As I mentioned in the first part of this series, the banking environment these days can be pretty frustrating, often resembling something out of a Tim Burton movie—dark, twisted and leaving you shaking your head saying “What the hell just happened?” In this installment of Banks vs Entrepreneurs, I’ve outlined the importance of weighing your options when looking to borrow capital and grow your business.
While the title of this series clearly pits banks against entrepreneurs, I want to be clear that I’m not casting aside all banks and bankers. There is a list, albeit a very short one, of traditional bankers that I recommend. In most cases, the bankers on the short list work with you and they take into consideration things like cash flow, prenuptial agreements, related LLC’s—random pieces that are unique to every entrepreneur. Upon request, I’m more than happy to share my short list; I’m just not going to post it publicly for fear of adding more flames to the already burning bridges with the other ones that routinely make my life miserable.
As an entrepreneur or small business, traditional financing can be a nightmare. With regard to “nontraditional” financing, there are so many different paths out there that knowing which one to take—and what to expect once you choose—can be not only confusing but also time consuming.
The preliminary questions to answer are boundless: Is it business or personal? Do you need a loan or a line? Amortizing or interest only? Secured or unsecured? Are you willing to sign a personal guarantee? What’s your debt-to-income ratio? What’s your credit score? What’s your credit card utilization? What do you have that can be used as collateral? What’s the loan-to-value on that collateral? Ugh!
Your particular situation will dictate what financing options you really have available. What I usually find after I produce loan package after loan package for traditional underwriters is that if the entrepreneur is not abjectly declined for credit, they are left with few possible options. Don’t panic. There are alternatives—many of which are based more on future potential as opposed to relying simply on past performance or current balance sheets.
One of my favorite non-traditional routes is peer-to-peer lending, which can be thought of as the eBay of loans. Those who pursue this can usually get up to about $35,000 from a whole lot of people that want to lend a fraction of the loan. When all is settled, you can come away with a pretty reasonable rate and the total is paid over three to five years. Two companies that are great for this are Lending Club and Prosper.
Another option is to consider factoring services that will buy part or all of your accounts receivable—usually for reasonable discount rates. This works by the service giving you an advance on your accounts receivable. Some factoring services will have you remit payments to them, some will just electronically take the future deposits from your checking account and some will have your customers pay them directly. Be sure you know which approach they take before signing anything, as you need to know up front and be comfortable if your customers will be contacted by the factor.
You could also go the route of venture capital (VC). This approach often has the advantage of high-level expertise that is provided in the form of a management overlay or a consulting arrangement. Be prepared to give up ownership if you do pursue VC and if your profession allows it (for example, doctors, lawyers and CPAs are just some examples that prohibit non-licensed individuals from ownership without certain criteria in place).
If you are really creative, you can build quite a bit of liquidity by pooling things like credit cards that offer cash advances at miniscule rates, commercial overdraft lines of credit of up to $20,000 that do not charge fees for advances, and loans on retirement plans where you are literally paying yourself the interest that accrues on the payments. You obviously want to use a combination of these with a careful thought-out plan, but these can often be a quick and easy resource to solve short-term liquidity problems.
Beware, as some non-traditional options can be dangerous. Be cautious of astounding fees and interest rates. One example of an option with exorbitant interest rates is one commonly called a Merchant Loan. The lender gives you a set amount and it is usually deposited into your account at lightning speed, which makes it very tempting to accept. Then you are set up for daily payments that are automatically taken from your account. A recent deal I saw was for $30,000 and had payments of $302 per business day for about seven months. The owner of the company thought that $302 sounded reasonable and his daily credit card sales would cover it. The actual annual percentage rate worked out to be over 104%!
Armies of business owners that I talk to are bound and determined to get away from needing banks at all, which is a major reason why I decided to write this series. Because entrepreneurs are running for the nearest exit wherever possible, eventually the lending environment is going to have to change. However, in the meantime, if you do a little bit of homework, you can save yourself from the usurious interest rates of predatory lenders, unnecessary inquiries that screw up your credit and endless loan packages that waste your time.
You know your business and you have a pretty good idea of your financial picture. Don’t hope for a miracle. In the current banking environment you need to make a plan and be prepared to ask the important questions. Weighing all of your options is the first piece of homework to do in order to arm yourself for the battle of ultimately getting financing. By taking the steps I will continue to detail in this Banks vs Entrepreneurs series, you will be in a better position to be successful, get the best deal and know what you are getting yourself in to.