As your company experiences increasing global commercialization of products, services and technologies, you may face new tax challenges and uncertainties.
“Even the smallest of companies are experiencing some interaction with global suppliers or customers,” says George Koutouras, partner, international and transaction tax, at Moss Adams. “So that means they have the need to consider certain tax aspects associated with global transactions, on one end of the supply chain or the other.”
With a U.S. tax system based on global income, it may make sense for a company — transforming from predominantly domestic to global — to keep earnings offshore to reinvest in new growth for foreign jurisdiction subsidiaries, as opposed to taking U.S.-sourced capital and committing it to offshore operations, he says. However, you must have an economic or legal justification to organize your business that way, as solely tax-motivated transactions are not available in today’s environment.
Smart Business spoke with Koutouras about businesses experiencing increasing growth globally and the potential tax problems.
When migrating capital offshore, why are bank debt covenants important?
When a company decides to go offshore, setting up operations or buying facilities, the first question is not what does that do from a tax perspective, but what are the restrictions on your bank covenants? Lenders may place restrictions on a company’s ability to use lent funds offshore, recognizing the difficulty associated with returning that capital to the U.S.
Review your bank’s financing restrictions. If they limit your ability to migrate cash or capital, determine if you can re-negotiate some of the bank notes, which is not always easy. A company may need to replace certain financing with other debt financing — it’s not a matter to be taken lightly.
Ultimately, whenever sending capital offshore, businesses and their advisers need to understand the intended end result. Do they need to repatriate it at some point to service debt, or do they intend to keep that cash offshore indefinitely to finance offshore growth? The answers will influence the structure that is created from the outset.
How seriously should a company consider local financing options?
If a company migrates some activities offshore, you might need to obtain local financing to expand operations. However, certain jurisdictions, particularly in Europe, are experiencing a credit crisis and, as a result, bank financing is not readily available. Without local financing, question whether there is any ability to service U.S. bank debt, or will you need a mechanism for intercompany financing? Often cash-rich companies use intercompany loans to more freely transfer extra cash between jurisdictions.
But an inevitable hurdle with related-party transactions is the need for a secondary analysis to ensure those transactions are at arms length. Otherwise, the jurisdictions involved, such as the U.S. and Ireland, may attempt to re-characterize or re-price payments to be more consistent with market turns, creating some unanticipated tax consequences.
What intellectual property (IP) will you need within a foreign region?
IP is a relatively broad category of assets that not only consists of patents and trademarks but can also include know-how and processes, and companies should match the commercialization of IP with the development of the IP.
Often businesses take U.S.-developed IP and parse it up among various global commercial centers. However, if IP is being sold in Europe, there may be a need to manipulate or develop that IP in a European-centric way. Companies should identify centers of activity for offshore endeavors, including the development of IP. Areas, such as Ireland for Europe and Singapore for Asia, have a skilled work force, good technology infrastructure for research and development, and a relatively low tax rate when compared to the U.S.
IP is an area where the U.S. is vigilant about establishing policies to restrict companies’ ability to migrate assets offshore, so outright sales of IP offshore aren’t without their accompanying tax costs. Often, property, including IP, in its earliest stages of development and/or recently purchased is the easiest to convey offshore without the inclusion of taxes. To the extent IP and other U.S.-owned assets are needed offshore, consider both sides of related-party pricing to avoid unsupportable accumulations of income or loss in the relevant jurisdictions.
How should you quantify the support needed from domestic management, sales force, technical help or home office systems?
The cost for headquarter-support services needs to be chargebacked by the offshore entity. Companies that aren’t charging for management services and/or systems that go offshore are vulnerable. For example, the U.S. might assert that the foreign entity should be paying more back to the U.S. for the use of the U.S.-based management, thereby creating more potential U.S. tax income. This is something that needs to be reviewed periodically; the management chargebacks existing today might not be the chargebacks needed in a year’s time.
What tax considerations are important for how you sell goods within a region?
Pay attention to how your company conducts sales within the jurisdiction. Sending your domestic sales force into a foreign country will extend the taxable presence to that other jurisdiction. To avoid that, a company can compartmentalize sales by setting up a separate company or using a third-party, such as distributors, already within the country’s marketplace. Another mitigation is to avoid signing sales contracts within market and thereby creating a taxable presence. Ideally, in such cases, all sales are negotiated and executed remotely, and the salesperson is merely demonstrating the product with no authority to sell on behalf of company.
Also, when selling inventory, the placement of property within a jurisdiction could create a taxable presence. The U.S. will tax the income, and the foreign jurisdiction may assert tax liability for sales within its borders, creating the possibility that the same dollar could be taxed twice.
George Koutouras is a partner, international and transaction tax, at Moss Adams. Reach him at (415) 677-8212 or George.Koutouras@mossadams.com.
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In the current economic environment, many businesses are finding financing difficult to come by. But with the proper preparation, gaining funding for your business is not impossible, says David Shaffer, director, Audit & Accounting, Government Contracting Industry group leader at Kreischer Miller.
“Getting your business in order and presenting a strong case to your banker can improve your chances of getting financing,” says Shaffer. “It’s not as easy as it once was, but even in difficult economic times, banks and other organizations are still providing financing to businesses.”
