Recession-Proof Your Business

Recession-Proof Your Business

Business owners were required to adapt quickly during pandemic-related lockdowns, supply shortages, labor shortages, and inflation. Now, business owners face the risk of a recession. 

In response to inflation, the Fed has implemented quantitative tightening which involves increasing the Fed Funds rate. This is making it more expensive to borrow and it has the potential to slow down our economy. 

Over the past few months, we have heard several CEO’s of publicly traded companies warn of an upcoming recession. While we should always hope for the best, we should also prepare for the worst. 

We can take steps to recession-proof our business by being mindful of the customer and our financials. We must first get into the right mindset and be willing to pivot when necessary. Innovation and expansion are possible when we are in the financial position to support it!

We can take care of our customers by understanding what is important to them and rewarding our best customers. It is beneficial to reach customers through stories and connect with them emotionally. As businesses and households cut back, we want our customers to consider us essential. We can also offer flexible client service agreements and/or payment plans. 

Being mindful of our financials means that we need to pay attention to our cash flow, profitability, and our balance sheet. It is wise to reduce excess spending, manage inventory levels, and review current contracts related to supplies, rent, etc. 

It is suggested to implement clever marketing strategies that don’t require a huge budget. Track your marketing key performance indicators. Which campaigns are achieving your desired results?

It is wise to look for ways to improve cash flow. It is also important to increase our cash position and reduce our debt. When possible, maintain unused lines of credit. Access to capital via traditional banks often dries up during a recession.

Business owners should consider strategic partnerships with other businesses which may help to reduce expenses and gain exposure to new markets. 

Other ways to recession-proof a business include innovation, creating multiple streams of income, adjusting prices to improve profit margins, diversifying suppliers, understanding the drivers of growth, and becoming a market leader in your industry.

Some of the most successful businesses were started and/or expanded during a recession.  Recessions can present opportunity. Look for the opportunities to thrive!  

To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you reach your financial goals and helping you obtain the best possible financing for your company.

Successful Business Owners Have Mastered These Four Soft Skills

Successful Business Owners Have Mastered These Four Soft Skills

There are many things that contribute to the success of a business including an understanding of the numbers, a business plan, a great product/service, and a great marketing and sales strategy.

Soft skills are also needed to be successful in business. It is believed that successful business owners have mastered the following: Focus, Leverage, Structure, and Solution-oriented thinking.

Successful business owners have great focus. They focus on the most valuable and highest paid activities. Successful business owners know their profit margins for each product and service offered. They focus on the work and tasks that will positively impact their bottom line. Do you focus on the ideas and tasks that have the biggest impact on your business success? It is easy to become distracted in this fast-paced world. If you can focus, then you can succeed. 

Successful business owners have mastered the use of leverage. Leverage is simply the ability to influence an environment or system in a way that multiplies efforts. While there are several types of leverage including financial leverage, there is also the leverage of people, tools, and strategy.

Successful business owners understand that they need a solid team. They hire the right people and leverage their time. Successful business owners leverage relationships and tools such as technology to help grow the business, increase financial returns, and boost productivity. 

Successful business owners have mastered structure in business. An effective organizational structure ensures a smooth workflow. A solid organizational structure will have clearly defined roles and responsibilities. Everyone within a company is held accountable for their particular job function. There are policies and procedures in place and the stakeholders work towards a common vision and goal.   

The last mastered soft skill is the ability to be solution oriented. A solution-oriented person will look for solutions instead of looking for something or someone to blame. Focusing on problems causes anxiety and stress; it causes our brains to shut down. We are back in charge and have a sense of control when we are solution oriented. As Helen Keller once said, “Keep your face to the sun and you will never see the shadows.”

To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you reach your financial goals and helping you obtain the best possible financing for your company.

The Complete Financial Picture

The Complete Financial Picture

When I started my career in commercial banking, one of the first things I learned was how to analyze financial statements. Once the accountant prepares financial statements, the bank uses them to determine the financial health of the business.

It is important to look at the complete financial picture whether you are running a business or investing in a company. A complete financial picture includes the balance sheet, income statement, and statement of cash flow. Each of these statements serve a purpose and tell a story. 

Many businesses/investors focus solely on the income statement. They may look at revenue growth trends, net income, earnings per share, EBITDA, and profit margins. While this information is important, it tells you very little about the assets, liabilities, net worth, and the cash flow of a company.

