NEW YORK (TheStreet) -- It's no secret that capital access for smaller companies has been difficult, at the very least, for the past few years.
But as the economy works its way forward, financing for small firms will also come back, and small businesses should be educated about the opportunities. From bank loans to peer lending, options for small businesses can be confusing and overwhelming.
Ron Walker is co-founder and partner of Next Street, a Boston-based merchant bank and adviser serving small urban businesses typically 15 to 20 years old and with $5 million to $60 million in annual revenue.
Walker spoke with TheStreet last week about small-business owners choosing wisely and preparing to finance their business needs.
Where do investors and lenders typically prefer to see capital used?
Walker: They want to see the money being used to assist in executing whatever the model is for the business to generate the desired results, i.e. profitability. So if you're going for operating capital, they want to see a detailed analysis of what that capital is used for, whether it's for people, whether it's for building your operations, whether it's for executing on models, etc. ... They want to know and see pretty clearly what the capital will be used for, but ultimately today they want to see what the result is.
Secondly, if it's more senior capital/senior loan types of capital for purchasing equipment, they want to see what it's being used for, what's the value, what's the return, but most importantly they want to make sure it's being used correctly. What you see in some businesses that didn't ask for enough capital is that they start using the capital for the wrong reasons.
For example, if you had a line of credit and need to buy a piece of equipment, but you're maxed out on your term loan, some businesses may use that line to purchase that equipment, and that actually is a very bad flag on the business as they go for more capital moving forward.
How does a small business that's not used to dealing with banks and outside investors decide what type of financing is best for them?
Walker: I will always go back to the importance of doing a strategic plan. The real issue is growth capital -- what it's going to take to get that business where it needs to be in, say, the next three to five years.
Equity capital has a much different use, source and repayment terms than debt capital. So you have to have a plan on your revenue and what are the resources you're going to need to execute the plan moving forward. Then you can determine the capital. And small businesses that are not used to it, they end up going for the capital first, not the plan.
How does a small business get a bank loan these days?
Walker: Really spend time on straightening up your financials. Depending on the size of the company, you may or may not need audited financials, but you need to get a review of your financials for the last three years as well as get the books in order that are going to be appropriate for the financial institution you are dealing with. Secondly and again, what I have seen lately -- because the bankers have taken their relationship managers out of the market -- is that bankers want to know that there is a plan behind the business model. I recommend strongly -- we see it all the time -- there needs to be plan supporting the sources and uses of the capital they are requesting from the bank.
The use of alternative forms of financing, such as peer lending, has picked up. What are your thoughts on these alternatives for small businesses, and when are they appropriate?
Walker: I think they are very appropriate when you can identify how you want to use the money.
For example, industrial revenue bonds in certain states. In Massachusetts, if you're a light manufacturer you can get a 3% revenue bond and, quasi-public, you could get subsidized lending at lower rates for your business, which works very well. Another example: You can often subordinate to the bank if the bank didn't want to do all of the lending, meaning if you can identify another from of capital that is wiling to take a subordinate position it can really help you get more capital at better rates for your company.
The message is there are all types of lending facilities out there with better rates and better terms, so you have to spend a little bit of time sourcing the different types of capital right in your neighborhood. City and states have various lending programs that small businesses are just not aware of. If we were working with that business, one of the things that we would do is an analysis of the types of capital that's out in the marketplace.
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