Smart Business spoke with Shaffer about how to position your business to succeed when seeking financing.
What does a business need to have ready prior to looking for financing?
Whether you are a new business or have 50 years of history, anyone looking to provide financing is going to want to see the plan of how the business is going to repay the loan. Most lenders do not want to have to liquidate the collateral to collect the loan; they want to set up reasonable terms and conditions so the business can repay the loan, over time, and the lender can make a reasonable profit.
In most cases, this means providing the lender with a monthly budget of the business’s income, balance sheet and sometimes cash flow for 12 months, and an annual budget for at least two years from that point. The lender will use these statements to create financial covenants, so management must be comfortable that they can meet, or preferably exceed, the budgets.
Lenders are also going to review management’s history and the business’s history of repaying debt. If there have been any issues with historical debt, this should be discussed with the lender up front, prior to the bank discovering it on its own.
If you are an existing business, three years of historical financial information should also be provided. Audited financials are best, but in most cases, reviewed financials will be sufficient. If the company does not have audited or reviewed financial statements, compiled or internal financial statements should be provided, but if this is the case, be prepared for more due diligence from the lender. If there have been historical losses or other items that might give a lender concern, discuss the issues with the proposed lender prior to sending.
If this is the first time through the process, owners should consider having their CFO/controller involved, or involve their CPA or legal counsel who is familiar with typical terms and conditions of business loans. But even if you have done this before, no matter how experienced you are, make sure that you have an experienced attorney who has knowledge of these loans review all documents prior to signing.
How long does the process typically take from start to finish?
Most banks need 45 to 60 days from the initial meeting to the time of funding a loan. If the loan is more complex, it may take longer.
What collateral will a lender typically request?
Most banks will request that all business assets collateralize their loan (assuming they are the only lender) and, in most cases, will require the business owners to personally guarantee the loan. If the loan is very risky, they might also request liens on specific owner assets such as stock portfolios, personal home, and/or cash surrender value of life insurance.
What interest rate can businesses expect in the current environment?
Banks and other lenders determine their interest rates based upon the perceived risk of the loan. Most business loans that are not high risk have variable interest rates ranging from prime minus .5 percent to prime plus 1 percent. Fixed rate loans will vary depending on the length of the loan and the collateral.
Other than banks and personal savings/assets, where else can a business seek funding?
President Obama recently signed the Jumpstart Our Business Startups Act, and one aspect of that, called crowdfunding, provides up to $1 million of loans for businesses. Transactions must be administered by a broker or a funding portal that is registered and complies with the Securities and Exchange Commission requirements.
The Small Business Administration and other government-guaranteed loans also provide funding alternatives to businesses. The SBA can provide loans up to $5.5 million. Such loans require a lot of documentation from a business, but their rates are very competitive. In most cases, a bank will still need to be involved to underwrite the loan, and many banks have specific lenders specializing is SBA loans.
Some companies also consider joint ventures. However, this is quite risky because it requires a strong leader to bring together a group of businesses so that each member of the group understands the risks and responsibilities involved. It also requires the involvement of an experienced attorney who can write a joint venture agreement that everyone understands and is willing to sign. Joint ventures are often used to complete a specific project for a customer when one company does not have all the skill sets to complete the contract on its own, so will go out and find a ‘partner’ with those necessary skill sets to propose on the project.
Venture capitalist/private equity is also viable, especially if the business is promising and can grow quickly with the proper funding. Typically, these companies will get an ownership in the business. Some firms have been willing to lend money to a company, but it is typically at a much higher interest rate than a bank may charge. The advantage of venture capital/private equity, however, is that the business now has the network of contacts of the venture capitalist or private equity provider at its disposal.
David Shaffer is director, Audit & Accounting, Government Contracting Industry Group leader, at Kreischer Miller. Reach him at (215) 441-4600 or email@example.com.
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Finding the necessary financing to thrive — or just survive — can be difficult for small businesses. But there are resources available to help startups and entrepreneurs compete in this market.
“SBA loans are designed for borrowers that might not qualify for conventional financing due to a number of different reasons,” says Romona J. Davis, Vice President of SBA lending with FirstMerit Bank.
Smart Business spoke with Davis about how to determine whether an SBA loan could help your business, and how to get started with the process.
What are the differences between SBA loans and conventional loans?
The main difference is that SBA loans are backed by the United States government, which provides a guarantee to the bank. SBA loans are for borrowers that might not qualify for conventional financing due to a variety of reasons, such as:
- Insufficient collateral
- A startup business or one that’s only been in existence for a short period of time
- The company is looking for a longer term on its owner-occupied commercial real estate purchase
- The borrower is in a ‘high-risk’ industry
- The borrower only wants to inject a minimum down payment
- Impending or current ownership changes with the business
- Inconsistent financial performance over the past few years
How does a lender determine if an industry is high risk?
It varies by bank. Most banks consider the restaurant industry as one that has a lot of risk associated with it. Also, when the economy changed and building contractors were negatively impacted, they became high risk.