The balance sheet serves as a useful tool as it provides a snapshot of a company’s resources (assets), a company’s obligations (debt and other liabilities) and owner’s equity. An investor/lender can analyze the balance sheet to determine a company’s working capital and balance sheet leverage (debt-to-equity). The balance sheet essentially shows how much a company is worth. 

It is especially important to understand the debt of a company in a rising rate environment. Banks often perform stress tests on their borrowers to determine their ability to service debt as interest rates rise and revenue/income decline.

The third financial statement is the statement of cash flows. The cash flow statement performs as a bridge between the balance sheet and the income statement. It shows how the money moved in and out of the business. It measures how well the company generates cash to fund its expenses. The cash flow statement is broken down into three sections: operating activities, investing activities, and financing activities.   

When we pull these three financial statements together and analyze them, we can calculate many ratios that show how well a company manages itself. Business owners can use financial statements to obtain funding, create a plan for growth, or even create a survival plan in the event of a recession. 

To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you reach your financial goals and helping you obtain the best possible financing for your company.

Interest Rate Swaps

What is an Interest Rate Swap?

During my 15 years in banking, I found that one of the most confusing products for my clients was an interest rate swap.  It’s not surprising as this is a challenging topic not only for commercial lending clients but for bankers as well. 

What exactly is a swap?  A swap is a derivative contract and/or an agreement between two counterparties to exchange a series of cash flows or financial instruments over a period of time. 

There are Several Different Swap Products

There are several different swap products including Currency Swaps, Commodity Swaps, Interest Rate Swaps, Total Return Swaps, Credit Default Swaps, etc.  

Total Return Swaps have been in the news lately as this was a product used by the Family Office, Archegos Capital Management, run by Bill Hwang.  The collapse of Archegos Capital was brought on by investments in concentrated positions using derivative products such as Total Return Swaps.  Total Return Swaps are common derivative instruments which allow a customer to bet on underlying securities without actual ownership of those securities. 

Investors in these derivative instruments receive the total return of a security from a dealer.  These returns are typically amplified in either direction with the use of leverage. 

The family office, Archegos Capital, was highly leveraged and substantial losses resulted from margin calls and bets turning against the firm.  There was lack of transparency and disclosure between the investment banks and brokers offering the same products; investment banks lost billions.

You may have also heard of a Credit Default Swap (CDS).  A CDS is like an insurance policy that protects against the default of bonds.  Investors also use them to protect against collateralized debt obligations and mortgage-backed securities.  This financial instrument played a big role in the 2008 financial crisis.  According to the International Swaps and Derivatives Association (ISDA), there were $62.2 trillion outstanding Credit Default Swaps by the end of 2007.  Due to the lack of transparency and reporting, it wasn’t realized that the financial institutions selling the credit default swaps were actually undercapitalized.  When debtors defaulted, the system failed and large insurers like AIG were left needing a bailout.  AIG insured collateralized debt obligations (CDOs) against default using credit default swaps.  Although the insurance product generated a lot of revenue for years, big losses took the insurance giant down to its knees when bonds and mortgages defaulted.   

Interest Rate Swaps

Back to our topic at hand, Interest Rate Swaps.  An interest rate swap (IRS) is actually one of the simplest swaps. There are typically two parties that are exchanging interest rates.  The interest rate in an IRS has been based on Libor in the past although banks are required to end the use of Libor at the end of 2021.  The Secured Overnight Financing Rate (SOFR) will likely take its place.

“Plain Vanilla” swaps exchange fixed-rate payments for floating rate payments; this is the most common type of interest rate swap.  One party pays a fixed interest rate while the other party pays a floating interest rate.  Every year the fixed rate payer pays a cash flow that equals a percentage of the principal.  The difference of the cash flow payments is exchanged meaning the principal itself is not exchanged, just the notional principal/cash flows.  The streams of cash flows are called legs of a swap.

After the swap is executed, the bank usually offsets the swap through an inter-dealer broker.  The inter-dealer broker may sell it to counterparties.  Each counterparty may benefit from the exchange.  For example, an interest rate swap product may benefit the lending client by providing a potential reward depending on which direction interest rates are likely to go.  The lending client also benefits by receiving a steady fixed rate which helps to manage cash flow.  Institutional investors use interest rate swaps to manage risk, hedge and speculate on the direction of interest rates. 

Interest rate risk is the main risk within a swap.  Ultimately, it’s a zero-sum game.  The gain of one party will be the loss of the other party.  If your company decides to enter into an IRS contract, it will be bound to the agreement for the length of the contract. 

