Experian’s research showed that because of deteriorating equity, high mortgage payments and limited refinancing options, business owners chose to ensure the business’ survival, preserving their source of income at the risk of losing their home. That’s the bad news.

Here’s the good news:

Business owners were less likely to experience a 90+ day delinquency on their mortgage than other consumers. In fact, by April 2008, the average home owner was 1.5 times more likely to experience severe mortgage delinquency than the average business owner

Additionally, Experian’s study found that small-business owners are relying on commercial lending options more often than personal financing options, to support their businesses. We think that’s smart business and it may very well allow the business owner to keep their business even if they have to start over personally.

But of course, the downside is that business owners’ personal credit can impact their business financing. Experian, which sells a credit score that blends the business owner’s credit with the credit of the business, points out that consumer scores work great for assessing consumer risk, but their blended score performs nearly twice as well as a consumer score for assessing business risk.

Incorporating can literally save your business.

I doubt many sole proprietors realize that filing for personal bankruptcy (due to medical debts, divorce or many of the other reasons people file) could mean the end of their business.

I didn’t.

But in a recent post on the Bankruptcy Law Network, California bankruptcy attorney Cathy Moran describes a recent case in which a couple who owned a business as a sole proprietorship were in danger of losing it – even though it was doing just fine – because they had to file for personal bankruptcy due to real estate investment debts.

She points out that:

…(the) business was a sole proprietorship. If we filed Chapter 7 now, Chapter 7 trustee’s first reaction to a going business is to shut it down. The trustee is concerned about his liability for regular business debts the operation may incur and the possibility that a customer may be hurt on the premises. The trustee wants to preserve the status quo by shutting the doors, even if there is nothing in the business that he can sell for the benefit of creditors.”

In this case, she was able to incorporate the business to save it.

But as another California bankruptcy attorney Douglas Jacobs points out in another post, waiting until you are contemplating bankruptcy to incorporate your business is risky business. It can be considered a “fraudulent conveyance” and can backfire.

If you haven’t been convinced yet that you need to incorporate, what else can I do to convince you that you need to check it out? It may literally save your business.

Last week, I asked an entrepreneur about his loan readiness and he told me his credit was in the toilet. So I turned to his partner, “My credit is even worse,” was his reply. I guess when it came to selecting partners, this criteria slipped their minds – don’t make the same mistake. Unless a partner brings irreplaceable technical expertise, they can always be replaced with someone that brings skills and credit to the table.

If you’re an entrepreneur with poor personal credit, you should consider bringing on a credit investor or partner. Ideally, you’ll need someone with 700+ FICO scores and good ratios (feel free to ask one of our consultants to do an analysis of a potential partner before you tie the knot). You may have better luck finding an investor or partner with good credit, than finding one with cash.

Credit investing is investing – rather than risking savings, they are risking their credit and guaranteeing the businesses debt (one could argue that this is an even greater commitment than cash). Keep in mind that this type of investor is bearing the financial risk for your business and should have a commiserate equity stake for that risk.

Business credit cards (the cards that require a personal guarantee) typically don’t care what percentage of the business your credit investor owns; however, banks will be much more particular. When applying for bank lines of credit, banks typically want to see 80% of the ownership on the application.

I’m sure your first reaction is: “I don’t want to give away 80% of my company!” First of all, I don’t blame you – but consider the value of owning 100% of a under-capitalized and failing business. Now, there are intelligent ways to provide coverage and upside for your investor – while preserving your ownership interest. The risk to the credit investor is typically short-lived, until the business can pay-off the debts and stand on its own two legs. I recommend structuring an agreement that protects your control of the business and provides for an option or claw-back of a predetermined percentage of the business. For instance, you may exchange an investor 80% of the business, but agree that once the debt is settled and the business is profitable that you can exercise an option for 60% for $5,000. This gives the investor an ongoing 20% interest for providing you with much needed capital and keeps you from unnecessary dilution (I just made up these numbers – so take them with a grain of salt). Of course, you should seek professional legal advise before implementing any of this – I’m just trying to expand your thinking!

