How Do I Find Cash When My Credit Is Bad?
Q--"I started my company in June 1998 to provide answering services, bookkeeping, transcriptions, and other services to business and government clients. Sales have been increasing by 150% each month. But our problem is cash flow. My customers take from 45 to 90 days to pay. My personal credit is worse than awful after a divorce. I don't own anything to offer as collateral, and the banks won't talk to me because I haven't been in business for three years. Bottom line, we need money for cash flow, payroll, advertising, etc. Any suggestions?" --Janie Montgomery, general manager, ASAP Answering & Personnel, Soldotna, Alaska
A.--It's sad but true: Montgomery's problem is far from unique. Start-up entrepreneurs have traditionally been forced to rely on their personal resources--savings, credit cards, homeequity loans, help from family or friends--when it comes to raising early-stage financing. But with growing numbers of people experiencing some type of personal financial problems (which run the gamut from high debt loads to personal bankruptcies), that's a strategy that sometimes won't work. Combine that with today's volatile capital markets and many business owners are finding themselves in a real bind.
But that's not to say that cash-strapped entrepreneurs like Montgomery have no options. Jesus Arguelles, a financial consultant based in La Quinta, Calif., suggests a two-pronged approach to raising capital: solve the immediate cash crunch while taking concrete steps to improve the long-term personal financial picture. "The first stage is, What does she need to support her cash flow for the next three to six months?" asks Arguelles. "If she needs, say, $30,000, and she has work orders or contracts in place from her existing customers, she should be able to raise it through a method called contract financing."
Contract financing allows you to borrow money from a financing company against a percentage of your outstanding contracts. It's one of three costly--but effective--ways to raise cash when your company is too young (or your personal financial records are too spotty) to help you qualify elsewhere. In Montgomery's case, Arguelles expects that contract-financing costs will run about 3% to 5% per month--pricey but preferable to closing up shop if there's no other way to support current operations at a fast-growth clip.
The other two methods, which are slightly cheaper than contract financing, involve accounts receivable rather than contracts. They include factoring, in which a company sells receivables for a discounted price to bring in cash sooner rather than later; and accounts-receivable financing, in which the company uses receivables as collateral for a short-term loan from a bank or other financier.
The main point to keep in mind is that these three options should be viewed strictly as short-term, last-ditch financing methods, since they can eat a big hole in your profit margin. "The reason to do this is to give your company a chance to build up a slightly longer track record, which will then hopefully allow you to move to other, somewhat cheaper financing options," notes Arguelles.
Two cheaper options worth trying: the Small Business Administration's SBAExpress program, and microloans, which are offered on a regional basis by some banks and other financial institutions, according to Hedy M. Ratner, copresident of the Women's Business Development Center, in Chicago. "What's possible is to qualify for loans of up to $25,000, providing you've got a strong business plan and good business fundamentals," she explains. The way to find out what's offered in your region is by contacting your state department of commerce, as well as regional SBA offices and local economic-development agencies. In some regions, nonprofit groups like Ratner's will work with entrepreneurs to improve their applications and chances of financing success.
Of course, in cases like ASAP's, it can only help to pursue all possible lending sources. That includes vendor financing if you're doing enough business with any company to make it worthwhile for it to support your business's growth activities; customer financing, so long as you position your request as one that will support expansion efforts (rather than simple survival); and cosigned loans. While the way this third option tends to work involves family members or friends, Arguelles notes that entrepreneurs can sometimes pay independent outsiders to cosign loans, typically for a onetime, up-front fee of 3% to 5% of the loan's face value. "In some cases, assuming that the outsider has enough confidence in the business venture, you can expect him or her to make the introduction to a willing banker," he says.
For business owners in Montgomery's bind, it's important to remember that there are two sets of financial goals that must be pursued simultaneously: raising short-term capital for the company (for roughly six months to a year) and improving the personal financial picture. "Until she, or any business owner, builds up a personal credit history that looks good, she won't be able to convince most bankers or other investors that she truly understands financial controls--and that will hamper her ability to raise capital," says Gayle Ehrlich, a partner at the Boston law firm Sullivan & Worcester. "The problem is, that's not something she can achieve in three months."
