We produce millions of dollars worth of financing opportunities for clients each month. On average, we are successful almost 75% of the time matching qualified businesses with term sheets. Along the way, we picked up on some of the common characteristics these businesses shared. None of this is rocket science and that might surprise you – or not. Most of all, it’s just a little bit of common sense and planning.
1. Have Business Documents Ready & Accessible
This is an easy one; make sure you’ve got the appropriate business documents ready and handy as you start your search for working capital. You’re going to be asked basic financial questions about your business so you need to produce those documents and statements within a day or so. Nothing creates a red flag more than an operator who can’t deliver the basics.
The Alternative Lending process is effective because of the speed at which it can produce results - but much of that speed is dependent on the business owner and how quickly they can move their business through the process.
Process aside, if you can’t get business documents together in a few days, you’re not sending a very positive message to your potential lenders. For reference these documents can include bank statements, business and personal tax returns, current P&L and balance sheet, business debt schedule, formation documents or articles of incorporation, and a business license.
2. Know Your Business’s Elevator Pitch
In a sentence, what’s your business about and how is it different from your competitors? Your potential lenders won’t need to see a documented business plan, but they will need to get an idea of the business, your products and services, its structure, your margins, etc. If you can’t quickly and articulately explain your business, it doesn’t help the lending process.
3. Be Realistic About The Financing
This one could also be called, “Lenders vs. Investors.” It’s important to be realistic about the amount of the working capital you’re seeking relative to the business’s current cash flow.
Investors are willing to make larger, more speculative bets in return for a bigger piece of the pie (equity). Lenders, however, need to cover their risk, operating expenses, and profit margin from the proceeds from the loan – this often doesn’t leave much wiggle room.
Lenders evaluate ‘coverage ratios’ to determine if the current cash flow can support the repayment of the loan. Yes, the current cash flow. Lenders don’t like to speculate. They make decisions based on actual data – not potential (more about this later). If current cash flow cannot support the loan, it’s unrealistic to expect the lender to take a gamble.
Also, having a history of NSFs or negative balances is an immediate indication that current cash flow cannot support current business obligations. It is almost impossible to borrow your way out of a hole. If you find yourself in this situation, you first need to correct the underlying issue (revenue vs. expense) before you seek financing.
If you go into the funding process with unreasonable expectations, you might turn off a prospective lender or source of capital.
4. Synchronize The Return On Investment
Lenders like to see a responsible borrowing history. One quick way to turn off lenders is to accumulate long term debt to finance short term objectives. The revenue may flow through your business, but the debt (liability) remains on your balance sheet long after the sale has been realized. Paying for last year’s inventory out of this year’s sales puts a drag on cash flow.
We advise clients to match borrowing terms to the useful life or revenue generating life of an investment. If the investment (what you bought with the loan) is only going to generate revenue for 4-6 months (like inventory) then the loan should be paid back in that same timeframe. If the investment generates revenue for a longer period of time, like a restaurant building a deck to service more customers, then the loan can be paid back over a longer period.
If you sell it in a month, you should be able to pay for it in a month. Otherwise, there is something wrong with your margins. Low financing costs are not a solution for poor margins.
Debt financing should be used strategically. The use of long term financing for short term opportunities will eventually make it more difficult for a business to grow.
5. It’s Not About Projected Growth
This is probably the hardest reality for businesses to accept. Business owners are optimists by nature. No one ever started a business with failure as an objective. Even with a strong growth plan and the necessary tactics in place, your financing will not be based on the promise of growth.
A lender will only base your loan on the ability of the underlying business to support the payback of that loan – the coverage ratios we discussed earlier. We raise this issue because passionate business owners can become argumentative about projections. It is often the biggest of all red flags when a client says to a lender, “but you don’t understand.”
Yes, a lender wants to know that the business has a growth plan, but they aren’t going to provide funding based on that promise alone. As Clint Eastwood once remarked, “Tomorrow is promised to no one.”