However, being part of a high-risk industry doesn’t mean a conventional loan is impossible.
What can SBA loans be used for?
SBA loans can be used to:
- Purchase owner-occupied commercial real estate
- Buy out a business partner
- Buy a business
- Purchase machinery and equipment
- Buy a franchise
- Construct a building (the business must occupy 60 percent of the space)
- Cover working capital needs
- Refinance existing business debt
What types of businesses are eligible for SBA loans?
To qualify for SBA financing, the entity must be designated ‘for-profit.’ In addition, the business must meet certain SBA size standards, demonstrate good character, have a positive payment history on previous federal debt (no prior defaults on federal debt), possess U.S. or Legal Permanent Resident status, and show reasonable expectation of repayment.
What are the required size standards?
The SBA has developed size standards for different types of industries. Companies must meet either a maximum number of employees, maximum revenue amount or an alternative size standard to qualify as a small business.
How is ‘good character’ determined?
First, the SBA looks at the company’s credit, tax liens and any prior delinquencies with the government.
Also, the SBA always wants to know if a borrower has any criminal background, has been under indictment, is currently on probation, has ever been on probation, or has ever been charged with or arrested for any criminal offense, other than a minor motor vehicle violation.
The two ways to assess character, from the SBA’s perspective, are through personal credit and personal background.
Why might a business opt for an SBA loan instead of a conventional loan?
Businesses might opt for an SBA loan versus a conventional loan if they:
- Want a longer term on their owner-occupied commercial real estate or equipment loan
- Want a straight term and amortization versus a balloon note
- Prefer a lower down payment on their transaction
- Have a collateral shortfall
- Want to consolidate business debt into one loan that could offer a longer repayment period
- Want to buy out their business partner with a minimum equity injection
- Want to purchase a business but there’s insufficient collateral
- Desire cash flow savings due to a longer term and amortization
How can businesses get started with the loan process?
If a business is interested in an SBA loan, the first step is to contact a bank that participates in the SBA program. The banker will need to make certain that the company is eligible as indicated above. Assuming the business is eligible, the borrower would need to provide a financing package to the bank for SBA consideration.
Disclosure: All opinions expressed in this article are that of the authors or sources and do not necessarily reflect the views of FirstMerit Bank or FirstMerit Corp.
Romona J. Davis is Vice President of SBA lending for FirstMerit Bank. Reach her at (330) 996-6242 or firstname.lastname@example.org.
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A software company’s primary cost is people. They don’t necessarily need to purchase equipment, furniture or fixtures. They need engineers and money to pay salaries.
“That’s going to be very different from a non-tech manufacturing company that needs big pieces of equipment to make their widget,” says Mike Lederman, senior vice president and regional market manager with Bridge Bank.
This means the types of loan products needed by technology companies are going to be unique to that industry.
“Look for a banking partner that is going to understand your business and not just look at the numbers,” he says.
Smart Business spoke with Lederman about the financing options for technology companies through the stages of their life cycle and how a company can surround itself with a strong support network.
What loan products are available to pre-profit/venture-backed startup technology companies?
Starting from early stage to more mature venture-backed startup companies, step one may be an invoice financing facility where a lender is financing individual invoices. Also consider a revolving asset-based line of credit, which uses accounts receivable to establish a borrowing base instead of specific invoices.
Next would be a general accounts receivable line of credit, which is structured much like an asset-based line but with fewer lender controls based on a company’s stronger balance sheet. Banks also could add a non-formula line of credit that you draw on and pay interest on the outstanding amount, much like a home equity line of credit.
On the term debt side, banks offer growth capital term loans, which come with financial covenants. This structure may include a six-month, interest-only period followed by 30 months of equal principal payments plus interest.
Also available are equipment term loans, structured very similarly to growth capital loans, but instead of funding the money up front the bank would finance the equipment a company purchases. The bank is looking more at the equipment purchase price to structure the availability.
Banks also offer a venture term loan, which is similar to a growth capital loan but without financial covenants. That’s a good fit for a company that has raised equity capital within the last year and wants to extend runway between equity rounds, in order to increase valuation for the next equity round.
Finally, bridge loans are a great way to help with working capital shortfalls prior to a defined liquidity event, typically an equity round.
What particular needs might a tech startup have that differs from startups in other industries?
A lot of Software As a Service companies will be the host for the software they deploy to their customers, so buying or renting space on servers is a big expense as their customer base grows and uses more bandwidth.
Where banks can help is with working capital shortfalls, meaning you’re past the development stage and you’re actually selling your products, but you have to pay your suppliers before your customer is paying you. You might have to pay at net 30 and you’re getting paid at net 90; that’s where a bank can add tremendous value with short-term working capital until you can collect from your customers.
How and why do loan structures change as a company evolves throughout its life cycle?
As a company matures, it has additional needs. On day one it might have only a few customer invoices, but as a company grows it gains new customers each comprising 10 to 40 percent of total accounts receivable. Now the company can qualify for a more traditional line of credit. Once revenues increase or an equity round closes, a company can consider growth capital or venture debt to support long-term working capital needs as opposed to the short-term line of credit used to pay vendors before receiving customer payments.
