revolving lines of credit, equipment leases, venture capital (a very selective capital source), merchant cash flow lends and government guaranteed bank loans through programs such as the SBA.

The next life cycle stage is those companies that are bankable but need more capital than a bank loan will provide.  These companies usually have a good financial track record but their rapid rate of growth and limited financial strength require additional funding beyond the bank.  Some sources for this additional funding include factoring, equipment leasing, mezzanine debt, and private equity investment.

The final life cycle stage is where bank funding is sufficient to meet all of the financial needs of the business.  These businesses have matured to the point where they have built up enough financial strength where a bank loan provides all of the capital that they require.

The second factor is the nature of the business.  This will determine which options are available to the company throughout its life cycle.  Those businesses that are asset intensive will want to pursue asset-based financing and work with lenders that have an appetite for the various assets they require.  Some companies are working capital intensive and will benefit from a revolving form of asset-based lending.  Other companies are equipment or real estate intensive and will benefit from equipment leasing/lending, and/or mortgage loans.  Companies that are do not have assets but have stable cash flow may be able to utilize a merchant cash flow lender or contract finance company.  Some companies have a strong base of intellectual property assets that can be used to attract various forms of financing.

A third factor that will weigh in is the financial strength of the business owners and support they provide through personal guaranty or other secondary sources of repayment, such as outside collateral.

As you can see, there are a variety of forms of finance that exist for businesses and many of these may be available to assist you with the growth and success of your company.

At Hennessey Capital, we maintain contact with many providers of these sources of funding and we welcome the chance to review your financing needs and identify an appropriate source for your business.  We always welcome the chance to share our financing expertise, and we would love to hear from you.

Accessing Capital When Traditional Credit is Constrained

By Mike Semanco, President, Hennessey Capital

What is a borrower to do?  Although the traditional credit market is showing signs of life, businesses are still facing a challenging credit market.  Hard asset (equipment and real estate) collateral values have dropped dramatically so refinancing of loans requires more cash in each deal.  Younger companies still require a track record, typically 2 years, to qualify for traditional lending.  Because of constrained credit conditions, companies have to think outside the traditional box to finance their business. 

 

In our business, we have seen companies negotiate preferred payment terms with their customers.  Down payments, progress payments and shortened A/R terms are being pursued as viable alternatives.  Companies who have normally written off the notion of factoring receivables are now using it as a standalone financing product or using it in addition to current bank lines to fund incremental growth.  ABL lines of credit are now more mainstream since most ABL lenders are focused on collateral and not solely on cash flow. 

 

In addition to working capital alternatives, companies are looking at micro loan programs and seed funds to help with growth financing.  These loans are usually under $50,000 but can make a difference to a young, growing business.  State funded programs are constrained with lack of cash but could also be a source for creative financing.  PO Financing for distribution businesses remain a good source of capital but project financing for manufacturing companies is non-existent in the traditional market. 

 

Young companies are traditionally undercapitalized.  In a tightened credit market, this creates more stress when new opportunities become available.  Communication is always the key.  Ask your banker if options exist outside their world.  Do be afraid to ask customers what may be available.  If customers like your product or service, they may be open to concessions.  Ask your professional advisors to make introductions to funding sources.  They should be aware of various options and point you in new directions. 

 

Credit is available.  You may just need to look outside the traditional box to find it.

Payroll Funding: Avoiding the Cash Crunch

By Joe Romeo, Senior Business Development Representative, Hennessey Capital

Are you pulling your hair out each time Payroll Check Date approaches?   Maybe a review of your working capital resources is in order.

Many companies face a recurring cash crunch when it’s time to pay their most valuable assets, their employees. Next to the fixed costs associated with buying inventory, building products or creating deliverable services, making payroll is often one of the biggest consumers of cash.

 

Typical scenario:  Your business is going pretty well resulting in a good amount of A/R, but your customers continue to defer payment to or beyond terms.   These are some of your best customers so you are caught in the delicate trap of “collections versus managing the customer relationship.”

 

There is a sound and simple solution for this scenario – working capital financing.   Services like factoring can give you access to immediate cash to provide gap financing and reducing the stress around meeting payroll.

 

Factoring advances of up to 85% of your A/R immediately, when you invoice your customers giving you the working capital you need to run your business and make payroll.  As a bonus, factoring is completely discretionary - you utilize it when you need it.

 

While we are on the subject of payroll, there are some other things you should consider.

 

Paying your employees and satisfying your payroll tax requirements are an essential part of running a successful business.  Many organizations outsource this service.  Outsourcing will save time and expense by not having to perform this work in-house, allowing the business owner to focus on running the business and managing the bottom line. 

