Numerous financing options are available for entrepreneurs and companies in growth mode, but do your homework first
When Kaye and Mike Hannes were looking to purchase Lakeshore Pallet from Mike’s longtime employer, they received assistance from the Sheboygan County Development Corp. to help navigate the pair through the financing process. For someone who is inexperienced in funding a new business or a large new expansion, like Mike and Kaye were at the time, the process can seem overwhelming. Lakeshore is located in Howards Grove, Wisconsin. Mike had been the operations manager there for 13 years.
“That’s one of the many projects that I have been proud to participate in,” stated Jim Schuessler, who at the time was business development manager at Sheboygan County Development Corp. Schuessler has since moved to become executive director of the Door County Economic Development Corporation in Sturgeon Bay, Wisconsin.
The deal involved senior financing from Bank First of Sheboygan, with the Sheboygan County revolving loan fund providing a loan for the transaction. Hannes received assistance from the Sheboygan County Economic Development Corp. (SCEDC) in completing the application process, including the creation of a business plan. The prospective buyers also received help from the Small Business Development Center at UW-Green Bay, which Schuessler said was “pivotal” in pulling the financing arrangement together.
Economic Development Organizations Help Entrepreneurs Grow Local Jobs
“There were many reasons to invest a lot of time on that program,” Schuessler continued, stressing that the services were offered at no cost to the Hannes couple, other than the time commitment involved. “Number one, Mike and Kaye are both good people—they are both local people.” And another important consideration for SCEDC is job retention and creation. While Sheboygan County has a strong manufacturing base, the Howards Grove area is less attractive to industry because of limited city services.
“We had jobs to retain, we had an area where it is hard to create jobs, so there were a lot of reasons to keep the business going,” Schuessler said. He also was concerned that if a buyer came from outside the local market, that efforts to find efficiencies might result in job losses.
Because Lakeshore Pallet is an ongoing business, the Small Business Development Center helped by building historical financial information. Then SCEDC worked with the prospective owners to determine a three-year projection.
‘Projections always have something in common—they are all wrong,” Schuessler quipped. “But we work to make sure there is some good rationale behind those projections, because we want to make sure that the entrepreneur can pay back the debt.”
While the Small Business Development Center crunched the numbers, Schuessler’s involvement centered on putting together the story. “I’m usually focused on the narrative side of it, explaining the financials, explaining the history, explaining how future financials are expected to occur,” he said. Mike and Kaye were very involved in writing the business plan.
“Generally, if an entrepreneur is willing to go through that hard work of writing that narrative, they are going to do the work that needs to be done to actually execute the business plan,” he said. “We provide them with a vetted business plan with historicals, with projections, and a narrative to explain the financials.”
Schuessler also worked with the buyers to create a financial plan about how the business would be funded, as well as the uses of the investment and how it would happen. “It was more complex than average to get it done,” he recalled.
“The end of it, the last spike in the rail, is (funding) sources,” Schuessler said.
While Schuessler declined to divulge details of the financing packaging, a SCEDC announcement reported that Bank First of Sheboygan was the senior financing partner. A portion of the funding came through a loan from the Sheboygan County loan fund. These funds are provided through the U.S. Department of Housing and Urban Development, and administered locally across the country. “There are job creation expectations tied to those loans,” Schuessler said. “Working with Mike and Kaye we had to project future employment through the business plan.” According to an SCEDC announcement, Lakeshore intended to hire another eight to 10 employees over the next three years.
Going to the Bank is the Last Thing—Not the First Thing
Schuessler cautions that creating sound historical financials and a promising business plan should precede a trip to the bank. “One of the vexing things with entrepreneurs is that they almost always go to financing first, and that’s really the last step, he noted. While in the old days you could make your pitch on a cocktail napkin, such practice is no longer good enough. Prospective buyers can alienate lenders if they start visiting every bank in town without having done the necessary preparations.
“I’ve seen deals that never got out of first gear because they had burned their financing options,” he said. “Banks take risks, and their whole job is to rent money. They want to rent money with as little risk as possible. So, the more confident they feel in the entrepreneur, and they have a plan, the more likely they are going to be to getting it funded.”
