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Archive for the ‘Business Loans 101’ Category

Strategic vs. Financial Buyers (the pros & cons)

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If you’re thinking about buying or selling a business, it’s important to know the types of buyers.  Buyers are generally classified into the following two different categories, including the pros and cons of each:

  • Strategic Buyers:  These are companies that believe your business fits well within their existing business, and there is a strategic reason for them to buy that might go beyond monetary gain.
    • Pros
      • Typically offer a higher purchase price than “financial buyers”
      • There may be some competitive advantages from joining forces with another company, including increased purchasing power with suppliers, cross selling to customers, cheaper cost of capital, etc.
      • No immediate plans to flip/sell the company again.
    • Cons
      • Tend to include their company stock as part of the purchase price (instead of giving you all cash at close).
      • They’ll probably fire a bunch of people, including management, because so many positions will be redundant (duplicative).  Part of the reason they pay a higher price than “financial buyers” is because strategic buyers can immediately cut so many costs out of the business; no need for two regional managers at the same company covering the same region.  And every $1 of cost savings the buyer creates is worth $5-$7 due to the EBITDA multiple effect in corporate valuation (companies are generally sold for 5x-7x EBITDA).
  • Financial Buyers:  Investors that are purely interested in monetary gain.  Similar to flipping houses.
    • Pros
      • Most employees, including management, will likely keep their jobs
      • Likely an all cash offer (versus buyer’s stock being part of the purchase price)
    • Cons
      • Increased leverage.  Financial buyers typically use debt to finance up to ~75% of the purchase price, leaving the business saddled with a significant amount of new debt that might strangle the company’s cash flow and limit its financial flexibility.
      • Lower purchase price.  Financial buyers typically pay less for a company than strategic buyers because there are fewer “synergies” to be had that might otherwise justify paying a higher premium.

-Brandon Hinkle / www.pluraFinancial.com

What is a Relationship Lender?

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I challenge you to find a bank that says they’re not a “Relationship Lender” these days.  When you think of the words “relationship lender”, does it conjure up images of your banker treating to a round of golf, buying expensive steak lunches, and giving you loan after loan at the lowest rate without regard for financial performance?  Think again.

Relationship Lender means the bank requires the company’s operating account in order to give you a loan (in addition to the standard credit criteria).  But the banker is not allowed to say this because of a federal law called “anti-tying” that says a bank cannot require you to sign up for one product (e.g. cash management) in exchange for receiving another (e.g. a business loan).  I’m not a lawyer, but that’s the explanation of tying given to me by our legal counsel when I worked at a bank.  Banks want your operating account (cash deposits) for two primary reasons: (1) if your loan is in default they probably have the right to “sweep” (take) all the cash in the checking account because it’s part of their loan collateral, and (2) banks are required to have a certain amount of cash for each $1 they lend.  The more cash people hoard at their bank, the more loans the bank can make and the more funds the bank can borrow from the Federal Reserve, etc.

Should you avoid “relationship lenders” when seeking a business loan?  Absolutely not; many of the most competitive banks also classify themselves as relationship lenders.   When a bank tells you they’re a relationship lender, should you ask what exactly that means?  Absolutely yes.  If nothing else, it will be an amusing conversation and a great way to start off your joyous relationship together!

Looking for a bank or business loan?  pluraFinancial.com creates relationships between banks & businesses online, or you can ask your local Small Business Development Center which bank might be best for your business.  Both are free ways to find the best bank for you & your business.

http://www.plurafinancial.com

Written by entrabanker

September 12, 2012 at 3:14 am

Growth Capex vs. Maintenance Capex vs. Internally Financed Capex

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Capital Expenditures

Growth Capex vs. Maintenance Capex vs. Internally Financed Capex

There are generally two reasons companies spend money on capital expenditures “capex”: to grow the business, and to maintain the business.  Once a company determines it needs to make a capex investment it must decide how to pay for the capex, either using company cash or debt.  Let’s explore each element of capex in more detail to get a better understanding:

  • Maintenance Capex: The necessary expenditures required to keep existing operations running smoothly.  Perhaps a new conveyor belt for the old machine, or new computers to replace the outdated technology.  These expenses don’t attract new customers or create the capacity for a bigger business; they just enable the company to keep running at status quo.
  • Growth Capex: The discretionary investments used to attract new customers or create the capacity for a bigger business.  Perhaps a new customer requires you upgrade your software before signing a contract, or maybe you need another machine to process all the upcoming orders from new customers.  These are the expenses/investments in additional assets to help facilitate growth.
  • Internally Financed Capital Expenditures: Spending internal cash (instead of debt) to pay for capex.  When banks are determining your credit-worthiness, they are evaluating all the sources & uses of cash.  Capital Expenditures (capex) is a big use (drain) of cash for many companies, particularly manufacturers.  The more cash is spent on capex, especially growth capex, the fewer funds are available for debt payments.  Capex financed with external cash (bank debt or owner equity) doesn’t reduce company’s cash flow, but capex financed with company cash does.  Internally Financed Capex is part of the FCCR, the ratio used to determine a company’s ability to repay its debt.  The bank often asks for an estimate of internally financed capex because that number won’t be included in any financial statement, but is necessary to calculate your company’s ability to repay debt!

If you have capital expenditures, it’s helpful to keep track of how much was spent to grow versus maintain your business, and how much was financed with company cash instead of bank debt!

-Brandon Hinkle/www.plurafinancial.com

When to Raise Capital (Part 1 – When To Raise Debt)

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-Brandon Hinkle/plurafinancial.com

There’s a popular saying in banking that it’s always best to request a bank loan when you don’t need it.  And there’s a popular saying in entrepreneurial circles that a banker is one who gives you an umbrella when it’s sunny outside, and takes the umbrella away when it’s raining.  Either way, you should always seek money before you need it.  This is particularly true for debt financing.