 

You can also combine a factoring facility with Hennessey Capital Payroll Solutions – a single point to handle all your human capital management needs.

 

Steering clear of the many pitfalls associated with the regulations involved with payroll is often difficult.  Outsourcing this function to a third party can be an effective remedy. Solutions can include general payroll administration as well as reporting and depositing your taxes with the proper State/Federal authorities. 

 

This involves:

• Accurately calculating and submitting payroll taxes to the state and federal agencies.
• Selecting the proper options available to pay employees and submit payroll.
• Making sure data that is stored or transmitted electronically is secure.
• Ensuring your data is protected from unexpected circumstance such as a fire, hurricane, snow storm, flood or power outage, etc. Optimal disaster recovery plans continuously back up all client data in different locations, so that even in the event of an unforeseen circumstance (weather-related delays, power outages, etc.) all clients’, employees’ and any corporate sensitive information is protected and secure.

As your business grows, you will likely need to hire more employees and add staff to manage those employees. As a company’s employee size increases, more attention needs to be given to Human Capital Management issues. 

Tips for Staffing Companies: How to Increase Working Capital

By Jeff Wright, Senior Vice President, Hennessey Capital

As we continue to see signs of an economic recovery, the strength and duration of it remains uncertain. As a result, companies are reluctant to hire permanent employees. Instead, they are turning to temporary staffing companies to fill their needs. The staffing industry is beginning to see an increase in the level of activity as businesses ramp up production and level of service. This can create a cash flow problem for staffing companies that do not have adequate cash reserves. Employees must be paid weekly or bi-weekly but must wait 30-60 days to collect from their debtors. This causes a drain on cash especially when they are trying to grow their business. They may also lose out on the opportunity to bid on new contracts, due to cash constraints. Management can inject additional capital or they can secure funding from third party investors. The challenge with either of these options is that current ownership may have to sacrifice a level of control within their business to achieve the desired outcome.

An alternative for staffing companies that face this cash crunch is to seek business financing. Since the staffing company’s primary asset is the people they contract out, it does create an accounts receivable that can be leveraged to generate the working capital they need to pay its employees and operating expenses on time and take advantage of new opportunities. If traditional banking sources are not available, a factoring company can provide an alternative source of financing. Factoring is the sale of accounts receivable or invoices at a small discount to obtain immediate cash. This type of financing gives businesses the ability to ensure growth without diluting equity or incurring debt. While factors are concerned with the long term viability of the company, their primary focus is on the debtor strength, the debtor’s ability to pay the invoices being purchased and the character of the management team. While traditional funding sources, like banks, may focus on the staffing company’s past, factors look at future opportunity and growth opportunities. A factoring facility is easy to qualify for and can quickly create immediate working capital availability to meet cash needs. Factoring can be used to bridge the gap between the time the service is delivered and the time the invoice is paid and helps in managing the in-flow and out-flow of cash for staffing companies that want to capitalize on the prospects that lie ahead for their in-demand service.

PO Financing- the ideal financing tool for the right situation

By Mike Semanco, President, Hennessey Capital

For many entrepreneurs, landing that large purchase order is just what the doctor ordered.  You worked hard to win the client, outlasted the competition and are in a position to build on your success.   The team celebrates until someone asks, “Do we have the cash to purchase the large amount of supplies needed to deliver the project?” 

Growth can be a major drain on a company’s cash and a major reason why we stress the importance of cash forecasting. 

Although purchase orders are covered in the Uniform Commercial Code as an asset of a business, it is not an asset that is easily financed, unlike accounts receivable, inventory, equipment or real estate.

Purchase order financing is offered by very few finance companies and is usually best suited for distributors.  Manufacturers and service providers are not ideal candidates for PO financing due to the concern of performance risk.  PO Financing for distributors allows for the securing of goods by way of letter of credit (promise to pay once certain stipulations are met), so that the distributor can increase its buying power with suppliers.   In the case of a distributor, they are not responsible for manufacturing the product so performance risk lies with the supplier.  PO financing will be structured so that the supplier will not receive payment unless they produce the proper product as defined in the PO, which eliminates the issue of performance risk and thus satisfies the PO funding source.

PO financing carries more risk to a lender than traditional A/R financing thus the cost is more than traditional A/R financing.  Due to the increased cost, companies must make sure they have sufficient margin in the order.  PO financing is typically used in conjunction with an A/R line of credit or factoring facility so that once the product is received by the end user, invoices can be financed and the cash can be used to repay the PO funding source.  This opens up the PO finance facility to be used for new orders. 

