Archive for May, 2008
Join Me for a Business Financing Strategies Webcast
May 29th, 2008
By The XBanker
Mark your calendars! July 29, 2008 will be the debut of Sound Credit Practices For Your Business webcast sponsored by Wells Fargo. I’ll be one of the panelists bringing you advice and strategies during the program.
Along with other top experts, we will be showing small business owners how to build and keep healthy personal and business credit, best practices for cash flow management, what banks are looking for in loan applicants, and strategies for creating a long-term plan for credit and business financing stability.
Registration for the event is now open. Did I mention it’s free?
I hope you’ll join us!
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Lack of Planning – Creating A Business Plan
May 28th, 2008
By The XBanker
Beware the temptation to jump into business before you’ve done the proper planning. And don’t underestimate that temptation. Once you have made up your mind to start a business, it is difficult to wait to get going. You want to start moving, making money, living the life you’ve dreamed of. But if you want your business to succeed, you must take the time to understand it, yourself, the industry, and the market.
It helps to consider how you would approach buying a house. Would you sign a check and move in? Or would you research everything first to make sure you aren’t getting a lemon? Treat starting your own business the same way. Don’t invest your time, money, energy, and dreams in a business you don’t understand inside and out. More businesses fail for want of proper planning than do for want of money.
Business plans are perfect for taking you from ignorance to understanding. In order to produce a good business plan, you must learn all the ins and outs of your proposed business. And the process of preparing the plan will teach you much of what you need to know in order to run that business.
The main reasons people skip business plans are often the same as the reasons people avoid accounting: 1) many people don’t like to write and 2) the time it takes to prepare the plan takes away from the time to run the business. But those reasons – those excuses, really – are just as inapplicable here.
Just because you don’t like doing something doesn’t mean you don’t have to do it. Running your own business will mean sacrifices. Luxuries like vacation time, sick days, salaries – these are the first things to go out the window (at least in the beginning). Taxes must be paid, shipments must go out, decisions must be made, invoices must be sent, and bills must be paid – whether you like it or not. Same with accounting. Same with planning. And, as with accounting, you can always hire someone to prepare your business plan for you.
The second reason people often skip the business plan stage is because they want to spend the time it would take to plan their business to be in business instead. They see the planning stage as taking time with no reward. But not only is that not true, it is also supremely short-sighted. It may be true that taking time upfront to plan your business will increase the time until you can start making money. But it will also likely increase the amount of money you can make. Writing a business plan allows you to explore your business before you start. It allows you to make your mistakes on paper rather than in the real world.
Write a business plan. You’ll be better for it. It will save you hassles and make you money in the long term. A good resource is my book “The ABC’s of Writing Winning Business Plans.”
What are some of the hassles you might be saved if you take the time to prepare a business plan? How about quitting your day job only to find your great idea won’t pay the mortgage? Or resorting to credit cards to finance the business? Many businesses fail within the first five years. Of those that fail, a staggering amount do not have business plans. An old carpentry adage says, “Measure twice; cut once.” Let your business plan be your measurement.
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Not All Industries Are Created Equal
May 27th, 2008
By The XBanker
When you are applying for a small business loan or unsecured line of credit at a bank, why do they ask you about your business’ industry? Does it really matter what type of business you run? If you have a history of business success, have stellar business and personal credit, an impeccable resume, and even an outstanding team behind you, the industry you are in shouldn’t play a role in the approval decision, right?
For better or for worse, the truth is that the industry you are in will play a fundamental role in the bank’s decision on whether to lend you money.
Each bank makes their own decision on which industries they “prefer” to lend to, which ones are a little “higher risk” and those that are “restricted”. Even though every bank writes their own rules, there are some generally accepted industry guidelines you should be aware of. The intent of this post is to explore these guidelines, and why banks make these distinctions.
The most basic principle of lending is that more approvals are a direct correlation to lower perceived risk. The more you have invested in your business, the less likely you will be to give up on that dream. Banks like to see you heavily invested! If there’s a discernable chance you will give up on your business in 2 months, your chances of getting some bank to lend you money is slim to none. If the bank determines that it is likely you will give your life for your business and do whatever it takes to make it succeed, then your chances of getting money increase. But what does this have to do with industry?
All banks have identified industries that they “prefer” to lend money to. These preferred industries are perceived to be lower risk. Most of these industries are professionals like Doctors, Dentists, Accountants, Attorneys, etc; people who have earned licenses and/or have gone to school for an insane number of years in order to pursue their business. If I had just graduated from college after 8 years of studying to be a dentist, what are my chances of quitting 2 months after I open my practice? Of course it’s possible, but it’s highly unlikely. Banks employ the same mindset. Generally, professionals have so much of themselves invested in their company, (time, money, etc), that they won’t give up when they hit their first obstacle. The nature of entrepreneurship is that we will inevitably have hard times; the chances of us and others in our industry sticking it out will ultimately determine what risk category the banks place us in.
