Understanding the Financial Spectrum
Filed under: Business Tips & Tactics, Finance Talk
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.
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.
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.
Small Business Loans Criticized
Monday President Obama released a plan to increase the federal guarantee of small business loans to 90% and decrease fees associated with the loans. However, the action is being met with significant criticism. Read the Wall Street Journal article: Small Business Loans Criticized
Access to Capital Webinar
Entrepreneurs throughout the country are encountering challenges in gaining access to capital. With credit markets dried up and few banks lending to small businesses, it’s become increasingly difficult for small enterprises to get the working capital they need to grow their business. If you are interested in learning more about the financial spectrum and where to turn when your credit line shrinks, register for the upcoming “Access to Capital” webinar.
Thursday, March 18
9 a.m. EDT
E-mail name and company to: Nicole@macombcountychamber.com.
Where Does My Business Fit?
In today’s often challenging job market, there seems to be an increase in those who are interested in starting a new business or growing their current small business into new markets and industries. All entrepreneurial ventures, regardless of business model or industry, seem to lead to the same place, because almost all require the same thing… financing.
Today, we’re going to try to demystify the financing quandary and provide some insight on how small business financing works.
Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.