What should a technology startup look for in a banking partner?
Numbers are important, but understanding the particular needs of the company is what differentiates a bank from its competitors. Avoid working with a bank that is only interested in your investors. Venture capital investors are an integral part of how banks underwrite credit, but it shouldn’t be the reason they do the deal.
Also, work with the same relationship manager at the bank throughout your life cycle — from the time you open your first checking account to an IPO — because he or she is going to know your history. Continuity is key to a successful relationship, and working with a bank that allows that is important.
Should the entrepreneur expect to provide the bank with a personal guarantee?
Not if it has received equity capital from an institutional investor. If a company hasn’t attracted institutional equity capital and hasn’t been able to sustain positive cash flow, a personal guarantee may be required. Banks need to understand there is someone willing to stand behind the company. The guarantor is responsible for the loan, but the bank’s expectation is there are other company assets to help repay the bank in a liquidation scenario.
How can service providers help you?
It’s important for an entrepreneur to be surrounded by a network that can provide service and support so he or she can focus on building the business. Get an attorney, bank and CPA that do a lot of work with technology startups. They can help with introductions, advice or serve as a sounding board. Focus on building the business and use your network of service providers to bring in partners. Attorneys and CPAs are phenomenal referral sources for banks and vice versa because entrepreneurs realize this is important to keep in mind as they grow their business.
Mike Lederman is senior vice president and regional market manager with Bridge Bank. Reach him at (415) 230-4834 or email@example.com.
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Despite a stabilizing economy and a letup in the banking crisis, small community banks approved approximately 47.5 percent of commercial loan applications in January, while banks with more than $10 billion in assets approved just 11.7 percent, according to Biz2Credit.
In comparison, lenders like community development financial institutions, accounts receivable financers, merchant cash advance companies, micro lenders and others approved more than two-thirds of applications from potential borrowers. The data confirm that executives have to be resourceful and think outside the box to secure the funding they need to expand their small or mid-size business in today’s tight credit market.
“Executives may be forced to restructure, cede market share or relinquish prime opportunities unless they avoid a short-term cash crunch by securing alternative funding,” says Eric Fricke, assistant professor of finance, Department of Accounting and Finance at California State University, East Bay.
Smart Business spoke with Fricke about the ways to finance growth by tapping alternative funding sources.
How can alternative financing help small and mid-size companies grow?
It’s great when a small business consummates a big sale, but it often ends up being a catch-22, because small and mid-size companies may not have the cash to purchase equipment or inventory to fulfill a substantial order. Alternative financing provides up-front capital when traditional commercial loans aren’t available. Best of all, the loans are scalable and may be easier to secure because they’re tied to a specific asset or invoice, so you may not need to submit a full business plan, financial statements and cash flow projections as is normally necessary to comply with today’s strict underwriting requirements.
When is alternative financing appropriate?
Alternative loans are perfect for businesses that have predictable cash conversion cycles. For example, importers and exporters have to advance cash to purchase products, and then wait until they reach stores and finally sell. And retailers and restaurateurs may have immediate needs for cash but can’t wait for future credit card transactions to finalize. Companies can close the gap in cash conversion cycles by securing a loan tied to a particular transaction, like accounts receivable, inventory, machinery, equipment and/or real estate.
What’s the best way to research and uncover alternative funding sources?
Sometimes traditional banks offer asset-based loans and other forms of alternative financing. But, you can find additional sources by searching the Internet or contacting your industry association and equipment manufacturers, since some vendors offer financing if you purchase their products.
What are the best sources of funding?
These are common sources of alternative funding.
- Asset-backed loans. Asset-backed loans are secured by collateral like accounts receivable, inventory or equipment and they may be easier to get because the lender may consider the credit worthiness of your customer. So, if you’ve sold a large number of T-shirts to a major retailer, a lender may be willing to lend you money against that invoice because of the retailer’s ability to pay.
- Equipment leasing. Equipment leasing is a popular option for companies with limited capital because the bank or equipment manufacturer purchases the equipment and leases it back to them in exchange for a monthly payment.
- Factoring. Factoring lets you sell your accounts receivable to a third party. The factoring company buys your invoice from you for an amount below the actual invoice amount. You get the up-front cash you need to fulfil the order and the factor collects the invoice once the transaction is complete.
- Merchant cash advance. This provides a lump sum cash payment in exchange for a percentage of future credit card or debit card sales. It facilitates cash flow because the lender deducts a portion of every credit or debit transaction until the debt is repaid.
What’s the downside to alternative funding?
Alternative loans tend to be more expensive than traditional loans, but the costs may be more easily allocated to certain customers, so you can more easily build the costs into the price of your products and services. Plus, the loan amount is scalable with your sales or a particular transaction instead of being tied to your net worth or cash flows. Some executives view the outsourcing of accounts receivable to a third party as a welcome benefit, while others like to maintain control of the collections process and client communications. But, for most owners, the benefits of accessing funds on an as-needed basis without navigating a grueling underwriting process far outweigh any drawbacks.
What else should owners know before pursuing an alternative loan?
