In this, the second article in a series about financing your business, we are going to examine how a lender views your business and what he looks for when you request financing. To keep things simple, in this article, I will use the term lender to mean both those that lend money to your company—banks, finance companies, factors—as well as those that invest in your company—venture capitalists, angel investors, and investment bankers.
The first thing you want to remember is that every request for financing you make is a selling activity. No matter how good your business idea, no matter how financially sound your company is, you are only one of many requests that a lender sees every day. And there is always someone who is in better financial condition than you are, or who will be an easier deal to close than you will.
Those who lend money are judged by the following criteria:
- How many deals do they review?
- How many deals do they close?
- What is the amount of each deal (larger is better)?
- How profitable is each deal?
Get the picture? Lenders are salespeople. Their product/inventory is money, and they don’t want it sitting idle. Instead, they want it out in the marketplace, where it will generate revenues (interest).
However, you need to understand that selling loans or equity investments is not quite the same as selling a product or service. For one thing, once a company sells a product or service, they do not want to take it back. The sale is closed, the profit has been earned. End of story, on to the next sale.
Lenders, though, definitely want the money back. Repayment of the loan or investment is absolutely necessary if the lender is to receive the required return on his investment. In addition, lenders tend to be highly leveraged, which means they make loans with a little of their own money and a lot of other people’s money. Being leveraged means that any time a loan is not repaid, it will have a significant, and severe, impact on the lender’s financial condition.
So you can understand why lenders are going to be very careful when they decide who gets to borrow their money.
With that in mind, let’s take a look at the three basic questions lenders consider when they evaluate financing requests and try to decide who gets to borrow money.
These questions apply to anyone that lends or invests money—it does not matter if it is a loan, an equity investment or a combination of both. However, the specific answers depend on the type of lender and the risk that the lender is willing to take.
For example, banks tend to be short term lenders and avoid very risky credits. Therefore, they will try to obtain collateral to secure their loan and will not make loans to companies that have insufficient assets to pledge, have a poor financial condition, or inadequate cash flow.
Equity investors, on the other hand, seek out the riskier investments and higher rates of return. Consequently, they will not necessarily seek hard assets as collateral, and will not be concerned if (at the outset) the company has insufficient cash flow or a poor financial condition.
In both cases, though, these three questions must be answered:
- Purpose – Why do you want the money? How will you use it? What has happened, or will happen, that causes the need for you to seek out financing?
- Repayment – How will you repay the money? If you are seeking short term debt, will your ongoing cash flow be the source of repayment? Will you depend on your customers to pay you in order for you to repay the debt? If you are seeking an equity investment, do you expect the value of your company to grow to the point where you can sell it and thus raise the funds needed to repay the lender?
- Collateral – What is the alternative to the lender if your intended source of repayment fails to materialize? In the case of a short term loan, will your assets have sufficient value so they can be liquidated and pay the loan in full? How much will it cost the lender if he has to go through the liquidation process? If you anticipate an equity investment, will the lender be able to take control of your company should you be unable to execute your business plan?
So do not forget the lender’s perspective when you are seeking money for your company. Anything you can do to give the lender what he needs, and to make it easier for the lender to approve your request, will only enhance your ability to get the financing you need, when you need it.
It can be extremely difficult to finance a business, particularly when you are just starting out. Most of the time, traditional methods of funding are not overly excited about giving you money to start a new business
Posted by: Robert | November 07, 2007 at 02:16 AM