Some “high risk” industries include Consultants, Investors, Real Estate Professionals, Financial related companies, etc. What does it take to be an investor or a consultant? The answer to that is absolutely nothing. It really doesn’t require one day of schooling or one penny (in most cases) to carry around a business card that says “Consultant”. Lenders understand this and that’s why these types of industries fall into the “high-risk” bucket. This doesn’t mean that banks won’t lend money to this group, because they dish out money every day to these industries – it simply means that the underwriting guidelines will be raised a bit from the “preferred” level. Instead of requiring 2 years in business for a preferred industry, the same bank might require 3 years. Or maybe the credit requirements will be 20-50 points higher. If you find yourself in the “high-risk” category, all hope is not lost; you just need to be a little more prepared before you ask the bank for money.
Each industry category could have hundreds of different types of businesses. I’ve given you only a few examples here to illustrate that not all industries are equal in the eyes of lenders.
Tip of the Day: You need to understand which industry bucket you fall into BEFORE you ask the bank for money. The steps you will take to get prepared for your loan or unsecured line of credit will be different depending on how risky your industry is. Remember, if you are declined for financing, you are basically shutting the doors to that particular lender for about 6 months. It’s better to take a few weeks or even a few months to make sure you are ready before the door closes.
So, how risky does your industry make you look?
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7 Reasons to Open a Business Checking Account
May 26th, 2008
By The XBanker
- Suppliers. Some local suppliers require a voided business check before extending lines of credit.
- Relationships. Having opened over a dozen business checking accounts, I have found that the process is easier if I open a second or third account with the same bank. It has been my experience that setting up the first bank account with an institution takes ten times as long as successive accounts with that bank. I recommend that you open at least one account with 3-5 major banks. You never know when these relationships will come in handy.
- History. A few months ago, a conversation with a banker at a national bank included the topic of new guidelines his bank was implementing. I took special note of a two-year active checking account history requirement before a line of credit or loan would be issued to a business. It’s never too soon to open an account.
- Merchant Accounts. If you have a merchant account you will want those funds to be deposited into a business account, not your personal account.
- Forms of Payments. In addition to accepting cash and credit cards as forms of payment from your customers, you may decide to accept checks. If your customers have to write checks to you personally, you will lose credibility very quickly.
- Making Payments. In addition to accepting payments, making payments to your vendors with personal checks also looks unprofessional and diminishes your standing.
- Separation of Funds. One of the fundamental principles of business compliance is separating your personal money from your business money. Following this one principle can help you strengthen your corporate veil. The liability protection offered by a corporation is only valid if that corporation is treated like a true business. The complete separation of your business and personal funds is a crucial early step.
What Does a Personal Guarantee Mean?
May 26th, 2008
By The XBanker
Sometimes when you are close to a subject it’s easy to forget that what is obvious to you may not be so obvious to someone outside the industry.
Case in point: personal guarantees.
For most people the meaning of the term “personal guarantee” is pretty obvious – you agree to personally be responsible for the repayment of the loan. It is usually used in a business sense: a business owner who signs a personal guarantee for a business loan is agreeing to be personally responsible for the loan if the business does not repay it. The term is not usually used in the context of personal loans because when you sign the note for the loan you are implicitly providing your personal guarantee. But it’s there.
We were pretty surprised and confused, then, when Entrepreneur recently published an article that muddied the waters. In “Nothing Personal: How can you protect yourself and your assets from risk when securing a business loan?” author Rosalind Resnick replied to a reader who was asking about how to find non-recourse loans that do not require the borrower’s personal guarantee.
The first part of her answer was fine, although I may have started out by explaining the difference between non-recourse loans and personal guarantees to make sure the reader understood what those terms mean. (A non-recourse loan is typically a secured loan in which the collateral can be repossessed, but the borrower is not personally liable if he or she defaults.)
However the second part of the article was just, well, wrong. There, the author described Prosper as an example of a service that facilitates loans that “don’t require personal guarantees.” Huh? Take a look at the sample promissory note provided on the Prosper website. A borrower is most certainly agreeing to guarantee repayment personally. (You wouldn’t get too many lenders if the loans didn’t carry a personal guarantee.) And Prosper reports all loans on borrower’s personal credit reports (not just loans with late payments as the article implies). How could they report to the loans on the borrower’s personal credit if the borrower wasn’t personally guaranteeing the loan?
