FinancingJuly 19th, 2021 by Nathan Hobbs
It all Starts With a Plan (and Sometimes a Good Neighbor)
By Drew Vass
Whether businesses designed from the ground up or franchises— most door and window dealerships are founded by industry veterans looking to advance their careers to ownership. That process might sound as simple as securing suppliers and knocking on doors (or establishing SEO) to make sales, but the costs for start-ups can range from tens to even hundreds of thousands of dollars—30% of which you should have in pocket, even when seeking financing, says Garth Knight, small business executive/business acquisition manager for Wells Fargo.
If you’re ready to start a business and don’t have a sufficient nest egg to crack, financial experts tell [DWM] that you should start by visiting your friends and family.
“Borrowing from scratch is tough to do,” says Dave Blankenhorn, a financial expert and small business advisor for SCORE, an organizational partner of the U.S. Small Business Administration (SBA) that provides free counseling. Blankenhorn spent 47 years in banking, including as a president for nine independent community banks. “You need to get somebody to support you,” he says. And because borrowing private equity from friends is a far cry from going next door to ask for flour or eggs, it also adds a layer of added responsibility for new business owners, he and other experts suggest. That, he says, drives some borrowers to succeed.
That’s not to say that there aren’t plenty of opportunities for borrowing among professional lenders, but many of those options require new business owners to have existing capital. Primary options include fixed and conventional business loans (with principal amounts to be repaid over set periods), but, “Not every business needs a 25-year loan,” says Don Vecchiarello, a representative for Bank of America. “Sometimes two to five years is sufficient, or you may simply want a line of credit extended to meet everyday cash flow needs,” he says.
Aside from business loans, there are other avenues to consider that may be sufficient for small startups. For instance, if you own a home, some experts say that a home equity line of credit (HELOC) is a good option.
HELOC’s are a subordinate type of mortgage (held secondary to primary loans) and an open line of credit that allows you to borrow against whatever equity you have in your home (the difference between what it’s worth and what you owe).
“There’s some advantage to [HELOCs], in the sense that they’re interest only, so you don’t have to worry about a payment program every month,” Blankenhorn says. “And so, when you get ahead in the game [with your business], you can pay it down, or if you need to borrow more, you can borrow more”—sometimes up to the full market value or a bit more, depending on the lender.
While it might sound unusual to some, other experts suggest that credit cards are a viable option for short-term borrowing, especially among those who might not qualify for business loans based on their credit and other factors.
“If you have great credit, then a business loan could be a great option. On the other hand, if you’re just starting out with bad credit and don’t have any revenue yet, you might need to stick to business credit cards or a short-term online loan,” says Priyanka Prakash, a business finance expert for Fundera. In those cases, you might be able to secure an introductory offer of 0% interest for the first nine to 18 months, in order to get you started, says Logan Allec, a financial expert and certified public accountant.
Among the eight financial experts interviewed for this article, all agree that conventional business loans aren’t well-suited to start-ups—mostly by design. Those loans, they say, are primarily established for businesses that have been in operation for at least several years and are already turning a profit, but looking for additional capital. Instead, the best avenue for new door and window companies includes what’s referred to as “SBA loans,” or those that are backed by the Small Business Administration. SBA loans are designed to be friendlier to new business owners and can provide anywhere from $50,000 to $5 million in borrowed capital.
Lean on Uncle Sam
SBA loans are designed to leverage federal support for small businesses, which enables lenders to loosen capital requirements for new business owners without taking on added risk. By setting specific underwriting guidelines (the conditions a borrower and business must meet in order to receive loan approval), the administration guarantees a portion of the loan amount for lenders. Even with those perks, financial experts say SBA-backed loans carry similar interest rates and fee structures to conventional loans, while generally requiring lower down payments and in some cases no collateral. They can be used for all of the same purposes as conventional business loans, including everything from funding real estate, business acquisitions and equipment, to the working capital necessary for operating expenses. Some come prepackaged with business support and they can be secured through financial institutions ranging from major banks to online lenders.
Other reasons for selecting an SBA-backed loan and lender include the fact that there are plenty of scams out there, experts say, and predatory practices, so you’ll need to be careful when selecting a lender.
“Some lenders impose unfair and abusive terms on borrowers through deception and coercion,” SBA officials suggest. For this reason, the administration suggests watching out for interest rates that are significantly higher than other competitors. Blankenhorn says most should fall somewhere around 3 to 4% over the prime lending rate (a quick Google search will provide you with several sources for what’s current). You should also be on the lookout for fees that go beyond around five percent of the loan value, SBA officials say, as well as ensure that lenders disclose annual percentage rates and full payment schedules. You can do that in part by sticking with reputable banks and other financial institutions—many of which advertise SBA loans directly on theirwebsites—but SBA also offers a free “lender match” service via its website that aligns small businesses with appropriate providers.
Get Your Ducks in a Row
SBA or not, before you think about approaching any lender, business and financial experts say there are numerous things you’ll need to have in order. One of the first things a prequalifying underwriter will look for includes what most describe as “sweat equity”—which is not only the sweat you put forth via groundwork and planning, but also capital.
“The idea is if you’re not invested in it, why should we be?” Blankenhorn says on behalf of lenders. “When banks or any lending institution looks at a business, they look behind it, at the owners, and see if they have the wherewithal to plug a [financial] hole if needed—if they’ve got other income and assets.
Generally, Wells Fargo will finance about 70% of a start-up, Knight says, “Which, of course, is a lot,” he points out, especially considering that more than 50% of new businesses fail, he says. “From a skin-in-the-game perspective, that means Wells Fargo has 70% of their skin in your game,” he says. Case in point: over the 12 months ending in September 2018, Knight says Wells Fargo approved nearly 4,000 business loans, dolling out $1.2 billion.
