Sunday, March 13, 2005

The World According to - When the bank says no

All in all........a pretty decent article, but it falls short in a few areas:

1. Discussing the practicalities and realities of the suggestions offered

  • Many times businesses put off dealing with a cash flow crunch until the last minute and I mean literally like a day before they need to come up with some money. No where in the article does it mention the time required to put one of these strategies into place.
  • The cost associated with these transactions. For many companies that are negotiating their first real commercial/corporate finance transaction, they are surprised by the commitment and due diligence fees charged by the lenders once they have issued a letter of interest. The article also does not disclose the approximate costs of hiring a financial advisor and the cost of papering an acquisition.

2. It does not use specific definitions:

  • What definition does Mr McElgunn use for "a growing company in solid financial shape" As someone who is active in financing smaller business, I see many company owners who would describe their businesses in those term only to see that while the company's revenue is growing, the company is not cash flow positive, but they do have good assets.
  • Most "non-start up" business owners see their business as "a growing company in solid financial shape", but as with the rest of life, it is all a matter of perspective. I have yet to speak with someone who thinks their business is garbage.
  • Also, what amount of revenue and/or profit must a company be generating to take advantage of these strategies. Many of the lenders mentioned in the article, such as the asset based lenders, will not look at deals under $5,000,000. In order to secure a $5,000,000 working capital facility, a company has to be doing at least $20,000,000 a year in revenue.

3. The article doesn't really give an outline of the criteria by which the lenders in the article make lending decisions:

  • Deal Size: Already touched on that topic above. From a lender's point of view, it almost the same amount of effort goes in to a $1,000,000 as a $10,000,000 so all things being equal, lenders will gravitate towards the larger deals. As a financier of small business transactions, the time involved with many small transaction is huge. Something that should take 2 days ends up taking 2 weeks and for most lenders, they just don't see the return on their time for the small deals.
  • Most asset based lenders will not lend against inventory alone. They will usually want to have a first position on the receivables as well.
  • In practice, most other lenders, especially sub-debt lenders like to see positive cash flow from operation. Also, depending on the size of the sub debt loan, it will cost a company upwards of 17 to 25% a year.
  • Most vendor take back notes are actually mis-priced, as per this excerpt from VanCity's Newsletter (which is also on my blog):
    Vendor financing typically commands little or no interest and has a fully subordinated claim on both the cash flow and assets of the business. As an asset class it consistently defies the typical relationship between risk and expected return in that the vendor essentially faces an equity risk level and generates at best a return (0% to 8% interest) commensurate with a fully secured debt position.Additionally, it makes little sense from the vendor's personal portfolio perspective. Often when a business is sold it is because the vendor seeks to retire. In retirement one typically wants to hold an investment portfolio that is relatively low risk, liquid and diversified. A sizable vendor note meets none of these objectives as it is a high risk, illiquid investment in a single private company that the vendor no longer controls

I think that readers of the article would be better served if they new the specific characteristics of the company that this advice was best suited for. Based on professional experience, if a company is doing under $3,000,000 a year in sales, almost all of the strategies are out of reach for them. That is not to say that these businesses are hopeless, it is just to say that going out and buying another business isn't really an option. I think that the topic of dealing with cash flow crunches and non-VC growth financing for businesses doing between $250,000 and $3,000,000 a year in revenue (and there are thousands of them.....this is Canada after all) is not adequately addressed in the Canadian business literature.


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