Tag Archives | financing

What is a Term Sheet?

See Also:
Other Peoples Money
Angel Investor
Venture Capital
5 Cs of Credit
Working Capital

What is a Term Sheet?

What is a term sheet? It contains the terms of an investment made by a venture capital firm. It is a summary of the legal and financial terms of a proposed deal. Basically it is a letter of intent (LOI) for venture capital investments.

Term Sheet & Valuations

It is important to understand the pre and post money valuations of your firm if you are taking on a VC partner. Contain the details of these valuations within the term sheet. It is important to understand how much of the equity you will hold after the transaction. Each round of equity financing typically has its own terms.

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What Does A Lender Want To Know?

See Also:
Relationship with Your Lender
Finding the Right Lender
The Dilemma of Financing a Start-up Company
Every Business has a Funding Source, Few have a Lender
Required Rate of Return
Venture Capital

What Does A Lender Want To Know?

I had a conversation with a prospect that needed working capital funding. He asked, “What does a lender want to know?” I hear this from every prospect I meet with. So, I gave my normal answer, “We will need personal and business financial statements, a completed application, detailed information on accounts receivable and inventory, and that is just the beginning.” After leaving the prospect, I realized not only did I not answer his question, but also I have never totally answered that question. I now know, the prospect is really asking me what information the lender is looking for so he can get the money.

When I answered this question in the past, I just gave a list of requirements and never explained why they were important to the lending decision process. This information is telling the company’s story to the lender. To start with, think of the financial statement you provide the lender as a score card. In the lender’s mind the more income you make the higher your score. As an example, the more runs a baseball team scores the more powerful the team is.

Tell Your Lender This

So after you tell the lender the score of your company, what else does a lender want to know? You should tell the lender about your company with the following information:

How much money do you want to borrow?

How much money do you want to borrow? The lender needs this information to determine the potential to loan you money.

Why do you want the money and how will it be used?

Why do you want the money and how will it be used? Think of this one as if your child or family member asked to borrow money from you. I believe you would want to know what they were going to do with the money.

What primary source will generate the funds to repay the loan?

Some ways the lender might expect you to repay the loan are; selling a building, producing a product and selling the inventory, or increasing the profits of your business to generate cash flow.

What is the secondary source of repayment?

Amazingly, lenders want to be repaid as you would if you were loaning money. So they consider such things for their repayment as liquidating equipment or injecting additional capital from personal funds.

How will the loan be secured?

How will the loan be secured (collateral)? The lender wants a security interest in whatever you are going to do with the money.

Who will guarantee the loan?

Who will guarantee the loan? From the lender’s point of view, you must be 100% sure of your ability to repay the loan. And, you must be willing to put your personal assets on the line. Otherwise, they would be risking their job by making a potentially bad loan.

The better you tell your story the better your chances are of getting the money.

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What Lenders Look At?

See Also:
Relationship With Your Lender
What Does a Lender Want to Know
Don’t Tell Your Lender Everything
Due Diligence on Lenders
Finding the Right Lender

What Lenders Look At?

I recently spoke to students at the University of Houston in the Wolff Center for Entrepreneurship on the topic of Dealing with Lenders. During the question and answer portion of the program, I was asked by a student, what lenders look at when they are deciding whether or not to approve a loan.

I answered the question by saying all lenders start with looking at the C’s of credit. There are normally five Cs of credit which I will define in a minute. But, the really important issue in getting your transaction approved rests upon your ability to present your case in satisfying each of the C’s.


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5 Cs of Credit

Depending upon your lender, the weight assigned to each “C” may vary, so you must understand the order of importance to the specific lender you are dealing with.

Character

The first C is Character. Normally borrowers don’t consider this but, lenders do. Lenders look at such things as your willingness to pay obligations, morality, and integrity. Lenders determine the borrower’s business character based on the historical information. To form an opinion on character, lenders will review the borrowers past success, payment history, and intangibles such as personal credit, family background and employment records.

Capacity

Another C is the borrower’s Capacity to pay. The lender normally looks to the business and determines if the business has a history of successful operations. The lender will determine if the business has paid their debts when they were due and shown a proven ability to generate cash flow. If you are trying to fund a start up, you must show prior business experience relating to the operation of the business you are trying to start. You must provide evidence of the capability of operating successfully and paying your bills.

Capital

Next, lenders look at another C Capital. Capital is the equity or net worth of a company. Capital signifies the company’s financial strength as a credit risk. The more capital a company has, the smaller the credit risk. Your company needs a history showing increasing sales, profits and net worth. Additionally, your company needs favorable trends in your operations, such as, constant or increasing gross profit margins.

Conditions

Another of the C’s is Conditions. Lenders will analyze how current and expected economic situations may affect your business. Such items might include past and current political history, and business cycles for you and who you sell to. Normally, the lenders like industries that are in periods of dynamic growth.