Shop around, because the costs of alternative funding vary among banks and other financial institutions, and if possible factor the cost of your financing into your pricing. Finally, read the fine print to make sure you understand not only the costs, but also the process and timeline for distributing funds, since some lenders may collect receivables for you and delay dispersal of funds from risky sales orders.
Eric Fricke is an assistant professor of finance in the Department of Accounting and Finance at California State University, East Bay. Reach him at (510) 885-2064 or firstname.lastname@example.org.
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If your business is looking to hedge against increasing electricity rates and do something good for the environment at the same time, you might want to consider solar.
Businesses can invest in their own systems to generate power, or agree to buy power from a third party.
A bank with an experienced team in solar energy finance can help, says Dan Pistone, senior vice president and manager of Bridge Bank’s Technology Banking Group.
“Several options exist to take advantage of the benefits of installing solar energy systems, and each option has its merit, depending on what your short- and long-terms goals are, and what type of business you own or manage,” says Pistone. “The right financial partner can help you make informed decisions about ownership versus leasing, and can provide insight into the implications of both options.”
Smart Business spoke with Pistone about how a solar energy system can help you lock in utility rates for years to come and how a bank can assist you in your efforts.
What does a business need to think about when considering solar?
Solar power is a growing industry and as new technology and improved manufacturing efficiencies continue to advance, solar energy systems are becoming increasingly accessible to business owners. If your company wants to install a solar energy system, you have two choices. You can buy the system and have the benefits of ownership, or you can secure a lease of a system, in which a third party owns the system as an asset and you agree to purchase all of the electricity it produces.
Over the last two years, the growth in renewable energy financing has come as a result of tax equity financing, corporate taxpayers who are looking to leverage the available state and federal tax benefits and large banks that are doing large-scale utility-grade projects. However, those banks tend to focus solely on big projects, in the 20 to 50 megawatt range. But, for smaller businesses looking at installing smaller rooftop or ground mounted systems ranging in cost from $500,000 to $15 million, very few financing options exist, quite simply because few banks have the expertise to effectively manage these complex financing structures.
So it becomes challenging for businesses to find a bank that has the infrastructure in place and the knowledge base to manage the complex nature of this type of financing.
If a business wants to use solar energy, how does it get started?
The first step for a business is to determine whether it wants to purchase and own the solar energy system, or if it wants to lease the system and make utility payments to the owner of the asset.
That decision starts with knowing your tax status. Entities such as nonprofits, schools and churches don’t pay taxes, so they wouldn’t receive the benefits of the subsidies that are available. So if you are a school district, for example, and you want to install a solar system in your schools, you wouldn’t get the benefit of the tax credit, or the benefit of depreciating the system as an asset, in which case it would make more sense to instead find a developer that can bring that tax investor in.
Then there are negotiations between the developer and the off-taker of the energy to determine what the utility rate is going to be over the term of the agreement and the escalation rate on an annual basis. Power purchase agreements are generally 15 to 20 years in length, which is favorable to business owners because it allows them to control the cost of electricity over the term of the agreement. Plus, banks and equity investors prefer the longer term because it provides a long-term asset in the agreement.
What will the bank look at when determining financing?
The bank will take a holistic view of the entire project, including an examination of the creditworthiness of the off-taker, and look at the developer, its history, and its ability to construct projects and its track record, as well as other agreements such as operations and maintenance. It will also look at the actual components of the solar energy systems themselves, such as the panel inverters, to get an overall comfort level for the project.
Then it will size that project by looking at the long-term cash flows that will be generated from the electricity sales, and the short-term cash flows, such as local and state incentives. It will look at all those different sources of cash flow that come into a project and decide which of those it feels comfortable lending against.
What should a developer look for when choosing a financing partner?
Energy finance for small-scale projects is a new and fairly complicated practice and, for many business owners or developers, there’s definitely a learning curve at the beginning of a project or system purchase. Look for a bank that is able to provide not only a flexible suite of loan products, but also one that is willing to advise you on how to appropriately capitalize the project and how to properly structure an agreement between parties in a lease. The bank should provide an advisory service, not just debt financing.
Many of the banks that are engaged in energy finance are really only focused on large-scale projects, so it’s often difficult to find the right partner. But if you can find that partner, they should have the ability to advise you on how to aggregate projects to achieve economies of scale. If your goal is to finance these projects, your bank should be a resource to educate and advise you on how to proceed every step of the way.
Dan Pistone is senior vice president, manager, Bridge Technology Group. Reach him at (650) 462-8502 or email@example.com.
In today’s economic climate finding financing resources for your business is especially difficult. Where do you turn to get help in locating the financing sources your business needs? Resolving these problems successfully in today’s world requires an adviser who is experienced in business issues and has a thorough understanding of the latest developments in financing facilities.
Business attorneys Ruth Mijuskovic and Jim Shnell of Jackson DeMarco Tidus Peckenpaugh note that financing methods have changed with the economic times and that the growing demand for funding has also created new sources and forms of financing.
Smart Business spoke with Mijuskovic and Shnell, who have broad experience in negotiating and closing business financings, to get their insights on the issue.
Why is it so difficult to arrange financing today?
