Florida CFO Group partners Dick Trueblood, Tom Walker and Dale West discuss alternative financing for small and large organizations.
Alternative Financing to Fuel Growth
Tom: You should always be looking at all of your financial options, from traditional banking to alternative financing and any combination that would maximize what your company needs for financing its operation.
Dick: It may be alternative financing, but it is not unusual financing. It is just one of the set of tools that is available to help provide a company with the sort of liquid working capital that it needs to do business. It can be quicker. It can be easier. It can be not much more expensive. And it is a great growth tool. It is not necessarily an I am in trouble tool.
Tom: That's the situation I've dealt with. The bank is locked in where they feel safe, but when you start growing like crazy, you may have to look at other ways to drive that success and drive that growth. Growth is the hardest thing in the world to handle from the finance side. The CEOs love it. The sales guys love it. But the CFOs are the ones that have to figure out how to pay for it
Dick: Of course there are instances where a company can't get conventional bank financing and has to search for alternative financing.
Tom: There are lots of reasons why a company would have to go to alternative financing. It is not saying so much bad about a company. Because ever since the recession, banks have basically trended towards the real big loans, the real safe loans. They are getting away from small business loans. If it is a smaller business, banks are probably not going to write it. I am working with a company with foreign ownership. Most banks don't want to loan to a company that has foreign ownership.
Dick: And with all the requirements that have been placed on lenders, a smaller company is not going to present the same kind of credit profile as medium to larger businesses. A small company is more likely to be in a growth mode so that their cash flow is less predictable. There may be more risk associated with it. They may have some past performance issues with a couple of warts in their credit profile. There are a lot of things that can impact the smaller company that do not land on the doorstep of a medium to larger sized, or more mature business.
Tom: From what I understand, less than 50 percent of the small business loans are being approved by traditional bank financing post-recession. Banks are sticking in their comfort zone with the medium and the larger size loans that are safer loans.
Alternative Financing for Start-ups
Dick: Most start-up financing is going to come from one of a couple of places; either equity, because it is a friends and family kind of thing; or maybe angel investors. Because start-ups are not terribly appealing from a traditional loan standpoint, if you do secure traditional bank financing, it is certainly going to have owner guarantees and owner pledging of assets such as houses -- something that would provide the security to a traditional lender.
Tom: Another common alternative financing source for start-ups is crowd funding. Depending on what type of money a start-up is looking for, sometimes it's a good option to look to friends and family, or angel financing as Dick was mentioning.
Dick: The other thing a start-up can do, particularly with a consumer oriented company, is to pre-sell the product they are going to manufacture or have manufactured for them. And certainly people have financed businesses starting up using credit cards.
Tom: I have seen certain banks offer credit cards with fifty- to a hundred-thousand dollar credit limits. It is not a traditional asset based loan like Dick was saying. But some banks have expanded into that area and will allow you to put some of your operating expenses on a credit card. Then, in effect, you are basically delaying payments for 30 days or so.
Common Forms of Alternative Financing
Dick: For companies other than start-ups I include anything that is asset-based lending. This can be regular customer receivables, or it can be CapEx financing if you're trying to raise money to invest in fixed assets for your company. Because there are people out there that will do that.
You can also lease capital equipment, which is relatively akin to borrowing against it in the first place. Many capital equipment vendors either have captive finance affiliates or a relationship with a lender. They will look at cash flows, but they will also look at how much would they lend against a piece of equipment: how readily marketable is it, if they have to re-market it, what does it cost them to move it from wherever it is to wherever it needs to go to, i.e. what could they realize on it, if they had to?
Tom: I've also worked with purchase order funding as well as the accounts receivable financing. As well as asset-based financing for inventory or working capital financing. For smaller businesses merchant cash advances generate funding based on future credit card sales. With this, a certain amount is deducted from their daily credit card sales to pay it back.
Dale: While it will take a little more research and planning, your company may be able to get grants from the government. Not all grants are necessarily science or research related but can also be industry specific. A company I've been working for has been very aggressive and successful going after grants, from environmentally friendly capital improvements to employee training.
Alternative Financing to Meet Unexpected Opportunities
Dick: Alternative financing can empower a company to take advantage of a short-term opportunity.
Tom: Most forms or alternative financing can be closed in about 24 or 48 hours. Purchase order funding and some of the others may have some paperwork involved with them and take slightly longer. It is a lot less red tape than financing. It is a very quick process. You do not even have to have flawless credit. Certainly, the interest rates are going to be higher than bank financing. But as far as the turnaround and the red tape, it is quite an advantage to the alternative funding.
I have turned around factoring deals in days. I have turned around inventory deals in a week and the same for purchase order deals. And you can certainly turnaround equipment leasing quickly. Quick turnaround is a major advantage of alternative financing. A small business needs money.
