By / Ron Coleman
Many businesses go broke because they have a cash flow crisis. This is very different from a profit crisis. It is not unusual for businesses that are making a profit to go broke because they fail to manage their cash flow. Four out of five business failures are due to factors internal to the business. Only one out of five is due to external factors. Failure to manage your cash flow is likely to be the biggest single concern you will ever face in your business.
It is critical that you set up your financing in the correct manner. There are two main uses for money within the business. One is for operations: this is your “working capital”. Working capital is the capital required to finance your activities. It is defined as your net current assets (current assets less current liabilities). If you don’t have sufficient working capital you won’t be able to meet the payroll and will likely be forced out of business.
You also need to ensure that you have sufficient working capital to finance an expansion. It is essential to use your working capital only for operations and not for long-term use unless you have a surplus of working capital.
The second need for financing is to pay for capital assets such as buildings, equipment, vehicles, and such. These assets are going to be used (and depreciate) over a number of years, and the financing should also be repaid over a number of years. This is generally referred to as “term debt”.
Financing your business
There are many ways of financing your business. Some will depend on what stage the business is at—startup or mature? Some will depend on what the financing is for. Here are some guidelines to consider.
Shareholder loans
When you loan money to the company you can take it back tax-free when cash flow allows. You should put a charge against the company’s assets to protect your shareholder loan. Get a lawyer to register your charge.
Operating Loans under $100,000
It is often better to get a personal loan for amounts under $100,000 as the cost of borrowing is lower on personal loans and the due diligence and compliance of the lender is lower. Likewise, the on-going fees by the lender will be less. Loan the money to the company as a shareholder loan. See the previous paragraph.
Financing equipment and vehicles
Lease or buy? It depends. In addition to discussing this with the equipment or vehicle supplier look for a fleet management company. Many associations have developed relationships with them and they will provide further insight into acquiring vehicles and equipment. One advantage is that they are not tied to a particular supplier.
Operating/working capital loans
I recommended getting smaller personal loans and lending the money to the company. If you are seeking larger loans or prefer not to go with the personal loans you do have a variety of choices. The line of credit type loans tend to be the best choice as they can decrease when you have the cash available to pay them down, thus reducing the cost of borrowing.
There are three different types of institutions that you can use for borrowing.
Credit unions tend to focus more on security. Banks tend to focus more on cash flow and debt payment coverage. It may be worth discussing with one credit union and one bank to get their different perspectives. The third option for borrowing is the Business Development Bank (BDC). Their lending rates tend to be higher than the commercial banks and the credit unions, but their lending criteria are not as strict. They also tend to be easier to deal with if you get into a cash flow crisis. They are more likely to work through this with you than other lenders. Did you know that the BDC has an online application for existing businesses to obtain up to $100,000 financing? Complete the online questionnaire at www.bdc.ca
Where possible, avoid factoring of accounts receivable as this tends to be expensive. Likewise, secondary borrowers tend to be expensive and have nasty fees attached to them. If your bank and the BDC turn you down for financing maybe you should reconsider what you are doing.
Mortgages
Getting a mortgage for your building needs to be undertaken carefully
- Is there a fee for the application?
- What is the term for the mortgage?
- Should you go fixed or floating rate?
- What term are you locking in for if you go for a fixed rate?
- Can you make annual pay downs of principal and how much?
- What is the penalty for early cancellation of the mortgage?
- What is the history of the lender? Do they have a good reputation for dealing with their customers?
- Can you afford the payments?
Rental premises
When renting premises for your business you want to ensure that you understand the meaning of “triple net” and other terminology. You need to ensure that you are comfortable with all the terms of the lease, including your personal guarantees. Normally, personal guarantees can be limited to the first two or three years. Also, be aware of what rights the landlord has in the event of you defaulting on the rent. Make sure you get premises that meet your ongoing needs. Moving a business every few years can be very expensive.
Personal guarantees
Virtually all loans will require some level of personal guarantees. If you have a partner in the business are you both liable for the full debt? If one partner reneges is the other on the hook for the full loan or just part of it? Can you get the personal guarantees limited in value and time frames?
Your Plan of Action
- Take professional advice on obtaining financing.
- Always allow a cushion to cover extra needs for cash (the rainy-day fund) and with mortgages and term debts always keep two payments available for times of need.
- Make sure you understand the implications of everything you sign.
- When deciding on the business premises consider both the long-term suitability of the premises.
- Make sure you decide if you should rent or buy. ▪