The best way to start is by working with a local credit-counseling service to set up a plan to pay off credit-card debts and clean up any other outstanding personal financial problems. It won't be easy at first. As Montgomery herself explains, she doesn't even pay herself a salary yet, since, like many start-up entrepreneurs, she is reinvesting all her company's spare cash in supporting its growth.
But Steven Enright, a financial planner and investment adviser in River Vale, N.J., warns that such a strategy can be risky for business owners in Montgomery's position. "She has to balance the growth of her company against the potential for getting squeezed out of the business by that growth when she doesn't have the capital to support it," he says. Enright urges her to start paying herself a modest salary, with the goal of directing as much of that money as possible to cleaning up her past credit problems.
"The irony that most people overlook," Enright says, "is that if you've got credit-card bills you can't pay, your debt load is probably growing a good bit faster than your company is--which means it will be tough to ever get out from under it." It's hard to predict how long it should take a business owner to repair past personal-credit problems. (The key variables for any entrepreneur are the size of his or her outstanding debt as well as the monthly paycheck a company can support.) But Montgomery needs to be able to achieve real improvements on the personal, as well as corporate, front with the close of each quarter.
Over the long term, Ratner urges, Montgomery--and entrepreneurs like her--should invest time in seminars that will teach her financial strategies as well as cash-flow and other business-management techniques. "You don't want to wind up in a situation where you grow so fast, and are so unprepared, that you push yourself right out of the box," Ratner says. --Jill Andresky Fraser
Four key rules for raising capital
Whether your company is new or well-established, and your personal financial situation is strong or weak, you'll increase your chances of raising funds if you follow these guidelines:
1. Figure out how much your company will really need the first time around. The worst mistake a business owner can make is to adopt the attitude "I'll take whatever I can get." You inevitably will need more, and you risk losing credibility with lenders and backers when you come back to them with your hand out yet again.
2. Don't try to raise cash without an operating budget, short-term cash-flow projections, and a three- to five-year business plan. If you don't have those documents in place, you'll scare off everyone except your mother and your best friend from kindergarten. In today's financial marketplace the competition for financing is fierce, and only the best prepared will succeed.
3. Make certain your capital structure makes sense from the beginning. This requires discipline. If you borrow money from people, draft promissory notes that clearly spell out how much your company owes, when it will pay, and whose rights are subordinated to others'. If you sell equity, don't give away more than is absolutely necessary, and consider consulting a lawyer about the benefits of setting up different classes of stock. Above all else, make certain that all your early-stage backers understand the ins and outs of their debt or equity positions.
4. If you don't succeed at first, try and try again. Financing prospects can change rapidly for good, fast-growing companies. So do what's necessary to hang on for another 6 to 12 months. Above all, stay in touch with any potential lender or investor who is willing to keep talking. If your cash flow stays healthy, you can hold on.
Heading off future problems
It's remarkable how many problems can develop when a fast-growing company is built around a poorly planned capital structure. That's why Gayle Ehrlich, a partner in the Boston law firm Sullivan & Worcester, advises fledgling entrepreneurs to clean up potential financial difficulties sooner--much sooner--rather than later.
In ASAP's case, Ehrlich objects to the fact that Montgomery has already sold 48% of her company's stock, mainly to a friend who invested $12,000 in start-up funds (twice the amount Montgomery was able to put in by depleting her personal savings). "The problem is, this person may have gotten too much of the company in return for far too little. When you're a start-up entrepreneur, you want to make certain you don't set up a situation where someone stands to reap way too much in benefits from your hard work." What the lawyer suggests is negotiating now--while the company is still young and relatively lacking in value--a price and target date for a buyout of part or all of outstanding stock. Then, when Montgomery's personal-credit picture looks shinier and the company's record is better established, ASAP may be in the position to carry out a more profitable equity-financing deal.
If potential investors still need convincing, here's another Hail Mary play worth considering: "Raise their comfort factor by placing Montgomery's equity in an escrow account, with a clearly spelled out plan for how she can earn it back in incremental stages if she achieves targets in terms of corporate and personal financial results."