When To Raise Debt For Your Business

If you foresee a need for cash in the future, and if you can prove your company has the ability to quickly repay a loan (plus interest), than you should start seeking a bank loan.

  • Criteria: See What banks look for in a business loan to better understand the bank requirements for debt, but suffice to say the bank needs to know your business has the wherewithal to repay a loan on time, plus interest.  You usually also need to put at least 20% of your own capital into the project being financed.
  • Favorable attributes of debt:
    • The ability to put other people’s money at risk (instead of your own) without giving up ownership.  Private equity folks get rich with this strategy.  Warning: too much debt can strangle a company.
    • Over the long term, debt is cheaper than equity (if you believe your business has meaningful value).
    • Loan interest (expense) can reduce the company’s taxable income.
    • Debt forces financial discipline; it’s harder to make risky investments when the company has loan payments to make each month.
  • $ Cost of debt: A traditional bank loan generally charges 5%-7% annual interest.   Sometimes the interest rate is variable, sometimes it’s fixed.  Fees generally range from 0% to 3% of the loan amount, depending on the bank and loan type.
  • Hidden cost of debt: 
    • Increased risk of bankruptcy.  Your cash flow might get a temporary boost from the loan, but be careful not to borrow too much money; otherwise, every cent your business generates will need to go towards debt payments, strangling the company’s cash flow.  If your business experiences any unfavorable surprises you might not be able to make the required debt payments, which could lead to bankruptcy.
    • Debt requires more financial discipline and cash management than equity because of the amortization schedule and loan covenants associated with debt.
    • Beware of vulture lenders.  The difference between 7% monthly interest and 7% annual interest is enormous.  7% monthly interest is equal to 84% annual interest.  No reputable lender speaks in terms of “monthly” interest rates.  Read the fine print and confirm that the interest rate being charged is the ANNUAL interest rate.  Avoid opportunistic vulture lenders at all costs.
  •   How to find the right bank for you:
    • plurafinancial.com (shameless plug) is a free online tool available to small business owners seeking to get matched with appropriate, reputable lenders to find the best possible rates.
    • Consult with your local Small Business Development Center.
    • Apply for a loan in person to 5-6 banks, including a few large national banks and a few small community banks.  Cast a wide net and don’t settle for the first offer that comes along!
“Part 2 – When To Raise Equity” coming soon!

Brandon Hinkle is the CEO of pluraFinancial.com.  Prior to plura, Brandon served in the workout group for GE Capital’s sponsor finance division (Antares), and was an underwriter in Merrill Lynch Capital’s corporate finance group. He started his career as an underwriter in Merrill’s small business lending division. Brandon has a BA from Michigan State and an MBA from Northwestern University. Contact Brandon directly at:bhinkle@plurafinancial.com.

Written by entrabanker

June 7, 2012 at 9:35 pm

What Banks Look For in a Business Loan

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Brandon Hinkle/www.plurafinancial.com

Banks primarily care about three things when making business loan decisions: cash flow, collateral, and personal guarantor strength.  Generally in that order of importance.  Let’s look at each item in more detail:

What is cash flow?   For banking purposes, cash flow is the pool of company-generated cash that’s available to make debt payments each year; generally this is EBITDA less taxes, dividends, and capital expenditures.  Banks don’t care much about projections; they want historical financial info to ensure there’s a track record of consistent, predictable cash flow.  When a bank is evaluating your loan request, they generally want a 25% cushion (for each $1 of required debt payments you should have at least $1.25 of cash available to make debt payments).  In other words, you need to have more cash flowing in than cash flowing out; ideally, 25% more!

What is collateral?  Collateral is the base of assets available for the bank in case the company is unable to make its debt payments with company-generated cash flow.  Banks typically want the “liquidation value” of the assets/collateral to equal the requested loan amount.  Liquidation value is basically the cash that could be generated by selling the collateral in the next 90 days.  The most common assets that secure a loan are accounts receivable, inventory, commercial real estate, and equipment.  Banks typically give a 20% discount to current accounts receivable & real estate, and a 30-50% discount to inventory and equipment.  For example, if your A/R aging shows $100k of current receivables, balance sheet shows $200k of sellable inventory, no equipment, and real estate that appraises for $500k, you’ll likely be eligible for $580k of debt: ($100k of A/R @ 80%) + ($200k inventory @ 50%) + ($500k real estate @ 80%) = $580k of net eligible collateral.

What is personal guarantor strength?  A personal guarantee (“PG”) basically gives the bank the right to go after your personal assets if the business goes defunct and is unable to service the debt.  A strong personal guarantee, for banking purposes, is one that has liquid assets in excess of the requested loan amount.  Liquid assets generally exclude retirement plans and funds held in trust because they’re not easy for banks to liquidate in a bankruptcy scenario.  The primary goal of a personal guarantee is to align your interest with the bank’s interest of getting the loan repaid.  Afterall, if you don’t stand behind your company, why should the bank?

Other things banks care about: 

  • The company’s net worth because it’s an indication of the cash that would be leftover if the company was liquidated today.
  • Your business & personal credit history, to gain comfort that you’re a responsible person of good character that finds a way to pay your bills on time.  Bankruptcy, for example, is usually a deal killer.
  • Customer concentrations.  If most of your revenue is generated from few customers, you’re more vulnerable than most banks are comfortable with.

In conclusion, banks just need comfort that you can pay the loan back, plus interest, on time.  The more evidence you have of that, the higher your chances of getting a good loan proposal!

For more info about how to find the right loan for your business, check out www.plurafinancial.com

Written by entrabanker

March 20, 2012 at 3:17 am