Financial Ignorance Is Not Bliss

The United States represents the capitalist system of free market economics. Yet many Americans do not understand how business, let alone capitalism, actually operates. In no area of commercial activity is this lack of knowledge more evident -- and the need for information more critical -- than business finance, which is the process by which a company obtains sufficient money to assure the successful creation of products, services, profits and jobs.

While much of the blame for this can be placed on deficient education concerning business fundamentals, even that does not explain the narrow ideas held by many financial professionals -- bankers, loan officers, receivable lenders, equipment and real estate financiers. Many of these "experts" concern themselves with their own areas of expertise. They ignore or even denigrate alternative money solutions. This confined approach may result from a profit motive, since lenders naturally want to make money by promoting their own methods. However, the entrepreneur in need of cash should know as much as possible about forms of financing.

A Host of Funding Variables

To have any chance of success, a business owner must master a host of financing techniques. These methods include the customary commercial practices of his or her industry; distinctive methods of borrowing and payment; credit; collateral; management and internal fiscal policies.

Obviously, lenders and investors are major sources of initial or expansion business capital. When considering any business, these pragmatic people look for one thing -- value, meaning total assets minus liabilities. Oddly enough, what some lenders consider valuable, others think is worthless. For example, projected earnings, past profits and management skills mean little to a traditional bank loan officer, who will insist on seeing a multi-year cash flow "track record" before even considering a loan. On the other hand, venture capital investors usually appreciate the value of so-called business "intangibles" such as innovative products, skilled management or accumulated experience and success in an established business.

There was a time when American bankers freely accepted and granted business applications for a variety of loans that kept the wheels of commerce turning. Still today, the majority of business loan dollars come from traditional banks. But as we have seen, the "good old days" of bankers' easy money are unlikely to return.

In those days it was possible for a business to obtain inventory loans of a six- or nine-month duration, based on inventory availability, with installment payments made as inventory was sold.

Banks were willing to make accounts receivable loans, based on the standing of business customers, a history of on-time collections and good credit ratings. While similar transactions are at the heart of the factoring business, traditional banks won't touch such loans today.

Once banks would even make fixed amount time loans to good business customers, with an agreed amount payable at the expiration of a set time period. While the lump sum payment was a drawback, not having interim installment payments was a positive advantage. Try to obtain one of these loans today and a banker will look stunned just because you asked.

The most prevalent form of bank loan extended to business used to be the line of credit, a revolving maximum dollar amount to be used as the borrower saw fit, with regular installment payments based on the outstanding balance. This kept interest payments lower and gave the business always-available funding. In the murky wake of the savings and loan scandals, new banking regulations make the line of credit an oddity from the past, for all but the best "blue chip" companies.

We have conducted this brief historic tour of past bank loan policies so younger readers will know what they missed. Older readers so inclined can shed a tear for nostalgia's sake.

Assess Your Assets

To formulate a business plan that will successfully attract financial support today, you must compile a solid inventory of assets and liabilities which demonstrate a true net asset value and these numbers must be verifiable and thoroughly convincing to a prospective lender. Oddly, many business owners fail to fully evaluate all their assets -- one of the important ones being accounts receivable, a point we will explore more fully later.

One very significant lesson a capital-seeking business person must learn is the proper matching of assets with lenders who can appreciate those assets. A rural bank specializing in seasonal agricultural crop loans may not know the first thing about financing wildcat oil well exploration, so don't bother trying to fund your offshore drilling project there.

The next step is to understand whether a prospective lender or investor will see your assets as secured or unsecured. Real estate lenders, usually banks or savings and loans, will only make secured loans; tangible real property gives them the collateral they want, and that security gives the borrower the cash he needs.

There are also unsecured sources of finance, backed by intangibles like patents, trademarks, new processes and products, or exciting, potentially profitable ideas and management. Here's where venture capital investors will be interested.

A business that formally incorporates can sell shares of stock as a means of finance, although incorporation means more lawyers, accountants and usually imposes strict compliance with federal and state laws and regulations that can be onerous and costly.

Then there are life insurance companies and pension funds looking for good investments, foreign investors, even public financing from federal and state direct lending and loan guarantee agencies. You might consider forming a limited or general business partnership, although that arrangement guarantees shared management with possible problems, especially when one partner puts up much of the capital. Or you may sell property and lease it back for extended periods as a means to raise cash.

One form of business finance often overlooked by those unfamiliar with the spectrum of lending possibilities is factoring -- the process of selling your company's accounts receivable for cash. Factors (the funding source)can be especially helpful to new businesses just starting up, or to an existing company in a cash bind for operating or expansion funding. Factors are unique because their willingness to provide funds is based not so much on the status of the client company, but rather on the economic strength of the customers who owe money to that company.

In the following pages we will discuss various forms of currently available business finance, the pros and cons of each -- all with a constant eye on helping you find the best commercial financing suited to your business and your unique individual needs.