Startup Funding Options

So, you want to start a business; you have this great idea for one; or, you have a product that you want to introduce to the marketplace.  But what is holding you back?  Money?  Well, there are several options for you to take advantage of.  Let’s take a look at them.

Many aspiring entrepreneurs will say that they will take the money out of their savings.  According to a recent study funded by the Ewing Marion Kauffman Foundation, nearly 70% of entrepreneurs rely o their personal savings. About a quarter of entrepreneurs rely on venture capital and “angel” or private investors (see my earlier essay on Angels vs. Venture Capitalists), while only 15% rely on friends and family. An even smaller percentage — about 7% — received funding through corporate investments. Crowdfunding is also a popular alternative. According to Fundable, a small business crowdfunding platform, crowdfunding raised $5.1 billion in capital in 2012.

There are other options other than those indicated above.  Depending upon the state you live in, you will want to reach out to an economic development agency.  There you will be able to find financing through tax-free bonds.  For example, in New York State there is the New York State Industrial Development Agency, which issues double tax-free bonds.  That is, the income earned from the bond interest exempted the purchaser from both New York State and federal income taxes.  These will offer a much lower interest rate to you from those in the market.

If you are contemplating a manufacturing-based business, you may consider leasing equipment, the supplier of the equipment will finance the purchase of the equipment.

If you are looking to purchase an existing business, the seller may be willing to fund at least a portion of the sale with a mortgage.  This is true especially in the restaurant business and other small businesses. The seller will usually stay with you in the business for about three months to make sure that everything is going smoothly for you and to introduce you to suppliers and other vendors.

Your success in this regard is to think about other financing sources and to think outside the box.

 

 

Getting to the Next Level – Purchase Order Financing

You have just received a large sales order for your designs, a great opportunity for you, and you cannot possibly fill it because your small business is low on cash or below water to purchase supplies in order to fill the order.   So what are you going to do?  Consider the hurdles:

  • Purchase the goods you will need from your suppliers, with upfront money you don’t have
  • Get the money you need from a bank, but without a long track record or history of impressive financial statements this may not work
  • Accept not receiving payment from your customer until 30 or 60 days after they received shipment, creating a cash flow gap you can’t manage.

If you turn down the order, you may lose your customer to a competitor and you will lose out on your opportunity to grow the business.  You will have to get creative.

There is a way to remedy this situation and that is through purchase order financing.   Purchase order financing (or funding) looks to the credit worthiness (and good fashion sense) of your customer.  Your creditworthiness or the fact that your business may be underwater is not an issue; your customer’s creditworthiness is.  A purchase order financing company works with your supplier or manufacturer to get your garments produced on time.  It also works with your customers to ensure payment of the invoice.

Here is how it works.  A purchase order loan is a fee-based, short term loan and there is no interest charged.  To see if the loan can be made, the purchase order lender investigates the credit history of your customer.  If the customer has a good, solid track record of paying its bills and has the cash flow to pay for the goods it has ordered, a loan can be made.  But there is some information required on your part.  You must know your costs for the product and the gross margin attributed to that product.  If you have a gross margin of 25% or more, then it is possible to execute a purchase order transaction.  This means that you will have enough room to make a meaningful profit.

If your customer has good credit, the purchase order lender delivers a letter of credit to the manufacturer that guarantees payment for the needed goods.  The factory then makes the products, and a third party verifies that the order is complete.  The factory gets paid and ships the goods off, usually to a third party warehouse.  It is rare that you would take delivery of the goods; they are usually shipped directly to the customer.po_financing_process_800

When the bill is paid, the funds go to the purchase order lender, which subtracts its fee and sends the remaining profits to you.  This fee may amount to 4%.

There may be a hitch to the receivables portion of the transaction.  If you have given the customer payment terms of 60 or 90 days, another type of specialty lender, a factor lender, comes into play to provide immediate payment to the purchase order lender. (See my post dated June 21, 2016). The factor lender buys the outstanding invoice at a discount and then waits and collects the full amount owed later, pocketing a profit in the process.  Meanwhile, the purchase order lender and you get paid immediately.  Thus, with this good news comes the bad, there is another layer of costs involved with factoring but this may be required by the purchaser order lender.