Here’s where it gets bizarre.
My colleague Luke Adams, who has been both a Prosper borrower and lender, pointed out the error to Entrepreneur magazine, which then contacted Prosper. In an email exchange between the editor and Prosper, the Prosper representative told Entrepreneur that the loan did not require a personal guarantee because no collateral was involved.
Again, terms that seem obvious are getting mixed up here. Whether a loan is secured (collateral) versus unsecured (no collateral) has nothing to do with a personal guarantee. While I couldn’t find a formal definition of personal guarantee on the SBA website (I guess they assume everyone knows what it means, too), I did find this reference which clearly distinguishes between personal guarantees and collateral as separate and distinct loan terms.
Don’t get me wrong. I love reading Entrepreneur magazine and I won’t cancel my subscription over this. I also think Prosper is one of the best innovations in lending I’ve seen in my 20-year career in consumer credit education. (Though my fingers are crossed that they will develop a true business loan option.)
But in the meantime, if you are looking for a business loan with no personal guarantee, make sure you’re getting the right advice.
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C Corporation Considerations
May 21st, 2008
By The XBanker
A C Corp has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corp can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits. This is not the case in a flow-through entity, such as an S Corp, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C Corp may be your entity choice.
C corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. C Corps don’t work well with businesses that want to hold appreciating assets, such as real estate, because of the tax treatment on the sale of these assets.
The most often-cited disadvantage of using a C Corp is the “double-taxation” issue. Double-taxation happens when a C Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The C Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.
There are many things you can do to avoid the double-taxation scenario. Structure the C Corp so that there are no profits left over — use all of the write-offs and deductions allowed by the IRS to reduce the C Corp’s net income. Offer great benefit plans! Pay higher salaries to yourself and the other owner/employees than you would if you were using a flow-through entity such as an S Corp. Yes, you will have to pay payroll taxes and personal income taxes on those monies, but you would pay personal taxes on dividends paid to you anyway. And it may be that in the big picture, the savings on one side outweigh the additional taxes paid on the other side.
The decision as to what entity is best for you really does, in so many cases, hinge on taxes, and that is why, with any corporate-related decision, you are wise to seek the advice and assistance of a good CPA.
Some quick things to note on C Corps:
- They can have an unlimited amount of shareholders, from anywhere in the world.
- For Nevada and Wyoming corporations, officers and directors can reside anywhere in the world;
- They can have several different classes of shares.
- They are the most widely recognized business entity in the world, and are the premier entity for going public.
In Nevada and Wyoming, nominee, or stand-in, officers and directors can be utilized, adding extra levels of privacy.
While we like and often use S Corporations, we keenly appreciate that C Corporations have their merit and place in your entity structure strategy.
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Business Credit Agencies
May 16th, 2008
By The XBanker
Business credit reporting agencies collect and sell information to help lenders and vendors evaluate potential business partners and borrowers. The top business credit reporting agencies are:
1. D&B: Dunn and Bradstreet
The “granddaddy” of business credit agencies.
2. Experian
The same company that offers personal credit reports also has a division that prepares and sells business credit reports.
3. Small Business Financial Exchange
Member owned exchange shares business loan information among members.
4. Equifax Business Solutions
Another one of the three major personal credit reporting agencies, Equifax also compiles and sells business credit reports.
There are many other specialty credit agencies as well. PayNetOnline provides leasing reports, for example, and eCredit (Cortera) offers many industry specific reports.
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The Downside to the S Corporation
May 14th, 2008
By The XBanker
A downside to S Corps is the limitation on who can be a shareholder, and what kind of shares it can issue. There can be no more than 100 shareholders in total, and no one may take their shares in anything other than their personal names (or in their living trust’s name). So, forget transferring your S Corp shares into an irrevocable trust, limited partnership or children’s trust. And, you can’t have any non-U.S. resident shareholders, either. Everyone who holds shares in an S Corp must file a U.S. resident tax return. And, you can only have one class of shares, which can be confining, especially if your plans include taking your company public or looking for outside investors. If you breach any of these requirements the IRS will strip your company of its S Corp status, and automatically turn it into a C Corporation, which may have a negative tax consequence.
Another downside is asset treatment. Both C and S Corps are not great vehicles if your business will hold appreciating assets, such as land, buildings, stocks, bonds, etc. The tax on them upon sale or upon distribution will be much greater if held in a corporation than if held in a limited liability company or a limited partnership. This is further explained in the book How to Use Limited Liability Companies & Limited Partnerships, written by Garrett Sutton and available at www.successdna.com.