During the recent recession, a number of banks and finance companies that had traditionally provided financing to businesses went out of business, and others merged in order to survive. The financial institutions that survived are now governed by new regulations that impose new procedures and constraints on their ability to provide financing.
What can a business do when it finds that it can’t get a line of credit or that its line of credit can’t be increased or has been reduced?
Many banks (and bank regulators) have raised the bar as to the companies that qualify for a line of credit, even when guaranteed by the principals. A company that is on the borderline of eligibility may find that a bank familiar with its industry is more willing to provide credit. If your company has tried unsuccessfully to establish a lending relationship with a bank, you may do better by seeking funding from another type of lender. Such ‘alternative’ funding may not only give your company the cash resources needed to grow into a business large enough to qualify for a bank line of credit, but also the opportunity to demonstrate your ability to manage credit issues.
One common alternative is the commercial finance lender. However, even this traditional alternative may not be available today and it is necessary to look to the newer ‘private credit funds,’ which occupy the space previously occupied by the commercial finance lenders. These funds often differentiate themselves by focusing their lending activities on particular kinds of loans, while others focus on certain industries or certain borrowers. If your company has experienced difficulty in establishing a credit relationship it may benefit from looking to a private fund that specializes in your industry or businesses similar to yours.
What should a company focus on when looking at other types of lenders?
A key issue when looking at other lenders is the purpose for the loan, as there are different lenders for different loans. For example, if you need a cash infusion to increase sales and accounts receivable, you may want to look to a lender specialized in factoring accounts receivable.
If the purpose for borrowing is to finance the acquisition of another business — perhaps a competitor or a complementary business — some private funds will make loans to enable a company to take advantage of such an opportunity and will base the loan on the borrowing capacity of the combined businesses. In some of these transactions, a private fund will provide funding that will be subordinate to a bank line of credit, thus making it easier for your company to obtain a bank line of credit and support the combined businesses with two layers of funding.
If you are planning to raise money through an equity investment, you may want to consider a convertible loan. Your potential new equity investors may be willing to make a bridge loan to support the company until the equity financing can be closed. The closing on the new equity investment (and conversion of the bridge loan into equity) may, in turn, provide your company with the additional equity base needed to arrange a bank line of credit.
What other kinds of loans are there?
Many lenders specialize in providing loans based on the collateral available in the business. Some focus on factoring of accounts receivable. If your business only sells for cash or credit card charges, you may want to consider a lender that specializes in lending against credit card cash flows. If you need funds for equipment, the solution may be to work with an equipment leasing company. Other lenders will provide loans supported by assets such as inventory, purchase orders, bank CDs and even real estate. If your business does not have ‘hard’ assets, but does have intangible assets such as patents or intellectual property, there are lenders that will lend against the cash flow generated by the IP.
Another type of funding that has seen a revival of interest and availability in this economy is lending supported by the SBA. The rules for SBA loans have recently been revised to make credit more available and, as a result, SBA loans have found new popularity. The SBA supports a variety of loans, such as the 7(a) Loan Guaranty Program, designed for a majority of financing needs including short-term and cyclical working capital needs and the 504 Loan Program, which makes long term loans available for acquiring land, buildings and equipment.
In summary, you should look at the characteristics of your business and the nature of its cash needs, then talk with experienced counsel about the financing options that may exist for your company.
Ruth Mijuskovic and Jim Shnell are business attorneys at Jackson DeMarco Tidus Peckenpaugh. Contact them at JShnell@jdtplaw.com and RMijuskovic@jdtplaw.com, respectively.
Chalk it up to simple economic realities, but a capital expenditure requires quite a bit of forethought these days. This makes finding the best equipment financing for your business more important than ever, says Tim Evans, president of FirstMerit Equipment Finance.
“We tend to keep equipment around a lot longer than we have in the past,” Evans says. “It’s important that when you get that initial piece of equipment and you make your decision on financing that you are thinking long term, not just short term, and that you understand the value of that equipment to your business.”
Smart Business spoke with Evans about how to set up the best equipment finance agreement for your business, and what not to do when structuring the agreement.
What are some issues companies should consider when financing equipment?
Companies should think through the true economic life of the equipment. How long will you be able to use it in its current application? Can it be converted to some other capacity to lengthen the life of the equipment longer than it would normally be? Are there upgrades or refurbishments that could extend the life of the equipment?
How can companies determine whether financing or purchasing a piece of equipment is the right choice?
You can’t be short-sighted in how you use your capital today. We’re coming out of a recession, and many customers are asking for sale leasebacks because, prior to the economic slowdown, they tied up their capital in their equipment purchases. When you run into a down cycle like we’re in today, you need working capital to run your business. But when you’ve tied it up in your equipment, you’re out of luck.
Equipment financing and leasing is the way to go to avoid a shortage in working capital. If you have the ability to finance your equipment and keep working capital in your business, that gives you more flexibility. It’s very difficult to structure a sale leaseback 12 to 18 months after you paid cash for the equipment, because the equipment depreciates and its value will be a lot less at that point in time.
What should business owners look for when setting up financing agreements for leased or purchased equipment?
