The following article was recently published by MONITOR, a leading publication serving the Leasing and Financial Services Industry. The article appeared in their “Specialty Lending” supplement.

The Small Business Funding Dilemma - A Big Problem

As the economy slowly begins to grind back into top gear, not everyone is ecstatic with their growth opportunities.

There is no doubt that the long awaited upturn is now here and gathering momentum on a day-to-day basis. However, even with this positive economic news, there continues to be daily media stories of downsizing, layoffs, and business failures.

Has the upturn come too late for some companies, or are there other components that add to the dismal news? There is no easy answer to the question – every company has their own reason for the action they are taking. As a generalization, big business has, in many cases, become too big and too fat. Now it’s time to slim down to a more manageable and economic model.

The current economic upturn isn’t going to effect that situation.

It’s not always size that causes these downsizing rituals - often the cause is rooted in globalization. The day of the multifaceted, multinational conglomerate is upon us. As these giants of industry and commerce are created, they drive their destiny with the elimination of jobs due to duplication and the need to be evermore cost efficient.

In many cases this race to be the biggest in a particular industry may be commendable from a stockholder’s point of view, and even for many of the employees of the global entity. There is, however, often a considerable side effect not generally seen by most people when we are talking globalization of financial institutions.

If we could turn the clock back just 10 years, we would find most towns hosting a range of financial institutions to take care of the needs of both consumers and business.

Looking at the same situation today, we see that many such institutions have gone by the wayside - some through bad management and undercapitalization. But many have disappeared in the globalization movement. In the banking world, there has been a critical shift in emphasis as far as localized service is concerned. While this, in itself, does not pose a problem to most levels of industry (as they have also been a part of regionalization) it has left one sector of the business world in a less than favourable position.

Small business in North America continues to be a major force in the economy. It is estimated that some one million new companies are formed annually in North America. This represents one million jobs that didn’t exist before, and if all of these new businesses, on average, only employ two or three employees in their first year of operation, then we have a very substantial number of new jobs being created.

As larger corporations continue to downsize or right-size, they achieve their perceived optimum level by cutting jobs. Few, if any, major corporations today are creating new jobs that represent a net gain of employees for that entity. It is clear, therefore, that with several million jobs being created annually at the small business and start-up level, that is where the real growth in the economy lies.

When a major corporation is seeking new or additional financing for their operations, they have a variety of options open to them. In many cases, a well written business plan and a call to their existing bank is all that is required. The luxury of this approach is seldom a realistic approach for the nation’s small business group.

The single fact that, over the past few years, we have seen the marketplace has narrowed considerably. A small business seeking financial assistance has far fewer local choices available today. Mergers and acquisitions within the banking arena has resulted in numerous communities losing their independent decision-making banker - replaced with what is effectively a representative of the regional office whose job is to act only as a conduit of information. This results in a complete loss of personal contact between the bank and the small business customer.

This identity crises is further compounded with the advent of credit scoring. No longer does a ‘bank manager’ look at their small business customer’s needs and gain an understanding of the business and its potential within the community. Today, everything is reduced to numbers. If your score meets the required number, the loan is granted. If not, the door is closed.

How does a small busness reach their next growth plateau if the bank's door is closed? Small business takes on many different forms. For example, some banks consider a loan of $5 million to be small business, while others focus on half a million dollars. Neither of these numbers really reflects the needs of today’s small business person.

A “small business” has typically been in business anywhere from six months to three years. The likelihood that they have reached a solid, profitable footing is remote. Their annual sales volume will probably be in the range of $350,000 to perhaps $3 million at best. They function with the smallest labour force appropriate and the headcount is unlikely to exceed 10-12 persons. The common element that binds all of these businesses is that they are very entrepreneurial in nature, and they are all undercapitalized and overtrading. These latter two traits certainly will not endear them to any conventional lender.

When conventional lending is not an option, “small business” must turn to the secondary marketplace. This non-bank financing arena embraces a variety of options.

A small business that has some ‘hard assets’ might be in a position to raise additional working capital through the use of such assets. If the business is fortunate enough to own real estate (maybe their own building) and assuming that these are unencumbered, a mortgage with a reasonable amortization period might prove a viable approach. Similarly, if the business owns equipment that is, once again, free and clear of liens and charges, perhaps a sale and leaseback facility might prove appropriate. In both cases, the lender will expect the small business to be able to demonstrate that they have sufficient cash flow on a regular monthly basis to comfortably service the debt they have incurred.

The majority of small businesses think that because their business is unique and has a tremendous future people will be lined up, ready to invest in their company. They see Venture Capitalists as a group of hungry entrepreneurs just waiting to buy into their opportunity. Nothing could probably be further from the truth. Venture Capitalists certainly provide a financing alternative, but the likelihood of a small business fitting the VC profile is quite remote.

The search for VC can be, and often is, very time consuming and complex. Then if VC becomes available most small business entrepreneurs are very reluctant to live with the terms and conditions imposed by the VC investor. “Venture Capital” in its simplest forms is probably where the small business owner has already been. The business owner has invariably tapped into family and friends - that is probably how the business got started.

Going public and the creation of an Initial Public Offering are not options for the vast majority of small businesses. The track record, earnings record, and proven ability to succeed are not yet entrenched in a small business.

Small businesses invariably have assets in one form or another. We have addressed land, building and equipment, and that leaves accounts receivable. Next to cash, accounts receivable represent a company’s prime asset and, as such, it can be used to finance company expansion. Accounts receivable financing can fall into several different formats, some of which will be available to small and growing companies.

The established, and probably most widely known, form of accounts receivable financing is factoring. This type of financing allows the company to use its accounts receivable base as collateral for a loan while at the same time having the factor perform valuable accounts receivable management work. This latter facility is often a much-needed service for small business where growth has taken precedence over such necessities as proper credit management. This type of financing also provides flexibility for small business inasmuch as the facility is usually geared to expand as the business expands.

Factoring works for many growth oriented companies, however, it may not be available to companies with either low sales volumes or only two or three months of business activity. In this case, invoice discounting may prove a more viable solution.

With invoice discounting, the small business is not normally subject to sales quotas; and has the opportunity to “pick and choose” which invoices they will discount and turn into immediate cash. Invoice discounting literally puts the sales of a small business on a cash-on-delivery basis, a mechanism that can accelerate growth for almost any company.

Where does small business go when conventional funders close the door? Clearly the options are very limited. It seems quite ironic that when small business is the creator of jobs and opportunities, they as a group are the least serviced when it comes to securing capital that can help them grow and create even more jobs.

Is there a light at the end of the small business financing tunnel? The answer is yes. However, it requires the entrepreneur to turn their attention to finding a facility that meets their needs and matches their circumstances. Small business must become more proficient at forward planning. So many companies believe that they will be the next Microsoft, but virtually none of them actually plan how to be the next Microsoft.

David T. Banfield
President of The Interface Financial Group
Providing working capital for small business.
1-800-387-0860
ifg@interfacefinancial.com
www.interfacefinancial.com