Collateral

The final C is Collateral. Lenders will determine the company’s ability to access and provide additional resources such as, equity or other assets, to use for repayment if the company’s capacity or character fails.

By addressing these C’s in your business plan and on your loan application you make the lender’s job faster and easier. Therefore, understanding and selling your C’s will improve your chances of getting the lender to approve your request.

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7 C’s of Banking

See Also:
5 Cs of Credit
Line of Credit
Credit Rating Agencies
How Important is Personal Credit in Negotiating a Commercial Loan?
Improve Your Credit Score

7 C’s of Banking

Every knows the 5 C’s of Banking. But what are the 7 C’s of Banking? Recently, I spoke to students at the University of Houston in the Wolff Center for Entrepreneurship on the topic of Dealing with Lenders. During the question and answer portion of the program, a student asked me “What do lenders really look at when they are deciding whether or not to approve a loan?”

7 C’s of Credit: Condition

Is there a logical need for the funds? Does it make business sense? Are the funds to be used to grow an existing and proven business product or service business or to be used for an unproven one?

7 C’s of Credit: Collateral

Is the proposed collateral sufficient? What type of value does it have? Is there a secondary market for it? The lender wants to know, in the event of a default, that it will be likely to recoup a significant portion of the amount lent.

7 C’s of Credit: Credit

For smaller enterprises, the personal credit score of the individual owner(s) will be reviewed. As with personal loans, such as an auto or mortgage loan, the bank is looking for evidence of a history of you paying your lenders on time. For larger companies, the bank will consult Dun & Bradstreet reports for evidence of the timely payment of vendors and other creditors.

7 C’s of Credit: Character

What do those who have done business with the prospective borrower have to say about its business practices? A bank will typically ask the applicant for a list of references, such as three customers and three vendors to contact.

7 C’s of Credit: Capacity

Does the borrower have the wherewithal to pay the debt service? Is it generating enough free cash flow to reasonably assure timely interest payments and ultimately the repayment of the principal balance?

Due to the expanding levels of transnational business and cross-border lending over the last few decades, you need to discuss the two new C’s.

7 C’s of Credit: Currency

What is the recent history and outlook of the primary currency in which the company will conduct its operations? Does the currency exhibit a history or likelihood of losing its value? The more stable the currency, the more attractive the loan request will be to a lender.

7 C’s of Credit: Country

Does the borrower conduct a significant portion of its operations in a country with a history of political instability? Is there the possibility of an expropriation of the borrower’s assets due to a change in the country’s government? Is the country’s current political and legal system hostile to the interests of foreign countries? There are two factors that would make the bank more likely to be willing to make the loan, including the following:

  • The more established the country’s government is
  • The more a legal system has demonstrated a reverence for bother property rights and the rights of creditors

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7 C's of banking

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Vendor Finance

See Also:
Time Saving Tip for Filing Vendor Invoices
The Dilemma of Financing a Start Up Company
Mezzanine Debt Financing
Commercial Agents

Vendor Finance Definition

The vendor finance definition is the receiving of financing for an asset from the provider of the asset. Vendor finance is a common way to receive an asset before having the money to pay for it. In addition, vendor finance programs can come on a piece of equipment, real estate, software, and even intangible assets.

Vendor Finance Meaning

Vendor finance means receiving financing from a vendor rather than a bank or investor. This often creates a mutual benefit; the buyer wants the item now in order to pay for it through increased productivity, while the seller of an item appreciates increased income from selling and financing an item rather than receiving just the sales price.

Vendor financed companies can agree to either debt or equity financing. To phrase this another way, a company can receive vendor financing in 2 ways. First, the business can receive the item at a sales price with an agreed amount of interest, on the sales price, which accrues as time progresses. Alternatively, a firm can receive the item in exchange for a certain amount of company stock. Here, no monetary repayment of the asset is needed because the vendor has already been paid in stock. Generally, vendor finance in the form of equity is more common for startup businesses. A vendor finance association may be available in some areas to gain advice and planning on the subject.


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Vendor Finance Example

For example, Jonathan works at a business brokering firm. His employer, a company which arranges the sale of a business between the exiting entrepreneur and a buyer, is a successful company with a professional reputation. Jonathan enjoys his work because he assists people in their exit plan, assists people in starting a business, and gets experience in a variety of entrepreneurial firms while he does it.

Recently, Jonathan is brokering the sale of a small, yet successful, chain of ice cream shops. The exiting business woman, the founder of the firm, has worked to the bone to grow the company. She has earned her retirement with her application of sweat equity.

Jonathan eventually comes across a soon-to-be entrepreneur. His experience in the restaurant industry makes him a likely candidate. The buyer is interested in applying the expertise he learned, mainly focused on growing restaurants, to a company where he will be the main controller of company success. Jonathan arranges a meeting between the two business people.

