At least 50% of new U.S. companies fail in their first five years. Five years of sweat, money, and hope vanishes for at least 1 out of 2 business start-ups and thereafter a similar amount fail in the following years. Odds are stacked against the entrepreneurs. Clearly each failure may happen for a specific reason, but often multiple. Maybe the entrepreneur was doomed to fail, without the talent for the job. They run out of money with no access to working capital, the market changes, supply chains fail, or unforeseen regulation changes impact profitability. Talent, Organization (Structure) and access to Capital, managed holistically through business cycles give a business owner the highest chances of success.
Capital Structure (*Stack) is how a firm finances its overall operations and growth by using different sources of funds. It includes equity, debt and hybrid equity/debt. Awareness of the value, upside and downside each type of funding source brings to a business, an investor or lender is vitally important. Many business owners elect to grow their business using debt, preferring not to dilute equity ownership. If the dilution of equity is accretive earnings per share is the real benchmark. You have to consider the reasons to use equity and the reasons to use debt, balancing both in order to reach your goals with the company’s overall capital structure. The conundrum is how to access debt and or equity and determining how it should be layered into your capital stack. A strong capital structure enables organizations to be effective, nimble and powerful. Capital structure should be managed based on the business circumstances, its cash flow, strategic direction, short-term liquidity needs, dry powder consideration and longer-term capital. Capital with liquidity fuels businesses allowing them to operate optimally, to act prudentially, to be patient when necessary and to seize opportunities as they arise, for growth. Whether it’s a hedge fund or grocery store a lack of appropriate funding has a predictable outcome. No business can thrive without proper capital and planning for funding to match their business plans.
*Capital Stack. A description of the totality of capital invested in a project, including pure debt, hybrid debt, and equity. The stack is described as containing the most risk at the top, traveling down the stack to the position with the least risk. Higher positions in the stack expect higher returns for their capital because of the higher risk. Lenders and equity stakeholders are highly sensitive to their position in the stack. Typically, the stack is arranged as follows.
- Sponsor equity
- Preferred equity
- Mezzanine investors (hybrid debt and equity)
- Second and other junior mortgages
- Investment-grade first mortgages
In many ways money supply to smaller business and startups has failed through traditional banking sources. Rigid underwriting makes it difficult to obtain working capital and as high as 80% of loan requests are refused. Tighter Bank regulation, implemented in response to the subprime mortgage crisis impaired and changed the flow of money, making it increasingly more difficult for smaller businesses to access. Ironically implemented to prevent tax payers bailing out too big to fail Banks, strict capital adequacy and liquidity rules have made it increasingly harder for banks to operate having to set aside more capital impacting ROI.
Regional and Community Banks traditionally with strong ties to local businesses have been harshly impacted in many cases struggling and often consolidating to survive. The large Banks have grown in size since the credit crisis. Controlling supply to protect their interests, Banks and lenders removed huge sums of credit (over $2.7 Trillion) in outstanding credit lines by the end of 2011, (most typically from high credit worthy companies and individuals) to aid their balance sheet strength, cost of capital and shareholder value. Big Bank profits are again on the rise. The trickle down effect of money supply the Federal Reserve and Government desired for small businesses (who help drive the US economy and create private employment) still has not really materialized.
Difficulty Attaining Conventional Capital
Traditional Bank lending is certainly viable for smaller businesses and an important option to have. Being Bank fundable is a sign your business is healthy or at the very least the risk associated with a loan is low for the Bank. Business collateral, a blanket lien, personal guarantee, recourse, covenants all protect and secure the Banks investment. At the same time they diminish leverage and operating flexibility for the business owner. It is important to assess what a business owner relinquishes in any Loan or Capital deal and how it may effect future funding.
Paradoxically, all too often a good business with strong healthy indicators, cash flow, collateral, character, capacity and credit may be refused a Bank loan. The Bank may have reached its lending limit for your industry type and have no capacity. They may just not like the sector risk of your service industry, or dislike retail businesses in a particular region. Their expertise may not match your business so they don’t feel comfortable with the underwriting. The knowledge and underwriting expertise required for assessing commercial real estate development financing is very different to that needed for lending working capital to a medical practice or lease arrangement with a vendor. The LTVs or ARVs you need to make a deal work might not work for the Banks underwriter. A cash-out commercial loan product may have usage restrictions. A manufacturer or a construction supplier business may not be a fit for their risk book. The lender may not be interested in fix and flip, single family projects, or permanent financing of a multi family development in a certain zip code. Speed may be necessary to take advantage of an opportunity and they simply cannot move quickly enough to fund.
There are a myriad of reasons Banks on average only approve 1 in 5 small business loans. As you might expect many clients of Lavan Financial Group come through Bank referrals. Unable to structure an internal loan, a conscientious Bank officer will seek another solution and often refer to Lavan Financial Group. Objectively they retain the checking and depository accounts of a satisfied business client with balance increases as Lavan Financial Group fund the business and incremental increases occur as the capital helps drive company growth and profitability. They help Loan Officers, Relationship Managers and Officers from work out departments of Banks, CPAs and Attorneys. Many professionals service providers, Commercial Real estate brokers become strong referral partners gaining benefits from delivery of capital solutions to business clients.
Fintech Attempt At Funding Solutions
Knowing smaller business owners are disadvantaged with limited options available beyond the traditional bank lending markets several Fintech companies have developed online market exchanges. Setup to provide a solution to small business owners by matching loan demand to lenders or private investors. They tend to be limited and narrow in their product focus, expensive and advance only smaller sums. Typically, service is not credibly consultative or personalized, certainly not relationship driven, they operate a transaction model. A no, or yes to funding, but will not take the time, or have the expertise to advise how to improve the fundability of a business. They do not have the knowledge and or goal to help with an action plan so a business owner may have access to capital through all business cycles and future financing demands.
Let Us Meet Your Commercial Finance Needs
At Lavan Financial Group, we are eager to earn your business and are confident that you will benefit from letting us assist you. Please contact us today to find out more about our various financial programs and to set up your free, no-obligation consultation with one of our financial professionals.