In addition to borrowing private equity in order to get skin in the game, personal assets might include savings and investments, or even spousal support and part-time jobs, for households with more than one income. What you shouldn’t do, experts advise, is use things like 401k and other retirement-based investments.
“Some people would come in and say, ‘Well, I’ve got a 401k that I had when I was working, and I want to borrow the 401k or I want to cash it in, or my IRA.’ I say, ‘Don’t touch that,’” Blankenhorn says.
Of course, part of the “sweat” in sweat equity also includes devising a detailed business plan—preferably one that illustrates how your business expects to become profitable within a few years, which experts say is a good rule of thumb and the point at which you can apply for a conventional loan.
“Most banks are actually quite willing to fund a start-up business by issuing what they call start-up loans. You must first, however, have a solid business plan,” says Annastasia Kamwithi, a senior editor for socialfish.org, a site that provides financial advice and information on lending. “The plan should be well structured, and it must convey things such as profit projections, modus operandi, the way in which you shall do the business, and the time in which you are anticipating getting a full return on your investment.”
That same plan will not only provide the information that lenders use to weigh the viability of a proposed business (according to underwriting guidelines), but it also gives you the assurance that you’ll make enough money to live on.
Starving Isn’t an Option
It’s pretty simple, says Justin Krane, president of Krane Financial Solutions. “You have to go buy [doors and windows] then deliver [them] to customers. That involves putting out cash and tracking what you just bought,” he explains. “If your gross margin, which is basically the sales price minus the cost to make and deliver on what you are selling, isn’t profitable enough, you won’t be able to pay yourself a salary, take money out of your business and live.”
Those situations are important factors for underwriters to consider, experts say, because they almost certainly add stress to an already difficult situation (a startup), via the necessity for things like part-time jobs and other detractors. It’s those details that build a picture for success or failure, among underwriters.
For crafting a solid business plan, there are plenty of professionals, like Krane and Blankenhorn (who is even free, via SCORE) to help, but some financial institutions provide their own tools. Wells Fargo, for instance, offers a free service through wellsfargoworks.com for developing plans, which, through a no obligation, trial-and-error format, can help you to weigh the viability of a business idea. The system even goes so far as utilizing zip code to determine how many similar or competing businesses already exist in a given area (another of the factors weighed in underwriting).
In the absence of professional help, the number one mistake that most new business owners make when crafting a plan includes, “not having clarity on their numbers,” Krane says. “Not tracking drivers of sales and identifying what they are.” For instance, that might include “thinking that marketing is an expense and not an investment,” he says, or, “not clearly being able to calculate the ROI of investing in their business.”
A viable monthly cash-flow plan for product- and service-based businesses, like door and window dealerships, should include estimated sales figures, Krane says, including the money you
make by selling and installing doors and windows. Additionally, it should show the cost of goods sold, with labor and materials, gross profit (what you’ll make before paying for business expenses and overhead) and general business expenses, which include not only what you spend, but things such as your own salary. You’ll also need to account for what’s referred to as “distributions,” he explains, which include the money you need to take out of your business to pay things like personal bills and taxes.
In the end, your plan should show an estimated net profit, which is the net income your company expects to make after paying all expenses. And while that might not happen right away, the idea includes showing lenders when it’s expected.
Fist Full of Resumes
Included in your business plan are other factors beyond money and financial projections that can play out in your favor, experts say—such as industry experience. If you’ve ever seen a company advertise things like, “a combined 100 years of experience,” that’s more than marketing speak for underwriters, so long as you have the documentation to prove it.
Conversely, “I had people come in and say they want to start a restaurant,” says Blankenhorn. “And when I asked them why, they said, ‘I like food.’” That’s nice but it’s not enough.
You can also acquire those assets, by accumulating the right resumes.
“In this case, for door and window folks, if you don’t have that experience, then you need to start thinking about your leadership and your management, and who that’s going to be,” Knight says. “Then you’re probably going to need to be bringing on a manager, general manager or somebody that’s got that type of industry experience.”
Those relationships can also provide other forms of credit—including with product suppliers, Blankenhorn says. In the event that you or one of your employees has rapport with a
manufacturer or distributor, those vendors may be willing to sell you product on 60-day terms for payment, which can serve as startup capital.
“If you have those relationships, these people want to sell doors,” Blankenhorn says. “If they think these people are good people and that they’re willing to go out and extend the repayment on their receivable, then that’s a great way to go, because you can get their materials and install them—all in time to have the money to pay the vendor.”
Whatever avenue you explore for financing, “You should never give up on it,” Kamwithi says. “There are plenty of plans you can put in place that will enable you to come up with the capital you require for your idea to come to pass. If one doesn’t work, just try the next one, and the next one, and the next one, until you’re able to find what you need to start your company.”
The Five Cs of Business Lending
Most creditors follow the “Five Cs” when making small business lending decisions, says Don Vecchiarello, a representative for Bank of America: capacity, collateral, capital, conditions and character.
Capacity: evaluates whether your business can support debt and expenses—in most cases including enough cushion to absorb unexpected expenses or a downturn in the economy;
Collateral: includes inventory, accounts receivable, cash, equipment and real estate. Lenders may also consider existing debt that you owe on collateral;
Capital: whether your business assets outweigh liabilities, along with how much you and other sources have invested;
Conditions: such as the housing market, the economy, industry trends and legislation/regulations; and
Character: including your own character and those tied to the success of your business. Personal integrity, combined industry experience and good standing can make a difference.
Drew Vass is the editor of [DWM] magazine.
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