At the meeting, Jonathan makes a discovery: the potential buyer has slightly less to invest in the business than the seller’s price. This appears to both to be a major issue which stands in the way of the sale of the company. Jonathan, at this point, steps in with another option: use a vendor finance plan on the remaining amount to be paid to the seller. Once Jonathan poses this option, the two parties restart negotiations.

Decision

The two decide on vendor equity financing for the remaining amount of money to be paid to the seller. To her this seems like an excellent idea: she can reduce risk while still taking benefit from growth of the company that she started. The buyer also appreciates this option: he can go into business by buying a reputable company which already has customers. The two resolve to complete the purchase. They also agree on a one year transition where the buyer will be able to receive consultation from the experienced manager.

Jonathan is pleased by his achievement. He takes great joy from helping one person harvest the benefits of their work while allowing another to begin the process without the struggles of the startup phase. He receives his commission from the sale. This achievement pleases Jonathan.

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Unsecured Credit

See Also:
Debits and Credits
Credit Letter
Direct Tax
Credit Memorandum (memo)

Unsecured Credit Definition

Define unsecured credit as credit not collateralized by an asset. It is a common form of credit used for business. Furthermore, an unsecured credit line comes in many forms, including the following:

Though it may go unmentioned, many businesses use it to successfully finance any of their operations.

Unsecured Credit Meaning

Unsecured credit means credit which, when unpaid, cannot be reclaimed through the seizure of an asset. This is important to note because unsecured credit facilities may be confused with secured credit. Though lenders have other methods to regain the value of the credit they offered (such as a court decree saying the lendee must repay the lendor), there is no asset promised by the receiver of the credit.

On a small scale, unsecured credit loans are more simple to acquire than secured credit. For example, credit cards are the easiest method of credit to acquire outside of the financing of “friends, family, and fools”.

On a large scale, an unsecured credit agreement is fairly difficult to acquire. The example of this would be mezzanine debt financing: mezzanine financing is virtually as difficult to acquire as venture capital. In this situation, companies generally use an unsecured credit facility when they can not receive secured credit. This situation occurs when the company can not meet the requirements or obligations of the secured credit lender or prefer to keep their assets free of obligation.

The business owner makes the final decision on whether secured or unsecured credit is the best decision. A general rule of thumb would be that if the company has more to lose by collateralizing an asset then not receiving the financing, unsecured credit may be their best option. consult a trained CFO to find the best option for your business.

Unsecured Credit Example

For example, Karl is an entrepreneur who has started a company which manufactures precision electronics for the military. Because Karl makes each item to changing specifications, Karl must keep a lot of supplies on hand. He must have a strong base of credit to cope with his customer’s changing demands.

Karl has recently outgrown his current lines of credit. To make matters more complicated, he already promised almost all of his assets as collateral for other loans. With no option left, Karl must find an unsecured credit provider. He knows that credit cards will surely not be able to support his needs. He sees mezzanine debt financing as the only option.

After consulting with a trained CFO, Karl realizes that his company will actually lose profit by receiving the funding. The CFO clearly spelled this out in the financial analysis he provided. It seems the best option is for Karl to grow a little slower. Though he will have to deny some customers, it will ultimately result in a stronger business. Going forward, Karl’s company will be financed by free cash flow. Though Karl does not feel like as much of a “high roller”, he is happy that he made the prudent decision.

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Sukuk

Sukuk Definition

A Sukuk is the islamic world’s version of a bond. It is also referred to as an islamic bond. Because Islamic people do not believe in charging or paying interest, they have been forced to maneuver their way around interest by renting certain assets or by taking ownership in a project.

Sukuk Meaning

A Sukuk structure is slightly different, but the principle is the same as a western bond. When a bank invests in a Sukuk or islamic bond, it is considered to be an investment in a certain project or asset that a company is working on. As the project or asset is complete or purchased, the company must then pay the bank rent expense from the cash flows of that asset or project. Overtime, the islamic bond is paid off in rent using fixed payments over a certain amount of time. Then the par value of the the islamic bond is purchased at a future date.

Sukuk Example

For example, Osman is looking to start a new production line in his business that will require the equivalent of $1 million dollars. Because Osman is building this line in Saudi Arabia, he plans on financing the costs using this islamic bond. He then goes and obtains the financing he needs from an islamic bank. The bank invests in the project. They decide that Osman will owe the bank rent of $80,000 per year and the final par value of the Sukuk, ($1 million) 10 years after the project is done. Notice that this is the same set up as a regular bond where the rent expense of $80,000 is equal to an 8% interest rate. And the par value of the bond is due at the end of the term like a bond.

sukuk

See Also:
Coupon Rate Bond
Interest Rate
What is a Bond?
Nominal Interest Rate
Outstanding Debt

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