A credit investor might be exactly what your business needs – so choose your partners wisely!

Let’s say you are raising $250k from investors to start your business, if the business is only worth $500k, the investors will own 50% of it; if the business is worth $1m, they’ll only get 25%. The higher the valuation, the greater the percentage of your business that you’ll retain. It can be challenging to justify your valuation without revenue – which is where promising entrepreneurs routinely get taken to the cleaners. This is why I typically recommend convertible debt to raising hard equity, and why I recommend obtaining debt financing in the early stages of your business.

First of all, most business won’t raise a dime in outside capital. Investment networks are flooded with hopefuls that burn time and money trying to raise money – not recognizing the complete tooling they will receive in the event that someone actually believes their concept has merit and wants to invest. It is a lot easier to attract capital, and to do so on your terms, if you have successfully proven the concept and have some traction.

Unless you’re building airplanes, you can probably get things moving with less than $100k. This is why the XBanker is an important asset in the Shared Success family – we are here to help entrepreneurs establish a strong foundation, nailing the fundamentals and obtaining “seed credit” so they can get things moving. So if you are still slumming on the investment networks and forking over gobs of money for a business plan that no one will read (and if they read it – they sure won’t believe it!) – stop. Let us help you get your first $200k, so you can bring on investors under the right conditions.

My first experience was a discussion with a consultant to a portfolio of companies in various stages of their business – all with immediate capital needs. We were exploring potential solutions for these people. Most simply needed $50-100k to purchase inventory or to invest in new opportunities – getting the money is critical to their success. Yet, as I started asking questions, I was being shot down with every possible financing option. It was apparent that these business owners were looking for $100k for 2-3 years at less than 5% interest with no colateral and no personal guarantee and they wanted it now, despite their less than stellar credit.

The second encounter was with a start-up that has just been exploding out of the gates, but with growth comes greater demands on cash flow.  Nevertheless, they needed a short-term, hard money loan. They were willing to pay 35% on the money for 5 days (that was their offer). What they failed to understand is that a lot of interest without collateral doens’t reduce the risk of a transaction. They initially balked at the collateral demands, but realized after some shopping that no one cares about how much future return they may get, if they feel that there is a big chance that they’ll lose their entire investment!

The final experience was a conversation with my neighbor, who is just about to land a couple huge distribution channels for his product. He called me minutes after he realized that he was going to need to figure out how to finance the inventory (FYI – your big retailers will want 60 day terms). We went through a handful of possibilities and he soon realized that he wasn’t facing the crisis that he thought he was. My advice to him was to start thinking about his hurdle rate.

I really didn’t pay much attention in my finance classes in business school, but I do remember the concept of a hurdle rate. Your hurdle rate is the minimum rate of return that you expect from a particular initiative. There are a number of ways to calculate this, but I’ll keep it simple: think of your hurdle rate as the return you could get elsewhere (an opportunity cost) or what your money costs you (your cost of capital). For instance, if I can get a 10% return by investing in the stock market, I should expect a 10% return or more from a comparable risky investment in my own business – so I might use 10% as the hurdle rate that every business investment needs to surpass. Another way to approach it, is if my bank line of credit has a 15% interest rate over a 1 year period, then 15% will be my hurdle or my cost of capital. As I analyze the return from a particular investment or expenditure, it better clear that hurdle.

This really isn’t rocket science (if an MBA can learn, anyone can :-), but it is an important concept. Rather than getting caught up in what interest rate you have, you need to be focusing on what return you can anticipate from that money. I want to pull my hair out when a business owner turns down an unsecured line of credit because the interest rate is too high (you only pay on what you use!). Don’t allow yourself to get caught up in the lowest rate game. Work to get qualified for the best possible rates you can, then turn your focus on making sound investments in your business that will produce a superior return – investments that will clear your hurdle. At the end of the day, it isn’t what you pay for capital that matters, it is what you can do with it!