The steps to create a C or S corporation are the same. Articles of Incorporation are prepared and filed, Bylaws are prepared, directors are elected by the shareholders, officers are elected by the directors, and shares are issued to the shareholders. This may sound difficult but we will be there to guide you through it all.
The S Corp Declaration, the IRS Form 2553, should be filed within 75 days of the incorporation date, so don’t delay if this is how you see your company proceeding. If you don’t file within that 75 day period, the IRS can deny you S Corp status for a full year, meaning that your first year of operations will be conducted at C Corporation tax rates.
The shareholders, directors and officers of the company must remember to follow corporate formalities. They must treat the corporation as a separate and independent legal entity, which includes holding regularly scheduled meetings, conducting banking through a separate corporate bank account, filing a separate corporate tax return, signing all documents related to the business in their official capacity and filing corporate papers with the state on a timely basis. If these steps are not followed, a business creditor may be allowed to “pierce the corporate veil” and seek personal liability against the officers, directors and shareholders. Adhering to corporate formalities is not at all difficult or particularly time consuming. In fact, if you have our affiliate handle the corporate filings and preparation of annual minutes and direct your accountant to prepare the corporate tax return, you should spend no extra time at it with only a very slight increase in cost. The point is that if you spend the extra money to form a corporation in order to gain limited liability it makes sense to spend the extra, and minimal, time and money to insure that protection.
And remember, while there are some downsides to the S corporation there are some significant benefits as well. Work with your advisor to see if the S corporation is right for you.
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Credit building loophole…or sinkhole?
May 14th, 2008
By The XBanker
An entrepreneur invents a “creative” credit building strategy: will it work?
A business owner asks us: “I want to build business credit. My idea is to set up two companies, have one lend money to the other, and build credit that way. Will it work?”
Our answer:
The short answer — don’t do it.
The long answer — it’s not as easy as it sounds.
First, you will have to report the loan to Experian and/or D&B. This is not as simple as calling them and telling them you have an account you want to report. Your company will have to be approved to report, and that means going through an application and review process first. If the company that wants to report is new, it will have to establish its own business credit before it can report. You may also have to undergo a site visit, and/or reference checks. Generally, a company must have at least 500 customer files before it can report to Experian, and D&B will require a smaller company to become a subscriber before it can report.
Secondly, one loan will not make that much of a difference. Each reference helps, but a single one will not make or break your credit history. You will still need to establish additional references.
Third, the credit agencies will request information on the principal of each business. If you are the owner or co-owner of both, that information will be cross referenced.
And that leads to the big problem here: This whole arrangement can easily be considered fraudulent. Loan fraud has been a huge problem lately and lenders are being especially careful. If the credit agencies don’t flag this one as risky, a lender may catch it.
If you think building business credit is tough now, jut wait until your file has been flagged as “high risk” by the commercial credit agencies.
There are easier, more legitimate ways to build business credit. Give them a try first.
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Accounts Receivable Financing
May 13th, 2008
By The XBanker
Accounts Receivable (“AR”) Financing is often confused with Accounts Receivable Factoring. Contrary to what some are professing on the web, these are two very different financing options. If you need a review of Factoring, read my post: How Factoring Can Benefit Your Business.
Accounts Receivable Financing consists of only 2 parties: the business owner and the lender (remember: AR Factoring involves 3). An “accounts receivable” is money that is owed to the business. Most businesses will have multiple accounts that are being paid on at any given time. An invoice is the usual method provided to advise customers of the amount they owe a company. All such AR invoices issued to customers are shown as an asset on the business balance sheet. The more assets you have, the less risky you are in the eyes of lenders: Banks love assets.
Not all assets are created equally though. Some assets depreciate (decrease in value) and some appreciate (increase in value). Some can be converted into cash rather quickly and others take a long time to become liquid. Accounts Receivables are usually viewed as good assets because most translate into cash relatively fast; typically in 90 days or less.
When a bank issues a loan to your company, secured by your AR, they don’t pick a certain number of your invoices and stake their claim on those specific ones. They are interested in the performance of your entire portfolio, the change in volume over the past few months and your collections history. If you can document, using your financial statements, that you have $XX,XXX as AR and your customers typically pay on time, you might be able to secure a bank loan or line of credit for 50% to 80% of “X.”
Again, this is different than factoring because you are still responsible for collecting on the invoices. It’s business as usual for you; now you just have a little working capital to go with it.
Read More »Take the SQ.
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Business Credit Success
Don’t you want to figure out how to build business credit? Business Credit Success can get you on the right track to getting the credit you want. How to build business credit -»
Incorporating a Small Business
Never underestimate the importance of having the right business structure when it comes to securing business financing. XBanker can help you avoid costly mistakes. Incorporate the right way -»
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