Advantages of swaps for commercial borrowers:

Borrowers typically want long-term fixed rates.  Since many banks do not want to offer a long-term fixed rate, they may suggest an interest rate swap.  Three main benefits include: possible prepayment benefits; swaps typically provide the lowest rate available; and swaps provides the borrower with a steady fixed rate and flexibility.

How does the bank benefit from Interest Rate Swaps?

Interest rate swaps definitely benefit the bank by reducing interest rate risk.  Banks tend to have a mismatch between their assets and liabilities.  Liabilities are deposits while assets are the loans given to different companies.  Long term loans are funded by short-term deposits. 

If rates were to rise, the bank would be obligated to pay depositors a higher interest rate but are often locked into loans with lower rates.  Banks have a risk management group called Asset Liability Management; this group focuses on the balance sheet by matching the risks of the assets to the risks of the liabilities.  A swap allows the bank to convert some of its long-term fixed rate loans into variable rates.  The bank is safer when they have assets and liabilities at a floating rate. 

There is economic benefit to the bank as well.  The bank receives a fee for executing the original swap.  Non-interest income (fee income) is recognized in the period that the swap is executed. 

What are the Risks of an Interest Rate Swap Product?

There are two main risks: counterparty risk and interest rate risk.  Counterparty risk otherwise known as credit risk relates to the chance that one party will default. Given that many swap contracts are cleared through Center Counter Parties (CCP), default risk is minimized but not eliminated. 

If your bank is suggesting an Interest Rate Swap there are a few things to consider:

  • The borrower must meet swap product eligibility requirements under the Commodity Exchange Act which generally means that a borrower has greater than $10 million in total assets and net worth in excess of $1 million. The borrower must qualify as an Eligible Contract Participant (ECP) and each guarantor must also qualify as an ECP.   Many banks may limit swap transactions for borrowers to those with principal loan amounts of at least $1 million and a minimum of three-year loan term length.
  • Are you comfortable with a variable rate loan or would you prefer a fixed rate loan? Companies with tight cash flow may want a fixed rate loan to minimize vulnerability related to interest rate volatility.  If you are a borrower that is sensitive to changes in interest rates, a fixed rate loan via an IRS may be right for you. 
  • It’s important to consider the future direction of interest rates. In a rising rate environment, the interest rate swap protects the borrower against higher borrowing costs associated with higher interest rates.  If interest rates drop, the borrower will be locked into the swap contract therefore the borrower will forgo the benefit of lower interest rates. 
  • Do you have an interest in paying the loan down early or making extra principal payments? When you enter into an interest rate swap agreement, you are bound to the length of the contract.  Both parties are exchanging a series of cash flows over a specific period of time.  The payment schedule must be followed.
  • If the borrower pays off the loan prior to the date of termination, the borrower will either receive a termination payment from the lender or possibly owe a termination payment to the lender.
  • With a fixed rate loan, a prepayment penalty is due if you pay off the loan early. Variable rate loans do not have prepayment penalties.  With a swap, the borrower must settle the swap contract at market value.  Depending on the direction of interest rates, you may be in a liability or you may have an asset. 
  • A swap will allow you to secure an interest rate on future financing but it should be noted that banks typically require a company to establish an interest rate swap product at the time of loan initiation or before loan initiation (not after the loan is in place).
  • A swap can be completed on just a portion of your loan.

To learn more about LonaRock, LLC and our business debt finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you become an ideal business client and helping you obtain the best possible financing for your company.

Alternatives to Traditional Financing

If you are looking to raise capital to grow your business, it’s a good idea to explore all options before jumping into a business loan offered by a traditional bank.  This blog will discuss the alternatives to traditional financing but first let’s look at the advantages and disadvantages of traditional bank financing.

Traditional bank financing typically offers lower interest rates than alternative financing options.  Banks offer full relationships with many additional services to cover all of your banking needs.  Traditional banks also allow you to keep full control of your company without giving up a percentage of ownership.  Small businesses may benefit from government backed financing through SBA loans offered at traditional banks. 

The disadvantages include eligibility criteria which is usually stringent.  As the saying goes, “The best time to ask for a bank loan is when you don’t need one!”  Banks offer lower rates because they are typically willing to accept less risk than other capital raising alternatives.  Traditional bank financing also comes with a long application process and a significant amount of documentation.  Please visit our Commercial Banking Documentation Checklist blog for more information about the documentation required. 

There are several alternatives to traditional bank loans.  Each one has their own advantages and disadvantages. 