My first experience was a discussion with a consultant to a portfolio of companies in various stages of their business – all with immediate capital needs. We were exploring potential solutions for these people. Most simply needed $50-100k to purchase inventory or to invest in new opportunities – getting the money is critical to their success. Yet, as I started asking questions, I was being shot down with every possible financing option. It was apparent that these business owners were looking for $100k for 2-3 years at less than 5% interest with no colateral and no personal guarantee and they wanted it now, despite their less than stellar credit.

The second encounter was with a start-up that has just been exploding out of the gates, but with growth comes greater demands on cash flow.  Nevertheless, they needed a short-term, hard money loan. They were willing to pay 35% on the money for 5 days (that was their offer). What they failed to understand is that a lot of interest without collateral doens’t reduce the risk of a transaction. They initially balked at the collateral demands, but realized after some shopping that no one cares about how much future return they may get, if they feel that there is a big chance that they’ll lose their entire investment!

The final experience was a conversation with my neighbor, who is just about to land a couple huge distribution channels for his product. He called me minutes after he realized that he was going to need to figure out how to finance the inventory (FYI – your big retailers will want 60 day terms). We went through a handful of possibilities and he soon realized that he wasn’t facing the crisis that he thought he was. My advice to him was to start thinking about his hurdle rate.

I really didn’t pay much attention in my finance classes in business school, but I do remember the concept of a hurdle rate. Your hurdle rate is the minimum rate of return that you expect from a particular initiative. There are a number of ways to calculate this, but I’ll keep it simple: think of your hurdle rate as the return you could get elsewhere (an opportunity cost) or what your money costs you (your cost of capital). For instance, if I can get a 10% return by investing in the stock market, I should expect a 10% return or more from a comparable risky investment in my own business – so I might use 10% as the hurdle rate that every business investment needs to surpass. Another way to approach it, is if my bank line of credit has a 15% interest rate over a 1 year period, then 15% will be my hurdle or my cost of capital. As I analyze the return from a particular investment or expenditure, it better clear that hurdle.

This really isn’t rocket science (if an MBA can learn, anyone can :-), but it is an important concept. Rather than getting caught up in what interest rate you have, you need to be focusing on what return you can anticipate from that money. I want to pull my hair out when a business owner turns down an unsecured line of credit because the interest rate is too high (you only pay on what you use!). Don’t allow yourself to get caught up in the lowest rate game. Work to get qualified for the best possible rates you can, then turn your focus on making sound investments in your business that will produce a superior return – investments that will clear your hurdle. At the end of the day, it isn’t what you pay for capital that matters, it is what you can do with it!

Business owners are routinely tooled by the government. We are easy prey. We are too busy creating value to show-up at protests. We have better things to do. Which is why politicians typically cater to the unproductive (welfarees) or unproducing (retirees & students). I typically avoid these issues, but I think it is only fair to surface items that I think may impact you. So I’ve decided to start a new series to call-out politicians and bureaucrats that vilify, target or hurt small business owners. Don’t worry, I’m not some partisan hack. I trust politicians about as far as I can throw them, regardless of party.

Yesterday, I stumbled across a story in the Wall Street Journal about a proposed new bill in the Senate that I think we all should be concerned about. The Senate is proposing a bill that will require credit card companies to report business owner credit card spending data to the IRS. Why does the IRS need to see what your business spends at Kinkos next month? They hope to use this data to nab business owners who under-report their income. They hope to confiscate an additional $9.8 Billion from small business owners with this move. The money is already earmarked to further enrich and bail out the banking industry. This seems like a good trade for a politician – they criminalize small business owners so they can line the pockets of the mortgage companies that gave them sweetheart deals on their personal mortgages.

Don’t get me wrong, I’m not advocating the under-reporting of income – but this whole thing seems creepy to me. Why should a business owner be called out separately from the average Joe? I think civil libertarians would go nuts if the IRS was pulling this on every American – especially since the objective is to increase audits of individuals, but you probably won’t hear much about this one. Business owners are easy to vilify and have few champions. Oh well, who is John Galt?