Purchase order financing is not ideal for every business but in the case of a distribution model where product needs to be purchased and sold to large entities or retailers, it could be a great tool to secure the cash needed for new growth.

10 Tips for Selecting the Right Factor

When entrepreneurs need working capital for their business, a quick way to obtain cash is by leveraging your accounts receivable. Factoring companies are a great source for this type of financing. Although factoring is a pretty vanilla process, the company providing the factoring can come in many flavors. A referral from a trusted source, banker, CPA or attorney, is a good start to finding the right company. 

 

Below is a checklist of things to consider when seeking a factoring partner.                                 

1. Relationship, partnership- easy to work with, straightforward process, easily accessible.
2. Do they have capital to lend or is their credit constrained?
3. Do they have resources that can complement their financing if needed- leasing, real estate lenders, consultants, etc? It’s important to be connected to other resources and entities that can help grow your business.
4. Factoring should be flexible, so watch for monthly minimums.
5. Fully understand your costs.  Ask about exit fees, service fees and documentation fees.
6. Local flavor and relationship.  Not always a necessity especially if references check out.
7. Industry expertise beyond factoring.
8. Ability to transition from factoring to line of credit without switching entities.
9. Relationships with banks are key for future introductions.
10. Community relationship.  Are they making a difference in your area?

Using Working Capital to Complement a Current Bank Line of Credit

By: Toby Dahm, Senior Vice President, Hennessey Capital

Before Reese’s Peanut Butter Cups became one of our favorite Halloween treats, nobody thought that peanut butter and chocolate could be combined to become something so delicious.  In the finance world, there is an often overlooked recipe for growth financing that creates a win/win/win scenario.  That recipe is to utilize factoring as an incremental financing tool in addition to an existing bank loan.

Hennessey Capital has utilized this strategy to propel many companies to a higher level of revenue and profitability, while enabling the client to maintain a very competitive financing cost structure.  For most small and middle market companies, a bank loan provides the lowest cost financing that they have access to.  However, it is common that a bank is comfortable at a certain level of exposure to a client, but the client’s growth trajectory creates a financing need that exceeds the bank’s comfort level.  This is where factoring can be the perfect tool to fill in the funding gap and enable the client to achieve success.

The benefit is that the client can very quickly put the factoring facility in place to complement the bank loan at very little fixed cost.  The factoring facility becomes a tool to finance their working capital needs as their growth accelerates.. By providing up to 85% financing of accounts receivable, without diluting any equity ownership, the factoring facility enables the client to access cash immediately, instead of waiting for their customers to issue payment.  Factoring provides great flexibility to the client by being able to finance the rapid growth when it is needed, while providing the choice to terminate the program when it is no longer needed due to expansion of the bank loan or a reduction in working capital growth.

An IT staffing company was able to utilize this program to take on additional work that enabled them to grow from $2 million in annual revenue to over $10 million during an 18-month period.  Although Hennessey’s factoring facility was replaced by an expanded bank loan, the client has continued to grow at a strong pace and is now achieving annual revenue that exceeds $100 million.  Another IT consulting firm utilized a factoring facility with Hennessey Capital to enable it to expand its base of consultants on one project from 10 employees to 75 employees over a 90-day period.  As they demonstrated their performance and profitability on this project, their bank agreed to increase their financing to replace the factoring facility.

Just as chocolate and peanut butter can be combined, a bank line and a factoring facility can also be combined to form a very healthy 3 way partnership between the bank, the client and the factor.

Credit Shortage Threatens Supplier Growth

Detroit Free Press writer Susan Tompor sheds light on the challenges that lie ahead for small to medium sizes businesses, particularly in the manufacturing sector. As analysts proclaim that the recession is over, how do small manufacturing shops access the capital they need to re-set production and re-hire workers? Read the article

4 Months and Still Going…

Multiple media outlets reported of the consistent 4-month uptick in SBA lending.  Better yet, all signs indicate that this type of lending will continue to increase through the remainder of 2009.  “I think it’s a continuation of the impact of raising the percentage that we guaranteed to 90 percent and the elimination of the fees to the borrower,” said Richard Temkin, U.S. Small Business Administration District Director. “And the banks’ credit requirements perhaps are loosening somewhat, though that seems to be a slow process.”

So, what does this mean for small businesses? This is an encouraging trend that hints that credit markets are starting to thaw from the deep freeze of early 2009 and that banks are increasing lending. For entrepreneurs who have been struggling for the past year, this is good news. Those who are fortunate to still have a traditional bank loan are more likely to keep it. Those of you thinking about starting a business and considering a SBA loan, might just be in luck. Overall, this is a positive sign that Michigan may have hung the “open for business” sign back outside its window.

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