  • Reputable Online Lenders
  • Crowdfunding
  • Merchant Cash Advances
  • Asset Based Lending
  • Invoice Factoring
  • Equipment Financing
  • Mezzanine Debt
  • Equity Financing
  • Issuing Bonds

Reputable Online Lenders typically offer fast, flexible and secure financing for small businesses.  These online vendors typically base credit decisions on your personal credit score and they require at least one year of business operating history and may require minimum revenue.  Decisions are quick and the funds are typically deposited same day.  They often come with no prepayment penalties and no collateral requirements.  Disadvantages include higher interest rates and the short term nature of the loans.

Crowdfunding offers equity and debt financing solutions.  Crowdfunding is a popular way for start-ups and small businesses to raise capital.   According to a Forbes article, the average crowdfunding campaign is $7,000. Given the small dollar amount, this type of capital may only be sufficient for small businesses and start-ups.  Equity crowdfunding is much like venture capital and angel investing only on a smaller scale.  A business owner gives up a portion of ownership in the business in exchange for capital.  Reward based crowdfunding allows you to offer incentives or rewards for their small donation. 

Merchant Cash Advances are a small business solution for those businesses that need cash quickly.  A merchant cash advance is not technically a loan but you are given a lump sum of money upfront in exchange for your future debit and credit card sales. Like many other cash advance alternatives, MCAs carry high fees and should be used in only the most problematic and dire situations.

Asset Based Lending (ABL) is essentially a business loan secured by the company’s assets.  This business loan typically comes in the form of a revolving line of credit.  If your business has AR, Inventory and Equipment, this might be the best solution for you.  While many traditional banks have ABL departments and specialists, a business can also source an ABL line of credit from private companies that work in specialized finance and factoring.  These private companies may be more costly but credit decisions and funding are typically faster.

Invoice Factoring is an alternative to a bank working capital line of credit.  Invoice Factoring is not a loan therefore collateral is not required.  It allows you to sell your invoices (accounts receivable) to a third party at a discount.  It provides immediate working capital rather than waiting for your customer to pay you.  This is best for B-to-B businesses.  Factoring fees can be expensive as they run from 1% to 5% of the invoice amount.  There may also be hidden fees.  Some of the same non-traditional finance companies that provide ABL lending may also provide factoring services.

Equipment Financing is much like ABL lending in that it is a business loan secured by the company’s assets.  In particular, equipment financing is secured by collateral such as equipment.  While traditional banks offer equipment financing in a streamlined fashion, there are alternatives to traditional banks.  Equipment Finance companies typically have less stringent requirements than traditional banks and funding is fast for both small and large companies. 

Mezzanine Debt is a hybrid between debt and capital.  It is the riskiest form of debt because it is unsecured and subordinated to senior debt.  Mezzanine debt does have priority over common and preferred stock.  This debt often includes warrant options which provide lenders with the right to convert the debt into an equity interest in the company.  Interest on mezzanine debt is tax-deductible. Mezzanine financing is used by PE firms and venture capital companies to help fund buyouts, mergers and acquisitions.  It’s also used by companies looking to fund large projects.  Given that mezzanine debt has the highest form of risk, it also provides opportunities for substantial returns.  Mezzanine debt is best suited for established companies. 

Equity Financing provides a great way to raise capital and fund the growth of your business.  Unlike debt, equity capital does not have to be repaid.  The owner of the business does have to give up a percentage of ownership in the company.  Equity financing can be achieved by taking the company public or via private investors.  Venture Capitalists, Private Equity Firms and Angel Investors are the most common type of equity investors of private companies.  While small businesses may raise capital via equity from friends and family, large established businesses should consider PE, venture capital or even the possibility of an IPO if the business is experiencing rapid growth.  Raising capital via equity can often take a lot of time, energy and requires a lot of out-of-pocket costs.

Issuing Corporate Bonds may provide a flexible way for a company to raise capital.  Corporate bonds are sold to investors; the original investment is returned to the lender/investor when the bond reaches maturity.  The company pays interest payments to the bondholders.  The interest rate is typically higher than debt financing because the bondholders/investors are taking on more risk.  Corporate bonds are a form of debt capital that must be repaid but does not dilute the value of existing shareholders.  Issuing bonds is also much cheaper than issuing equity shares.  There are also tax benefits to issuing bonds as the interest is an expense that reduces taxable income.

This blog was written to inform business owners and executives of the options available to raise business capital.  As you can see, there are several alternatives to traditional financing.  If you have any questions or need further guidance, feel free to reach out to us today. 

To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you become an ideal business client and helping you obtain the best possible financing for your company! 

