Debt Financing ETP 3700

Courage: Risk and the Dimensions of Work Life Cycle of a Business Venture Bootstrapping Self, Friends and Family Equity Financing Debt Financing

Short-term Debt Expected to be paid within one year Most often used to finance short-term expenditures such as inventory, supplies, payroll, etc.

Short-term Debt Trade debt Not a given - need to establish a relationship Communication critical if cash flow is tight Build a relationship with long-term vendors

Short-term Debt Banks Some banks specialize in working with entrepreneurs Smaller local community banks often more willing to work with local small businesses

Short-term Debt Asset-based lenders Lend money against assets Cheaper than factors, but more expensive than banks

Short-term Debt Factors Advance money on accounts receivable through “purchase” of A/R Good for businesses that are not “bankable” at current time Expensive money: 4-7% per month (annual 50-85% equivalent financing rate) Use for short term only whenever possible Plan for transition to bank or other lower cost financing

Long-term Debt Beyond one year Most often used to fund fixed asset purchases

Long-term Debt Banks: term loans Leasing companies Real estate lenders

Overlooked Forms of Debt Property leases Long-term employment agreements SBA or other government backed lending programs

SBA Loans Funds provided by independent lenders Loan guaranty from SBA transfers risk of borrower non-payment, up to the amount of the guaranty, from the lender to SBA SBA loans are commercial bank loans guaranteed by the SBA

Eligibility for SBA Loans WHOLESALE - not more than 100 employees RETAIL or SERVICE - Average (3 year) annual sales or receipts of not more than $6.0 million to $29.0 million, depending on business type MANUFACTURING - Generally not more than 500 employees, but in some cases up to 1,500 employees CONSTRUCTION - Average (3 year) annual sales or receipts of not more than $12.0 million to $28.5 million, depending on the specific business type

Basic SBA Loan Programs Basic 7(a) Loan Guaranty SBA’s primary business loan program Helps qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels.

Basic SBA Loan Programs Basic 7(a) Loan Guaranty Loan proceeds can be used for: working capital machinery and equipment furniture and fixtures land and building (including purchase, renovation and new construction) leasehold improvements

Basic SBA Loan Programs Basic 7(a) Loan Guaranty Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets. Start-up and existing small businesses DELIVERED THROUGH: Commercial lending institutions

Basic SBA Loan Programs 504 Loan Program Provides long-term, fixed-rate financing to small businesses to acquire real estate or machinery or equipment for expansion or modernization. Typically a 504 project includes a loan secured from a private-sector lender with a senior lien a loan secured from a Certified Development Company (funded by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the total cost a contribution of at least 10 percent equity from the borrower. Maximum SBA debenture generally is $1 million

Working with Bankers Initial contact “There’s a bank on every corner.” Get to know your banker’s boss Make sure they get to know you and your business before you give them financial statements or plans

Working with Bankers Criteria for Lending by Bankers 1. Ability of the business to generate enough cash flow to easily make interest and principle payments 2. Entrepreneur’s ability to personally pay back the loan if the business fails 3. Assets to serve as collateral

Working with Bankers Key Loan Documents 1. Loan proposal 2. Loan document Terms Restrictions Performance requirements 3. Personal guarantees Major shareholders Joint and several liability Eventually becomes negotiable

Working with Bankers On-going Communication Bankers hate surprises Give them a little more than they want, a little more often than they want it Verbal and written

Downside of Debt Increased risk during economic slowdown Impact on proceeds from business sale Restrictive covenants Personal guarantees