Risk & Business Magazine Reider Insurance Fall 2015 - Page 24

Financing Growth Financing Early Stage Growth for Entrepreneurs BY: GREG CRABTREE, PARTNER, CRABTREE, ROWE & BERGER, PC T he entrepreneurial conundrum: you have a product or service that the market really needs, but how will you finance it? For many, this is the hardest hurdle to pass. Here are my recommended sources of funding, ranked in order of best outcomes. Profits Surprised this tops the list? Don’t be! If you can get the current activity level of your business to a 10%-15% level of profitability, your business funds its own growth. It generally means slower growth in the early stages, but it builds a commitment to profitability which then bankrolls future opportunities. As we have focused our clients on profitability first, their bank funding needs have become minimal to nonexistent. Their challenge is now “what do I do with my cash” instead of “where did the cash go?” This approach requires one simple rule: you leave all of the after-tax profits in the business until the business has more cash than it needs. We call this your “Core Capital Target:” when you have two months of operating expenses in cash with nothing drawn on a line of credit. Just like the top performing mutual fund, if you reinvest your dividends by leaving them in the business, you can make your business your best performing asset! Your own cash This may seem obvious, but many entrepreneurs have cash outside of the business that they would rather keep separate, and choose instead to borrow funds inside of the business. You may have your reasons, but I prefer you to put the cash in as capital because I find entrepreneurs to be far more careful with their own cash than they are with debt. Bank Line of Credit Lines of credit sound great, but if you did not get profitable first, the bank is not likely to give you one. Lines of credit are essentially advances against a business asset (i.e. Accounts Receivable) that are shortly going to turn into cash. When you draw against a line, it’s as if the bank is paying your customer’s invoice and the customer’s ultimate payment then goes to pay the bank back. It works in theory, but entrepreneurs have a tendency to just leave a hefty unpaid balance on the line. The biggest trap to a line of credit is when you draw on a line to fund business losses. Since you can only repay debt with after-tax profits, drawing on the line to fund losses puts you in a death spiral. If you are not disciplined, you will shortly max out the line and be in workout mode with the bank. Factoring This has become an effective tool of financing receivables on an invoiceby-invoice basis. Each time you issue a customer invoice, the factoring company gives you an advance on the invoice (around 95%). The factoring company then collects your payment from your customer and remits any remaining balance less the factoring fees. Some of the newer factoring arrangements allow you to still maintain customer collection and communication, which has traditionally been a barrier for most companies to use a factor. The effective interest rate on factoring is still higher than a traditional line of credit, but I do like the invoice-by-invoice discipline. Some of the newer factoring arrangements charge a near-equivalent of a merchant fee for credit card processing, which makes it very attractive. Bank Term Loans A term loan is one that the bank makes you repay over a fixed monthly payment. These loans typically are based on an asset you are purchasing. I like this type of debt if the debt matches the useful life of the asset being financed. Friends and Family You can structure debt from friends and family, but I do recommend that you structure it no different than if you were borrowing from a bank. If you treat the paperwork casually, you are likely to treat the terms casually as well. Greg Crabtree, Author of Simple Numbers, Straight Talk, Big Profits, is a partner at Crabtree, Rowe & Berger, PC, an accounting firm focused solely on the needs of entrepreneurs, helping them build the economic engine of their businesses. 24 RISK & BUSINESS MAGAZINETM FALL 2015