How to Secure Funding For Your Business: Six Principles for Financing Growth

Six Principles

Need some money to finance your ambitious growth plans? Before approaching the capital markets, says Vistage speaker Gordon Tunstall, make sure you know the ground rules for success.

1. Match your financing needs with the correct financing product.

   When most entrepreneurs think about financing, they immediately go to bankers or venture capitalists. But in today’s capital markets, those represent only two in a wide variety of lending alternatives. To sustain your company’s growth, get the right financing product(s) for your specific capital needs.

   “For example,” says Tunstall, “if you go to a bank or commercial lender when your capital needs require mezzanine financing, you won’t get the loan because you won’t have the collateral to support it. If you borrow from a venture capitalist when you could have used mezzanine financing, you’ll probably give away far more of your company than is necessary. Most entrepreneurs do a great job of buying the products, services and raw materials needed to run their operating companies. But they don’t do such a good job when it comes to purchasing capital investment products.”

   In order to pick the financing products that meet your capital needs:

   • Do the research.Take the time to learn about the many different types of financing available in today’s capital markets. Identify the type of lender that fits your industry, your type of company and your financing needs, and focus your efforts in that area.
   • Get crystal clear about your financing needs. Talk with your CFO, your accounting firm, your attorney and anyone else who plays a key role in planning the growth of your business. Make sure you know the exact framework of your financing needs before approaching the capital markets.
   • Get professional help. Raising growth capital could be the most important decision you ever make in your company. The money spent to hire an experienced professional who can help craft your business plan and find the right type of financing will pay for itself many times over. If you insist on doing the plan yourself, at least have an outside party review and challenge your assumptions. “The key to successful financing,” advises Tunstall, “is to select your financing products with the same care and precision that you hire employees or buy raw materials for your operating business.”

2. Minimize risk Entrepreneurs often think they have to bet the farm in order to obtain financing. On the contrary, says Tunstall, financing your growth should involve less risk, not more.

   “Before signing any financing agreement,” he advises, “ask this question: am I taking more risk to finance this growth than before I decided to grow the company? If the answer is yes, don’t sign the paper. Rapid growth carries enough risk on its own without adding to it through the wrong kind of financing. The faster you want to grow, the less risk you should take.”

   To minimize risk:

   • Look for lenders willing to structure flexible agreements. Avoid agreements filled with restrictive covenants and warrants.
   • Build in a cushion in case things go wrong.
   • Don’t take out a second lien on your house, give any kind of personal guarantee or give up control of your company.
   • Never give away opportunities to protect yourself.

3. Adjust your lending agreement for actual performance. When you present your business plan to lending institutions, they will automatically discount it. Why? Because they have no assurance that you will achieve all the goals in your plan. Accordingly, they will discount your performance projections and take more compensation in the form of fees or equity.

   According to Tunstall, you can’t do much about this discounting because lenders must have some way to protect themselves. What you can do is negotiate a clause that adjusts the terms should you hit all your objectives in the agreement.

   “When lenders discount your business plan, don’t argue,” says Tunstall. “Simply accept it as part of the process and get the best deal you can. However, don’t hesitate to ask for a clause that will adjust the terms back to what they would have been had the lender believed in your plan in the first place. Most lenders will agree to something like this. If not, you have the wrong lender for your capital needs.”

4. Conduct a very broad search of lending institutions.

   When looking for growth capital, don’t limit your search to a handful of institutions. Doing so takes too long, limits your options and fails to build competition for your business. Instead, start with about 100 lenders and work your way down to a final “short list.” In particular, look for lenders who specialize in your industry, size and type of company. If you run a carpet company, for example, don’t approach lenders who specialize in high-tech medical device firms. Once you have a small group of finalists, deliver your business plan to all of them at the same time.

   “There are a lot of lenders out there, and they all have different ways of analyzing and structuring deals,” Tunstall points out. “The more you approach, the better the odds of finding one who fits your specific financing needs. By creating competition among several lenders, you greatly increase the chances of getting the best deal for your company.”

5. Never give up control.

   Many financing transactions require you to give up some equity in exchange for the money. Some equity is okay, says Tunstall, but if you have to give up control to grow your company, don’t do the deal.

   “I’ve seen far too many entrepreneurs give up more than 50 percent of their company and then get thrown out or bogged down by people who don’t accept their ideas for growth,” he cautions. “If you have to give up control, don’t grow!

