Debt Financing

ETP 3700

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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 debtNot a given - need to establish a relationshipCommunication critical if cash flow is tightBuild a relationship with long-term vendors

Short-term Debt

BanksSome banks specialize in working with entrepreneursSmaller local community banks often more willing to work with local small businesses

Short-term Debt

Asset-based lendersLend money against assetsCheaper than factors, but more expensive than banks

Short-term Debt

FactorsAdvance money on accounts receivable through “purchase” of A/RGood for businesses that are not “bankable” at current timeExpensive money: 4-7% per month (annual 50-85% equivalent financing rate)Use for short term only whenever possiblePlan 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 SBAhttp://www.sba.gov/financing/index.html

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 typeMANUFACTURING - Generally not more than 500 employees, but in some cases up to 1,500 employeesCONSTRUCTION - 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 ProgramsBasic 7(a) Loan Guaranty

SBA’s primary business loan programHelps qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels.

Basic SBA Loan ProgramsBasic 7(a) Loan Guaranty

Loan proceeds can be used for: working capitalmachinery and equipmentfurniture and fixturesland and building (including purchase, renovation and new construction)leasehold improvements

Basic SBA Loan ProgramsBasic 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 businessesDELIVERED THROUGH: Commercial lending institutions

Basic SBA Loan Programs504 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 liena 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 costa 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 bossMake 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 CommunicationBankers hate surprisesGive them a little more than they want, a little more often than they want itVerbal and written

Downside of Debt

Increased risk during economic slowdownImpact on proceeds from business saleRestrictive covenantsPersonal guarantees