SBA vs Conventional Business Financing

While conventional business financing typically offers the lowest interest rates, there are times when an SBA loan is the best option or maybe the only option for a small business.  Conventional loans typically require a down payment of at least 20%.  Traditional loans are often the best financing option for established businesses as they are cost effective. 

SBA loans are business loans guaranteed by the Small Business Administration.  The Small Business Administration partners with several banks and lending institutions across the country.  The SBA makes it easier for small businesses and start-ups to get loans through the bank because they help reduce the bank’s risk.  The SBA uses money provided by the government to guarantee up to 85% of the loan amount. 

The two most common types of SBA loans are 7(a) loans and 504 loans.  In this blog, we will explain the two main SBA loan programs as well as the advantages and disadvantages of funding your business via an SBA loan. 

The advantages of SBA loans include lower down payments, extended repayment terms, and competitive interest rates.  SBA loans allow for underwriting based on financial projections which may benefit individuals that are looking to fund a franchise purchase.  SBA lenders allow you to put a minimum of 10% down and loan proceeds can be used for a variety of costs including soft costs, operating cash, franchise fees, etc.  For more information regarding the terms, conditions and benefits of SBA lending, please visit the SBA.gov website.  It is a great resource to find out how an SBA loan can help you fund your growing business. 

The disadvantages of SBA loans include higher costs and a longer application process.  Interest rates are often higher than rates offered in traditional financing.  SBA and closing fees can add up although SBA fees may be rolled into the loan.  The loan application process typically takes longer than a traditional bank loan application.  The SBA will require personal guarantees of the owners with 20% or more ownership in the business.  Although a fully collateralized loan isn’t always required, SBA loans often require that collateral shortfalls be covered by a lien on personal assets.  For loans in excess of $350,000, the lender may take enough collateral to fully secure the loan such as a mortgage on the available equity in your personal real estate.  If your business fails and you are unable to pay back your SBA loan, they have the right to take personal assets such as your home.  The benefits of an SBA loan often outweigh the disadvantages and costs.

The SBA 7(a) loan is the most common loan.  According to the Congressional Research Service, the U.S. Small Business Association backed over $22 billion in SBA 7a loans in 2020.   7(a) loans can be used for working capital, equipment, real estate and other asset purchases.  They are also used for the establishment of a new business.  7(a) loans are great for franchise owners.  The maximum amount for a 7(a) loan is $5 million.  Eligibility requirements include gross annual revenue of at least $100,000 and a credit score of at least 650.  Businesses with tax liens, foreclosures or recent bankruptcies will likely be denied.  A 10% down payment is typically required.  If your real estate purchase represents more than 50% of the debt, then you can finance all of the debt over longer repayment periods. 

SBA 504 loans are a great option for a business that is looking to finance the purchase of fixed assets.  Fixed assets include equipment, buildings and land as well as improvements to an existing building or the funding of construction of a new building.  504 loans cannot be used for working capital, rental real estate or to refinance existing debt.  504 loans are available through Certified Development Companies (CDCs) like Growth Capital in Cleveland Ohio.  The major benefits of 504 loans include lower down payments with a minimum of 10% down, longer amortization periods, no balloon payments, and a fixed rate for the life of the portion of the loan with CDC/SBA.  The CDC in your area works with a bank loan officer to fund your loan using a 50/40/10 split.  The bank covers 50% of the loan, the CDC covers 40%, and the owner covers 10%.

The sba.gov website has several resources and guides for small businesses.  They cover topics such as planning your business, launching your business, managing your business and growing your business.  They also have a Learning Center on their website that is worth a look.  When a small business doesn’t meet the minimum requirements such as minimum debt service coverage of 1.15x, the SBA team will gladly coach you.

We hope that you have found this information helpful.  We recognize that there are many ways for a business to raise capital.  SBA loans are great for small businesses as they allow for minimal down payments and extended terms.  If you are looking to purchase a franchise, SBA financing may be the best alternative for you. 

Now that you have a better understanding of SBA loans, you are probably wondering how to find an SBA lender.  Some banks are more SBA friendly than others.  The most active SBA Lenders include: Live Oak Banking Company, Huntington National Bank, Newtek Small Business Finance, Celtic Bank, Byline Bank, U.S. Bank and Wells Fargo.  There are also smaller banks throughout the country that are SBA friendly.  Feel free to reach out to us for more guidance. 

To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033.  We look forward to helping you become an ideal business client and helping you obtain the best possible financing for your company!