One of the biggest misnomers in the industry is to look for the absolute lowest rate for your equipment financing. Money is money, but when you are looking for equipment financing, you want to work with a partner who understands your business, and who understands the necessity of being able to do something different down the road if your situation changes. You need flexibility.
Often, companies get offered a below-market rate that looks great at the time they signed the deal. But what if they are two years into their five-year deal and they need to make a modification? When you go into that low of a rate structure, many times the flexibility just isn’t there because of the tight requirements in order to achieve the goals that the lessor established in the deal.
At FirstMerit, we look at it as an overall relationship. Our goal is to give you the ability to work within your business frame to make any necessary changes in how you are doing business if your situation changes.
You should look to work with a lessor that is flexible. If you just go with whoever is offering the lowest rate on the street, you’ll find that service and price don’t always go hand in hand. We will always be competitive, but we also pride ourselves on being a good service partner.
What are some typical equipment financing mistakes that companies make, and how can they be avoided?
The biggest mistake companies make is they aim for the lowest possible payment. Typically, that means you get the longest possible term, which can create a lot of issues down the road.
You might have an asset that won’t be of any use to you after five years. But you have a targeted payment in mind, and because of that you need an seven-year term. The structure of the lease, the potential buyout on the back end of the lease, whether it is a fair market value lease or a conditional sale — those are all issues you want to be aware of, because they are going to impact what happens down the road when you decide whether you want to buy that equipment or return it.
Another key point: make sure you understand the tax ramifications of your transaction. It may be beneficial to your company to pass any bonus depreciation on to the lessor (the bank) and do a true lease, because you could receive a lower payment structure. In this case, the lessor would take the depreciation benefits and then pass those benefits back to you in the form of a lower rate.
Always ask questions and make sure you read your documentation — especially the fine print. You don’t want any surprises down the road so make sure you read your documents thoroughly.
How can business owners determine whether an equipment lease being offered by their bank is a good one for their business?
There are three major components to consider. First, how long are you keeping the equipment? Can you utilize the tax benefits? If cash flow is an issue, is 100 percent financing more attractive than a conventional term loan where a 20 percent down payment may be required?
Tim Evans is president of FirstMerit Equipment Finance. Reach him at (330) 384-7429 or Tim.Evans@firstmerit.com.
At some point, nearly all small business owners will need to borrow money, whether it’s to purchase, expand or renovate commercial real estate, finance the purchase of an existing business or grow organically. One viable option for small businesses in need of financing is to apply for a loan backed by the Small Business Administration.
While the SBA doesn’t provide direct loans, it does provide guarantees on loans that originate from the agency’s partnering lending institutions, says Angela Freeman, second vice president at First State Bank.
“If you partner with the right bank, preferably an SBA Preferred Lender, the bank will complete the application for you and make the process as painless as possible,” says Freeman.
There are several common misconceptions about SBA loans. The first is the belief that they require a lengthy application process and that it takes too long for funding to be secured. In reality, because loans are handled through lending institutions, the process isn’t much different than applying for a conventional loan and, in some cases, can be even easier.
Smart Business spoke with Freeman about SBA loans, the common misperceptions associated with the program and the benefits of working with a preferred partner.
What are some of the most common myths associated with SBA loans?
There are many misconceptions about SBA loans that might prevent business owners from inquiring or applying. Some mistakenly believe that SBA loans are only for the smallest of small businesses. However, the maximum amount of a loan has increased from $2 million to $5 million.
While it is true that the SBA used to have a very structured definition of what a small business is, it has now expanded the definition and opened the parameters so that more businesses can apply. Government data show that 98 percent of all businesses in America would qualify for an SBA loan under the current definition.
Another common misconception is that because the SBA is a government program, all SBA lenders are the same. In reality, each lender has its own credit philosophy. For example, credit criteria such as historic cash flow, collateral loan-to-value percentages and management experience vary from lender to lender.As a result, it is important to build a strong relationship with a top SBA lender, again preferably an SBA Preferred Lender, in your market to learn about its credit parameters.
Another myth is that SBA loans take forever to be credit approved and funded. Over the last several years, the SBA has worked hard to speed up processing times, reduce paperwork requirements and, in general, make it easier for banks to provide small business customers the capital they need. Many of the myths and rumors about the SBA are rooted in previous bad experiences that simply don’t hold true today.
While in the past, the agency has struggled with slow processes and arduous requirements, a great deal has changed. The SBA is now investing in people and technology to create an agency that is more efficient and responsive.
How can working with a preferred SBA lender help expedite the loan process?
A preferred lender is an institution that the SBA has designated as its agent. Most of these lenders have dedicated staff who specialize in SBA loans and can process these loans as efficiently as conventional loans. There are a number of rules involved with SBA loans, which cover who is eligible for financing, what can be financed and what interest rate can be charged.
A lender who is not intimately familiar with SBA loans might not know all of the stipulations, or not have necessary processes and procedures in place to comply. You can go to www.sba.gov to find information on your local SBA district office and the top lenders in your market.
How would you address the myth that an SBA loan is a last resort for financing?
