The Green Sheet Online Edition
December 13, 2010 • Issue 10:12:01
Financing business startups: What ISOs should know
Being an ISO is harder than ever as we enter, to use the title of a new book by Gary Shilling, The Age of Deleveraging. Shilling - who successfully predicted the 1969 recession, early 1970s inventory bubble, 1973 to 1975 recession, early 1980s disinflation, and 2000 dot-com collapse - has a new prediction: debt will be transferred to governments and central banks, resulting in slow economic growth (2 percent) for at least the next 10 years.
This is well below what economists feel is necessary to keep the unemployment rate stable, around 3.3 percent. How will this affect you as merchant level salespeople (MLSs) and ISOs? For one thing, U.S. consumers will shift their 25-year borrowing and spending party to a focus on saving.
They will buy less. Increased regulation will stifle innovation and efficiency. Consumers will put off purchases because they expect prices to drop. There will be fewer clicks at the POS and less revenue for you.
You can approach this situation two ways: continue to walk in the door and announce, "I can get you a better rate on your credit card processing," or be a proactive business advisor to your merchants - and help them survive.
A cash-flow crisis
The best way to do this is to help merchants find ways to increase cash flow to get the funds they need to keep their doors open. You can do this by making contacts in your community that small businesses don't typically have.
They are so focused on coming to work every day and turning out the product that they have neglected to make these contacts themselves.
For this, you must know what merchants go through to finance startups. In June 2010, Discover Small Business surveyed small business owners, and over half of them reported temporary cash-flow problems.
One small-business owner said, "Maintaining consistent cash flow is our number one challenge, because when sales are good, 60 percent of current assets is tied up in accounts receivable."
When asked their preferred method of business financing, merchants overwhelmingly say, "bank loan." The problem is many of them don't know a banker, don't know how to approach a bank or are not bankable - aptly summed up in NatWest Small Business Chairman Peter Ibbetson's comment: "The lender kind of needs the money back at some stage."
Analyst Delphine Paterson said banks now need more information from borrowers than before. Here are tips for dealing with bank lenders she published in her e-zine Forward Financials:
- Approach the bank early.
- Be clear on what your business actually does and what it wants to do.
- Be clear on what you need the money for, specifically.
- Use a believable forecast of cash flow, income statement and balance sheet.
- Show the bank how you will repay the loan.
- Show a downside forecast, including Days Sales Outstanding.
- Demonstrate your track record and why you can do the things you say you will do.
- Use a rolling forecast to track actual results, and talk to the bank officer at least once a month.
One of the best contacts you can cultivate as an ISO or MLS is a local lender who specializes in Small Business Administration financing. Generally, this will be a "community bank," typically a small, local financial institution. A small business will almost always start at a community bank and only graduate to a larger bank because it needs a line of credit that is bigger than the bank's legal lending limit.
But even a community bank SBA officer may not be able to make a loan happen, which spurred the development of loan brokers and consultants who specialize in the SBA loan process.
Most entrepreneurs are not able to complete an SBA loan application without help from a loan broker, CPA or good bookkeeper. You can develop contacts with these types of professionals by being totally involved in your community, whatever that is, and it need not be only geographic.
Many startups are considered eligible only for an SBA loan, whereby the government guarantees the lender a certain percentage of the loan, typically 85 percent. However, most banks do not offer SBA loans.
Find one that does these loans - and does them well. The bank has to "sell" loans to the nearest SBA district office, and banks get a semi-permanent reputation there for either understanding or not understanding credit risk. Required documents include a written document stating the reason for the loan request, history of the business, lease agreements, percentage ownership breakdown, estimated profits and cash flows, and projected opening day balance sheet.
An existing small business applying for an SBA loan needs to include three years' financials, aging of accounts receivable and accounts payable, and debt schedules. Keep in mind that most small businesses do not want to pay taxes, so they minimize profit - not good when you are applying for a loan. For the same reason, they will not have audited financials.
At some point, an entrepreneur has to shift focus from not paying taxes to being profitable enough for this to no longer be an overriding concern. That is when the business is really viable. When this happens, the firm can have a full order book and hire new people to keep up with the work, only to find it doesn't have enough cash to pay the bills and keep the doors open.
Some industries always have cash flow problems. For example, the garment industry has traditionally relied on factors, which are firms that buy your accounts receivable at a discount (typically 30 percent) and advance you the funds now.
Others who are unable to borrow via traditional bankloans can use asset-based lending, in which a specific asset is used as collateral (inventory, machinery and equipment, or even intellectual property). Asset-based lending is subprime lending. Interest rates are higher than traditional prime-plus based loans. When you give financial advice, referring the client to a subprime lender is not optimal. Is there another way?
A new type of exchange
Recently, I attended a presentation by The Receivables Exchange. I have no connection with this company, financial or otherwise. I believe it has created an important source of financing.
It started with the idea that traditional business-finance solutions are based on cash flow, and most small businesses cannot meet their requirements. TRE realized that some kind of asset-based solution, standardized on receivables, would make more sense.
To use the company's words, "We concluded that the most liquid noncash asset on the SMB [small and midsize business] balance sheet was receivables outstanding - a highly underutilized asset, collectively valued at about $17 trillion annually in the United States. "The existing receivables market is highly fragmented and inefficient. There was no information share, such as factor-to-factor, or bank-to-bank.
"And for many small businesses, the constraints and cost of capital were more than their business [could] handle, and there was no easy way to benefit from responsible use of those solutions over time."
TRE's solution is so obvious you have to wonder why nobody had thought of it before. TRE started an auction - a centralized, transparent model to sell receivables and monetize them.
This represents the true sale of receivables; it is not collateral, and the proceeds are not a loan. The companies listing their receivables retain control over what they offer for sale, when and at what price.
Originally, the target market was SMBs with from $10 million to $100 million in sales. TRE doesn't sell via ISOs now, but I think the company would be receptive to doing so. Here is what makes TRE's solution work so well:
- No personal guarantee of the seller is required.
- No all-asset liens are placed, only a lien on the actual item being sold.
- Pricing is market-based and shows seller's financial information and transaction history, information on seller's customer, and payment history.
- There are no minimum requirements to maintain a balance of outstanding invoices.
- Access to a large group of buyers lowers the cost of capital and diversified funding.
- There are no monthly fees or obligation to sell receivables in the future.
- TRE performs due diligence on the seller applicant - lien/bankruptcy searches, verification of fiscal-year and year-end financials, tax returns, bank statements, etc.
- Sellers set the buyout price (similar to eBay Inc. sellers).
- Sellers' privacy is respected; their customers are unaware of the sale.
On average, a seller can lower the cost of capital by as much as 30 percent after six months of trading on this exchange, according to TRE. SMBs need to know about this, and you can tell them. To learn more, go to www.receivablesxchange.com.
By providing valuable financial advice, you can become a trusted advisor and ongoing resource. If you will not or cannot, you'll be just another person who walks in the door and says, "I can get you a better rate on your credit card processing."
And there will be three more guys this week coming by with that same line.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at email@example.com.
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