Access to capital remains one of the more difficult challenges that face the business owners I work with. Most businesses I work with see more opportunity than they have capital. We are in one of the longest and strongest periods of economic expansion in North America, yet banks still continue to be conservative with providing capital to small to medium sized businesses to finance growth. It seems banks are in the business of rejecting loans, not issuing loans.
When I work with clients, we tend to focus on growth and expansion. To that end, a common question that arises is how to finance growth and acquisitions especially when so many banks are asset-based lenders (e.g. only lend when there is significant real estate in the deal). I work with a lot of bank and non-bank lenders that are cash flow and credit-based lenders. Which is to say these lenders focus on business fundamentals other than simply the real estate available to secure a loan.
These are some of the common items lenders evaluate when considering a borrower:
- Clear Financials. Lenders look at the world always assessing the worst-case scenario. Where business owners and entrepreneurs see opportunity, lenders only see a wasteland of non-performing loans. Lenders need financials that clearly outline the financial state of the company in a format that can get through an underwriting committee.
- Business Plan. Lenders want to know that the buyer has an intimate understanding of the business opportunity at hand. As the lender will likely finance the majority of the acquisition or investment, and it is critical that a borrower demonstrates they are a responsible steward of the lender’s capital. A defensible pro forma that clearly outlines both expected revenues and expenses demonstrates the borrower has thought through the expansion plan.
- Management Team. The experience of the existing management team is an important consideration for a lender. Teams that have experience increasing revenues, decreasing costs, and managing growth are looked upon favorably.
- Personal Guarantees. This is a hot button item for many borrowers, but an important one for many lenders as it relates to acquisition financing. A personal guarantee is about having skin in the game. From a lenders perspective, if they are going to front the majority of the capital to finance an acquisition they want to ensure if times get tough the borrower is incentivized to roll up their sleeves and work through challenges in the same manner they would if it was their own money.
- Seller Financing. I strongly advise all my clients to include seller financing in every acquisition they contemplate. In addition to aligning incentives between buyer and seller, lenders appreciate seller financing as it is a strong indication that the seller is confident in the business’s performance under the buyer’s leadership. The inverse is strongly correlated as well – absence of seller financing can portend overlooked risks.
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