Financing Small Business Growth

A while back I wrote a series of posts here, here, and here on buying a small business.  One of the things I said in that post was:

Then, there are the banks. From my experience, it is very, very
difficult to get a bank to make an collateralized loan - i.e. a loan
that is secured only by the cash flow of a company rather than by
assets. In fact, I have never been successful at that. About the only
way that I have found that banks will make a loan is if it is an SBA
loan, where the SBA basically guarantees the loan for the bank. The SBA
goes through cycles of being very open to lending to being very tight.
I have not dealt with them for over two years, so I don't know what
their stance is today. Remember, though, that the SBA is not going to
approve any loan where the buyer has no experience in the industry or
where the buyer is not putting down his own money as well. The SBA has
a lot of information here.

This statement is still mostly true but I have learned a lot over the last couple of months.  The following is an update.

One of the things they tell you all the time in business school, but frankly I always found impossible to really internalize, was how much cash growth takes.  I guess I always thought of businesses with cash flow problems as being unsuccessful, slowly sliding down the drain and trying to make ends meet.  Wrong.  Growth is tremendously expensive.  And stressful.

My business is based on concession contracts.  Each winter, we are usually presented with the opportunity to bid on many contracts.  We narrow the field down to 4-6 we bid on, hoping to win about 2.  One of the things I did last year was greatly improve our standard bid materials, hoping that would help us win good projects.  Did it ever.  We bid on 6 last year and we won 6 (including Burney Falls, Pyramid Lake, and Lake Havasu).  Yea!  But then I began adding up all the investments in new inventory, new equipment, salary (you always have to hire people before the first revenues come in), licenses, building improvements, etc.  Eeek!

After a lot of work with bankers, I stand by most of my statement above.  Most bankers will not lend to businesses on cash flow, and always want some type of collateral (like my home equity).  Over time, though, I have found a few bankers who are willing to lend on cash flow and really understand business growth and why maybe I don't want to have my business's growth rate limited by how much equity I have in my personal home.  There are bankers who will put together packages of long-term loans backed by the SBA plus short term working capital loans that will now let me grow faster.  The folks at Copper Star Bank, for example, have been great. 

One of the reasons I felt the need to post this update is that I have been told that my difficulty finding a good business banker was due in part to my location here in Phoenix.  The Phoenix banking market is very real estate driven, so bankers usually come from that background rather than a business background.  I am told that those of you on the east coast or in the Midwest may have an easier time finding good business bankers.

Postscript: By the way, you might ask how I feel as a small government libertarian about accepting the government subsidy implicit in an SBA loan.  The answer is "conflicted".  Some libertarians are fine accepting government services, on the theory that they certainly have paid for them with all their taxes.  Some try to avoid government services, but that is almost impossible in today's world (such as using government roads).  I generally try to be pragmatic, operating somewhere in the middle.

As far as SBA loans go - I don't know what the commercial banking world would look like without SBA loans.  I think that the banking world would have found an alternative way to mitigate the risk (e.g. via securitization) without the government gaurantee, but we can't know.  The fact is that SBA gaurantees exist and banks would be crazy not to use the gaurantees in making business loans.  So, the reality is, if I want a cash flow based loan for a company my size, it will likely carry the SBA gaurantee.  My appologies to all those whose taxes support my loan gaurantee.

  • It's early yet, but someone (Zopa.com) is taking a stab at addressing the needs of small business (and small investors) through a private sector approach that bypasses the banks. I'm very interested to see how this develops - disintermediation with a nod towards risk management through portfolio lending.

    At the moment, their lending criteria appear to be based on personal credit and the amounts are quite low to work within U.K. laws regarding commercial lending. However, they do allow lenders to choose to participate in higher-risk/higher-reward lending. The next logical step to me would be to set up markets using alternative forms of security. More info to be found at http://www.zopa.com/ZopaWeb/default.aspx

    Zopa came to my attention via Johnnie Moore's Blog: http://www.johnniemoore.com/blog/

    BTW, I'm a long(ish)-time reader, first-time commenter. Great site, one of my first RSS subscriptions after being given an introduction to blogs. I'm half-converted to libertarianism, which makes for interesting conversations in a country (Canada) that was founded on the principles of "peace, order and good government".

  • Don't apologize for using SBA funds. Just concentrate on making your small business as successful as you can! That's what we taxpayers are expecting. We also KNOW that there are "fits and starts" involved in growing a small business. We also know that small businesses grow better than very large businesses, when all the population of businesses is examined.

    I am an accountant, so I've studied economics, formally. This stuff is all so well established as to be "axiomatic".

    I'm sorry to hear about Florida. I don't like it when large entities, like States "throw their weight around". But that is basically what they are doing. Perhaps the blogging will get a rise out of other Florida-based bloggers.

    If enough citizens in Florida became unhappy with this sort of "bait and switch" operating style. . .they could change things in the state.

    Good luck.

    Chris Tune
    Valley Village, CA

  • Even though you may be a good credit risk, banking regulation require that loans be supported by a certain percentage of collateral. If the business venture fails and the business is not able to pay its debt, the receipts will not be there either. So from the point of view of a safety and soundness auditor such a loan is really not secured unless the value of the loan compared to the size of the overall business is insignificant.

    You're right. Without the SBA guarantees, few small growing businesses would get bank loans. This is why venture capital pools have sprung up, but they often cut hard deals. All of this does have significant implications for the economy, though, because most of the growth (especially job growth) is in small businesses.

  • jb

    There are non-bank lenders who will loan on a percentage of receivables and inventory. I used these guys - http://www.fcfinancial.com/ - in the past, and they were easy to do business with. It seems like factoring, I know, but the interest rates are quite good, if you're profitable of course. Good luck.

  • Small business financing is a bitch, no doubt about it. But one of the problems is that many small business owners look at the wrong variables when trying to financing their business.

    Lots of small business owners make the mistake of using personal assets to securing working capital for a smaller business and ergo, you are limited by the amount of equity in your house. Yes, the money is cheap, but there isn't enough of it.

    By factoring your A/R (I run a factoring business so shoot me, I am biased), you unlock anywhere from 75% to 90% of the value of your company's A/R, albeit at a higher cost than a mortgage on your house. But as long as your business generates a profit margin that is greater than the cost of the money, it is the right decision.

    What most small business owners do not ask themselves is "how much profit am I missing because I lack adequate cash flow?"

  • Small business financing is a bitch, no doubt about it. But one of the problems is that many small business owners look at the wrong variables when trying to financing their business.

    Lots of small business owners make the mistake of using personal assets to securing working capital for a smaller business and ergo, you are limited by the amount of equity in your house. Yes, the money is cheap, but there isn't enough of it.

    By factoring your A/R (I run a factoring business so shoot me, I am biased), you unlock anywhere from 75% to 90% of the value of your company's A/R, albeit at a higher cost than a mortgage on your house. But as long as your business generates a profit margin that is greater than the cost of the money, it is the right decision.

    What most small business owners do not ask themselves is "how much profit am I missing because I lack adequate cash flow?"