Regardless of the actions of the Senate, you need to make sure that you separate your personal life from your business as much as possible. Co-mingling expenses is a fast-track to losing your corporate veil and exposing all your personal assets to litigation. You need to build business credit that you can maintain separately and to make sure that you are making legitimate business expenses.

Feel free to drop a line to the champions of this bill and let them know how you feel about it: Sen. Max Baucus (D., Mont.) & Charles Grassley (R., Iowa).

In the Finance Traps report, I discuss the concept of YSP or Yield Spread Premium. Whenever you have a brokerage model, one where an independent broker is packaging a loan or lease with a particular bank, you will encounter YSP. Banks will tell a broker what rate you qualify for, and if you elect to have a higher rate, the banks pay the broker more commissions on the loan. This rebate is called YSP. It was designed to help pay closing costs – so rather than pay your closing costs, you can take a slightly higher interest rate and use that rebate at closing. Unfortunately, most brokers don’t explain or even disclose YSP. Instead, they markup the rates that they show you – pocketing over $3 billion in YSP rebates each year. This gravy train just got derailed.

RateSpeed will do for mortgages what Travelocity did for travel. The mortgage finance world is about to change, as is expected when you offer consumers transparent pricing and access to once-privileged data. With RateSpeed you can enter your loan information, anonymously, and pull completely transparent mortgage rates. You can see exactly how much YSP you can use to offset your closing costs, and all the loan data that your broker sees. Progressive mortgage professionals will flock to RateSpeed, some out of necessity, others out of a desire to offer flat-fee mortgages, transparently. Go to www.ratespeed.com and search mortgage rates today.

The credit crunch is only likely to get worse, predicts economist Joseph E. Stiglitz in a recent article in Inc. magazine titled, Raising prices amid a sputtering economy? We’ve been here before. Here’s how businesses should prepare. (June, 2008 pp. 75-76). He also warns that “…small businesses are likely to feel the pinch the most.”

“Credit availability appears to be erratic,” says Stiglitz. If you are looking to for VC money or a bank loan, that may well be the case, as The XBanker recently pointed out in his advice for getting cash fast. On the other hand, many vendors are eager to keep selling their goods and services, and may be willing to negotiate even better terms than before, especially if you can demonstrate that you’re a good credit risk.

Take action now to prepare for the worst — and the best. Things will turn around again, and when they do, your business may look very different than it does right now. If you are doing the same thing you’ve always done, don’t be surprised when that strategy no longer works. On the other hand, there may never be a better time for your business to grow.

“Stagflationary times are complicated,” warns the economist. But business owners encounter challenges all the time.

Wrong! warns Jerry Mills CPA in his terrific book, The Danger Zone: Lost in the Growth Transition which I read on a flight to San Francisco last week. I had met Jerry a couple of weeks earlier at a conference in Baltimore, and would be seeing him again, so I knew it was time to learn more about his business.

The Danger Zone proved to be a deceptively easy read (Jerry tells me his second book is even better). I say “deceptive” because the writing style and content kept me engaged throughout the whole book. No CPA-style knuckle-wrapping here. Just solid insight and advice. But the advice he shares should not to be taken lightly. Ignore it, and your business may crash and burn like so many others have.

Jerry Mills is well-qualified to advise owners of growing businesses. He practically invented the “rent a part-time CFO” business long before it was popular. In the past few years, his business B2B CFO has been growing rapidly and he now has more than 80 partners across the country. He also continues, however, to serve as CFO to businesses in the Phoenix AZ area.

In short, he’s worked with a lot of business owners in diverse industries who wonder why the heck they are running out of cash even though business is “booming.” In fact, Jerry says, typically an increase in sales means the company has a decrease in cash, which is the opposite of what most entrepreneurs expect.

There are many more lessons in this book, and I’ll talk about them in future posts. But in the meantime, I want to remind you that sales aren’t the main metric you want to focus on as your business grows. As always, “Cash is King,” or as Jerry would say, “Cash is the lifeblood of your business.” But credit is also essential. Without access to credit when you need it, your business may be unable to move to the next level.