The SBA program is designed for credit-worthy borrowers who have difficulty getting access to financing at reasonable terms. It is true that there is a requirement that stipulates you are unable to get a conventional loan. However, it is also true that many times a bank can’t consider a request for a conventional loan but may be able to look at an SBA loan differently.
Take, for example, a company that needs a $200,000 loan, but the equipment is only valued at $150,000. In this instance of a collateral shortfall, a business won’t be eligible for a conventional loan, but through the SBA 7(a) program, 75 percent of the loan is guaranteed by the government, and the bank only has to rely on the 25 percent on the collateral remaining.
What are the fees and up-front costs associated with SBA loans?
The SBA program is resolute in the fact that small businesses are not to be charged an application fee, or a bank management fee. Guarantee fees — typically 2 to 3.5 percent of the guaranteed portion of an SBA loan — allow the program to operate at an efficient cost for taxpayers. Fees are not usually a barrier to borrowers because they can be financed over the term of the loan, which may be longer than a conventional loan.
In addition, SBA loans have flexible interest rate policies and can be made at fixed or floating rates, and pegged to a prime, LIBOR or SBA peg rate. SBA rates are competitive with other forms of financing and are a much better value than credit cards and other alternative financing mechanisms that many small businesses use when they are unable to access conventional credit.
Angela Freeman is second vice president at First State Bank. Reach her at (586) 498-7465 or AFreeman@thefsb.com.
If you’ve tried to obtain or increase bank financing lately for your business, and been turned down, you’re not alone. The “word on the street” is that bankers’ lending criteria continue to be stringent. So what can you do to improve your chances? Obtain the assistance of a CPA who knows how the process works.
“Through including a CPA firm in the relationship between your bank and business, you can increase your chances of success and reduce the frustrations of the application process,” says Jeff Hipshman, partner, HMWC CPAs & Business Advisors in Tustin.
“Your CPA can also work with you throughout every phase of the process to help solve your company’s needs and meet your objectives,” says Curtis Campbell, a partner at HMWC CPAs & Business Advisors.
Smart Business spoke with Hipshman and Campbell to learn more about how business owners can benefit from the assistance of a CPA firm in securing bank financing, whether the economy is in a recession or going strong.
What is the role of financial statement reporting?
Accounting firms prepare financial statements for businesses, which are typically required by lenders and investors. Bankers analyze your company’s ‘capacity’ to repay a loan from these financial statements. This is one of the criteria that bankers use in evaluating debt repayment ability (the others commonly referred to as character, capital, collateral and conditions).
Your balance sheet and income statement, when accurate, provide a testimony over the years as to your ability to manage the business. Cash flow can be evaluated from your financial statements so that the banker can analyze your debt repayment. Collateral is demonstrated on the balance sheet and, along with notes, UCC filings and other documents, will provide the banker with key information. Your company’s equity is also an essential element that is critical for evaluation of debt repayment. It is important, therefore, to select a CPA firm that understands your business and can prepare financial statements meeting the highest quality standards.
My company should ask for the highest amount possible, right?
One of the easiest ways to let a banker know that you don’t really understand the lending process is to ask for an unreasonably high loan amount. This happens all too often, for example, when a business owner will ask for a $500,000 line of credit based on $300,000 in assets and minimal profitability. A CPA can help you to evaluate your needs and ask for the appropriate amount based on a banker’s perception of your company’s debt capacity. Your CPA can also project the cash flow cycle that your company may experience under a variety of scenarios. You will then have a better idea of your needs for outside financing.
What type of financing should we seek?
Your CPA can help to determine whether your business needs an operating capital line of credit or a loan or lease for a fixed asset. Sometimes this isn’t too clear to the business owner, who may only see that there isn’t enough internal cash flow to satisfy needs. An accountant can also do various analyses to compare costs of different financing options and your ability to repay each in a timely manner.
Are there options beyond traditional commercial bankers?
The typical business owner has a higher opinion of the company’s ability to repay a loan than does a banker. Bankers have regulatory and internal lending policies that limit their ability to extend credit. For example, banks tend to frown upon a company that has not shown consistent profitability or is highly leveraged in assets to liabilities. They also have other financial ratio criteria that must be met, may stipulate certain collateral, and might even have internal policies regarding lending to specific industries.
As such, your business may not qualify for traditional bank financing. An accountant who is experienced with such matters can help steer you toward other types of financing. While such financing might be more expensive, it may also be more useful in meeting your cash flow or expansion requirements.
Do we need a business plan?
The banking business, from a lending perspective, is all about managing risk. They lend a significant amount of money for a relatively low return, so bankers need to be convinced that your company is a good credit risk. They need to know why you want the money, how you are going to use it and how you will repay it. Your business plan should help the banker to start putting together the pieces of this picture. An effective business plan portrays your company’s objectives, management team, marketing strategy, operational structure and financial history and projections.
Accountants who have prepared business plans will know when one is needed and what should be in it. Count on your CPA to help you prepare the information needed to provide appropriate answers to a lender’s questions.
Jeff Hipshman and Curtis Campbell are partners at HMWC CPAs & Business Advisors (www.hmwccpa.com) in Tustin. Contact them at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.