   “The best way to avoid giving up control is to create competition for your transaction. Put together a business plan that describes everything you will do in the next five years. Make it clear and compelling so that lenders can understand it, react to it in a short period of time and make a proposal to you. Never include a term sheet because lenders will take it and work backward from there. Instead, send out your plan and let the lenders propose their best deal.”

6. Write a world-class business plan.

   Your business plan’s quality and credibility has a huge impact on the quantity and quality of the financing you get. In order to get the most money and the best possible deal, create a business plan that lenders can’t resist.

   A well-documented business plan contains narrative description as well as hard numbers. The key is making sure that one supports the other. Tunstall believes that every line item should have some narrative that describes the assumptions behind the numbers. However, the narrative must be credible or the lender won’t buy your plan.

   “For example,” he says, “suppose your business plan projects a three-percent increase in gross profit margin and your explanation for the increase says ‘We will have less scrap.’ No lender will buy that explanation because you can’t prove it. To build credibility, you need to say something like, ‘We have signed a contract to have X part made by Y company, who will guarantee us a lower price.’ Now you have a valid reason why gross margins will go up three percent.”

   Above all, cautions Tunstall, don’t make the mistake of thinking a two-page summary will capture the attention of lenders. Most financial institutions won’t even look at that kind of plan because they know it has no substance. It takes more than a few pages to provide the raw data to support your projections and conclusions. Without that data, your plan has no credibility whatsoever.

   “Plan your growth based on your potential, not on your current capital position,” adds Tunstall. “Most companies prioritize the needs of the company based on their existing capital, which is wrong. Instead, project the company to grow to its full potential and strive to get the best financing with the least risk, the least dilution and fairest transaction terms.

   “Also, make sure you like the people you will work with because you will have to deal with them for the life of the agreement. You may have a great transaction, but if you aren’t comfortable with the people, pay a little more and get somebody you like.”

How to Find the Right Lender

How to find the right lender for you? Tunstall recommends the Internet as a quick and reliable way to conduct research. Simply log on to your favorite search engine and search under key words like:

• Financing
• Venture capitalists
• High growth
• SBIC
• Mezzanine financing

One relatively new category of lender is Small Business Investment Corporations (SBICs). According to Tunstall, SBICs involve lending programs that are funded by the federal government but implemented by entrepreneurs at the local level. Here’s how it works.

A group of former entrepreneurs get together to form an investment fund. They raise a certain amount of money to invest in mezzanine transactions for high-growth companies and apply for an SBIC license. If the government approves the license, the Small Business Administration lends the SBIC (at low interest rates) up to three and a half times the amount they raised in the local community. The restrictions are that the SBIC can invest only in companies with less than $50 million in annual sales and 500 employees. Plus, the company borrowing the money has to show written verification that their bank turned down their request for growth capital.

Currently, more than 200 SBICs are scattered throughout the U.S. To find out about SBICs in your local area, consult the telephone directory under “U.S. Government,” call the Small Business Answer Desk at 1-800-8ASK-SBA, or search the Internet under “SBIC.”

Another option for finding lenders involves hiring a broker. Firms like Tunstall’s offer a complete package of services that help you craft the business plan, broker the plan to a variety of lenders, select the best deal and negotiate the terms of the deal.

For those new to the ways of today’s sophisticated financial markets, the investment required to hire a broker or consulting firm can pay huge dividends over the long term.

If you decide to use a broker, advises Tunstall, keep the following in mind:

• For negotiating the deal, most brokers will want the option to obtain a certain amount of equity in your company at the same price the lender pays for it. Be aware that the price your broker negotiates for your equity may be affected by his interest in obtaining it.
• Most brokers will also want you to include a term sheet with your business plan. Don’t let them talk you into it. If the broker insists, find another broker.
• Ask your broker whether he is receiving a finder’s fee from the lending institution. If so, it doesn’t necessarily mean you shouldn’t do the deal, but you need to know who is getting paid for what.

“Finding lenders is easy,” insists Tunstall. “The hard part is identifying the one that’s right for you. Look for someone who has done deals in your industry and with your type of company. Check references carefully.

Get to know the people who will play a large role in the future of your company. Whether you do it on your own or use a broker or consulting firm, invest the time and energy to do it right.”