The Grueling Process of Getting Funding
Be prepared for a long haul and frustrations when it comes to finding funding, especially if you are new to the process. “They (lenders) are very demanding,” one business owner told me anonymously about his experience of buying a pallet company. “If you want to get any money out of them, you need to know exactly what they want done. In the end, they came through, after we met all of their criteria.”
“It was a long haul, over a year of nerve-wracking experience,” he continued. “It was up and down—go and then not go.”
But a smooth financing experience can be better ensured through preparation and experience. “The stressful thing for them is that a lot of the smaller guys just haven’t done it yet,” observed Howe Wallace, CEO of Pallet One. “It is your first time to go sit with a banker, and you are being asked for all of the stuff that they want, and you are not used to sharing that—that’s your own business. And they ask you questions that you really can’t answer because you don’t understand what they have asked you. It can be daunting.”
Banks are most likely to approve a business loan if a business has a history of profits and solid cash flow, promising cash flow forecasts, a healthy balance sheet, a strong management team and a business plan.
For people looking to fund acquisitions or expansions who are new to the process, Schuessler recommends visiting their local economic development corporation early in the process. The economic development council can also often provide research and a rough appraisal of the business. “If you don’t have a sound appraisal that you have conviction in, and you don’t have the money in your pocket, it is encouraged to contact the local economic development organization because of the various resources they offer.” he said.
Senior and Secondary Lenders, SBA Loans
Often more than one lender can be involved in a deal. The senior lender, Pallet One’s Wallace explained, typically finances the bricks and mortar, as well as perhaps working capital. As outlined above, banks have very rigorous requirements. And for many prospective owners, the bank may not fully fund an ongoing business, meaning that a secondary lender may be required. Secondary loans often come with greater risk and a higher interest rate.
“Most of the time, the senior lender has a credit ratio of EBITDA they are willing to consider,” Wallace said. “And that credit ratio might be two to three. The bank might say ‘We’ll lend you two and a half times of EBITDA’—that’s what the loan value is.” But as a going concern, the market value of the company might appraise at a higher multiple than 2.5, forcing the borrower to seek secondary financing to fund the gap between what the seller wants and the bank will provide.
In the case of Lakeshore Pallet, a secondary source of funding was the revolving loan from the local county. Other typical options include asking the seller to hold a note, or personal investment. Additionally, funding sources such as direct lenders and online peer-to-peer lending are becoming increasingly popular for small businesses in many industries. One direct lender, LiftFund, offers SBA loans.
SBA loans are small-business loans guaranteed by the U.S. Small Business Administration, and issued by participating lenders, mostly local banks. Because loans are guaranteed, banks are more likely to take a chance on lenders that they might otherwise avoid. The SBA can guarantee up to 85% of loans of $150,000 or less and 75% of loans of more than $150,000. The maximum loan amount is $5 million. Loans made under SBA’s popular 7(a) program may be used for working capital, construction of new buildings, renovations, starting a new business, or expansion of an existing business.
Self-funding Never Goes out of Style
Debt is not for everyone, however, and Wallace observed that the decision to borrow money must be weighed against your tolerance for debt. “For some guys who have worked all their lives to get out of debt, they don’t want to get back in it. They decide they don’t want to grow that badly.”
Wallace stressed the importance of saving on a regular basis, and not spending everything in your pocket on “new duck hunting clothes.” Don’t assume that every year will be as profitable as the last. “Just incrementally take a portion of the proceeds of your business and reinvest it into the business you know,” he said. “It gives you a lot more security when you actually go to the bank.” Just think of it as one more preparation before you go to a lender—developing a culture of saving and reinvestment.
In fact, a saving to reinvest mentality has been a part of the pallet industry’s DNA for decades.
“Mom and dad started this business, and I’m second generation, and I’m going to run it the way they taught me, and that’s to save your money and buy what you need, and be smart about it,” said one second generation pallet business owner.
In the last three years, he has installed a new cut-up line and a complete, new baghouse from self-funding. “Literally, I just set the money aside, and when I get the money for it, I call the company I want to install something and say, ‘Go get her.’”