Dale: For some unique sales opportunities, don't be afraid to try and restructure a payment plan with your vendors; inventory suppliers being a good example. Your vendors want to sell the product as much as you, so share with them your opportunity and work to correlate collection and payment terms around the transaction. If the company has a good payment history, most vendors will work with you, particularly if you have some competing vendor options.
Finding the Right Combination of Alternative Financing
Tom: There are some exciting opportunities for combining alternative financing with traditional lending. I'm starting to work with cargo financing for my client that imports goods from offshore. Anybody that imports goods must pay the supplier well in advance of when you see cash flow. It may take 45 to 60 days to reach you and another 30 to 60 days to get paid from a customer.
Cargo financing will give you 70 percent financing based on your bill of lading date. You have 75 days to pay that back. That allows for the product to get there and to be shipped. Then apply whatever other type of finance you have; factoring or whatever else you have and not be out-of-pocket to the supplier at all. It is a really great tool. It does not have any collateral assigned to it. It is really a real easy process to get the funding as you need it.
Dick: The right solution can also be a combination of alternative financing sources. Certainly, you can put together receivables financings along with CapEx financings. It is probably more based on what your capital or cash needs are than it is based on the willingness of somebody to do it. Another common combination is in the retail business where they will factor the receivables, but will still have traditional bank credit for other working capital.
Tom: You need to have a thorough knowledge of all of the different alternative financing options in order to put together the right package. Each alternative financing method will have different collateral requirements. Depending on what collateral is required, you may have receivables or inventory available, or you may need to seek alternative financing where there is no collateral required.
Dale: Not all options are alternatives to bank financing, but work with banks to make the financing more palatable. For example, New Market Tax Credits are often associated with low-income housing communities, but are also available for several opportunities that support business growth, job creation and spur economic development. While more paperwork is involved, several banks in the Tampa Bay area work with New Market Tax Credits.
Dick: If you have traditional financing or are negotiating for traditional financing – you need to read and understand the terms. Then consider, if you decide that you want to employ some sort of asset based lending, if the loan agreement that you are negotiating gives you the flexibility to put that in place. Because some traditional lenders will lock up every asset in sight as part of their loan and collateral package.
Tom: That is exactly right. If you just go with traditional asset based lending from the bank and don't negotiate properly, you can find yourself where you do not have the needed flexibility. This is one of the key areas that CFOs serve a critical role. Because while a company needs financing, they may not know how to get it. Or, what the right first step is. Or limit themselves by going down to your neighborhood bank and not knowing anything about alternative financing.
One other thing I would add are the actual contracts that go with the different types of financing. As Dick is saying, you need to be very careful that they do not put your company at risk. Everything is always negotiable in my mind.
Dick: There is a range in the financing terms. Typically, lenders are going to put forth the loan terms that are most favorable to them -- it does not mean that you cannot squeeze out some better terms.
I think most lenders assume that there is going to be some negotiation. They have left – in the terms that they present up front – some room to negotiate and still put you in a position where everybody can do business.
Tom: You really need somebody that understands this and can read through the terms thoroughly to find the hazards. You may be focused on the rates you are paying. But there may be something very small – later in the contract about a minimum requirement or something similar that can have a significant effect on your financials. It could be something like your minimum revenue requirement for the year is XX dollars. Then they apply their rate to it. If you do not hit that revenue number, you will still have to pay the agreed upon amount.
Dick: The devil is in the details…
Tom: You really have to consult professionals that understand this role. If you do not, you could be missing something that is going to hurt your business.
Final Thoughts on Alternative Financing
Tom: This is something that you need to have a CFO on. You absolutely need to have a CFO on. Because of all of the types of alternative financing and all of the mix and match with traditional lending and what might be the right fit for a company. This is difficult. It is changing on a constant basis. There is no governmental, or state, or county resource that will help you to make these types of decisions.
Dick: I have always believed that as a CFO, the more flexibility you can provide in those kinds of arrangements the better off you ultimately are. It will give you initial and then continuing alternatives going forward.
Tom: I would say, if you are a small business, you need to evaluate all of your financing options; traditional financing and alternative financing. I mean, all of the alternative financing. What mix is the right mix of those types of financing for your business? You have to understand all of your options. You have to understand how much you can borrow against each of them and what kind of collateral they require, and which one might be your best alternative. Because they may be very similar.
Dick: Alternative financing can be relatively simple and straightforward to put in place compared with traditional lending. It can happen quickly. These are significant advantages to a business owner or operator. That is not the case with traditional financing. In some cases where you might not qualify for traditional financing, it gives you the flexibility to get some capital to deploy in your business. It helps support the business and helps it grow.
Tom: The characteristics of your business are going to drive the finance structure that you will need. But it is not as simple as saying; if you can get bank financing that is the only thing you need. Or, you do not need to consider alternative financing. You should understand all of your options. Why you are electing to choose one or the other based on the characteristics of your business and your needs.