Here is what you do to start the Purchase Order Financing Process.  You provide a valid purchase order with a credit worthy customer and the expertise to  manage the process.  The purchase order lender provides payment to your supplier, allowing your goods to be produced and shipped.  Payment is typically completed through issuing letters of credit and ultimately the payment of the invoice.

Benefits to using a purchase order lender.  While you stand to get 94-97% of the profit (implies a 25% gross margin), you are getting money to help you grow your business. You can use a purchase order lender many times; there is no restriction.  The transaction does not show up on your balance sheet (off balance sheet financing) as a liability, thus working capital is not impaired by this transaction and your total debt to equity ratio is not increased.

Who, other than the fashion industry, use purchase order lending?  Importers, exporters, wholesalers, assemblers, distributors and manufacturers, who are experiencing rapid sales growth, capital constraints, sales volatility, seasonal sales spikes, high development costs, stretched credit, new product launches can take advantage of this type of financing.  Industries that can benefit are electronics, housewares, sporting goods, toys/games, furniture, food products, hardware and industrial goods.

To find a purchase order company you can look at industry information and the yellow pages.  Make sure you check references first.

 

 

 

A Lesson in Factoring

Do you have a lot of money your clients owe you in the form of accounts receivable? Do these invoices take time, like 60 days, to get paid?  Are you in need of cash to finance your next production line?  You are not a good credit and are not able to get a bank loan.  What can you do?

Factoring may be the answer.  Factoring means that you sell your accounts receivable to a factor or third party at a discount to provide funding.  It is a short term solution to your working capital problem.

account-receivable-financing

Here is how it works.  You sell your invoices to a factor at a discount and these invoices act as collateral.  You would typically receive 80% of the invoice value upfront.  You will receive the balance remaining less a factor fee once your client pays the factor.  The fee can be paid in any number of ways, but it usually nets out to be about three to five percent of the invoice value.  Factoring is not a loan and does not show up on your balance sheet.  It is the sale of an asset; therefore, you have no liability here.

To qualify for this factoring, your invoices have to be free and clear of any liens.  This means that no other company has a claim on payments when they come in.  Your customers must also be creditworthy.  Why? –  Because the factor will rely on their good credit and ability to pay the invoice quickly rather than on your credit history.

Learn how the factor deals with your clients during the collection process.  Does he send out dunning notices with an indication that the factor is to be sent the payment?  If the client does not pay your invoice, the factor may ask you to pay back the money he paid you on the invoice plus a fee – – something that is called recourse factoring.

If you decide that you want to seek out a factor, do your comparison shopping by looking at factor fees and the amount of the discount on your total invoices, a deposit or application fee, the advance rate and monthly minimums should also be considered.  Factors will not work with start-ups; you need to have a large amount of accounts receivable for the factor to work with you.  You can find factors in the telephone directory or in industry trade publications. Your banker may be able to refer you to a factor, but decide on a factor that knows your industry, can customize a service package for you, and has the financial resources you need.

What makes a Good Business Plan?

At my former job in a major investment firm, I had the responsibility of developing new business for the firm.  In that position I received about 40 business plans a week from entrepreneurs and senior managers of companies seeking financing, and I reviewed about 25 per week.  Why didn’t I read all 40 plans?  Here’s why.

The opening section of a business plan is the business description probably written in two paragraphs.  Here the writer describes his business and product and indicates what his target market is.  If after reading the opening paragraphs I do not know what his business is or what he is talking about, I reject it and move on to the next business plan.  A writer has to write his business plan in a way that is easily understood and is simply written.  If you are an engineer and cannot relate your business in simple terms, then get someone else to write it.  There is no excuse.

I also look at the sentence construction, grammar and spelling.  If there are spelling mistakes or grammatical errors, it indicates to me that the writer has exhibited a level of care which is not conducive to managing and growing a company.  He is neglectful and pays no attention to detail.  If you have a shot at having a professional investor look at your plan, then by all means make sure that you have done your research accurately, use proper grammar and your financial information is added correctly.

When I have a business plan to evaluate I look at its presentation.  Is it neat and attractively done so that it would make you want to open it up and begin reading it?  Does it indicate what the business is and what the product is, how you are going to make money and what your profit will be?  Is what you say in the first section of the plan supported by the financial information in the second section of the plan? Are your profit margins, return on investment, and return on equity comparable with similar companies in your industry?

When you are constructing your business plan, heed the above and you will be sure to generate interest in an investor to read your plan.