A common misconception is that someone who gives you a loan is like a person who hands you an umbrella when the sun is shining, and asks for it back when it is raining. To dispel this myth, entrepreneurs need to understand that the lender is running a business, just like the entrepreneur. That business is money, and has all the trappings of brick and mortar enterprises. The lender makes loans on the premise they will be paid back at some time interval, much the way traditional businesses make sales on the premise they will be paid on a time interval.
Therefore, as an entrepreneur, please understand that your potential lenders have the same pressures you do. They need their money to be working for them. Idle money is not ideal money. As I stated in my previous article, I have often argued with many of my colleagues that there is far more money than there are good deals. So as an entrepreneur, know that the uphill battle you are facing is winnable. The person you are pitching to wants to lend money. The question is, do they want to lend it to you?
To save you and your lenders a lot of time, a good first step is to identify your lender by their types of loans. I call this knowing your lender. Nothing shuts down a loan opportunity quicker than someone who starts in with a long-term debt pitch to someone who primarily lends short term debt. Debt structures are exponential, so knowing the ins and outs of each are not important. What is important is to know the type of lender, their strategy, size of loan, and similar transactions.
For this blog, let’s stick to debt investors. In a previous article, I addressed equity investors. For future articles, I will address strategy, size and risk. In my opinion, having a certain amount of debt on the books is healthy. Why dilute the equity investors when debt can solve the capital need? Too much debt can be troublesome, no debt can signal lack of growth. These are debatable stances, so I won’t take a hard line either way. Best to know your options and proceed as you are comfortable.
As an entrepreneur, before going out to institutions, I suggest you start here:
- Friends and Family – Usually your first investors. Many entrepreneurs are met with resistance to investment from outside sources if the insiders and their network has not participated. Not to mention, if things get a little sideways, it is much easier to work through the issues with those you have relations.
Once that option has expired, here a few types of debt for consideration:
- Senior Secured – This lender will take first position in case of default. Be sure that they will do their diligence on the company. Having secured debt on the books is not a bad thing. It shows there is a serious partner willing to lend.
- Subordinated – This tends to be “gap filling debt” that senior debt did not cover. Once you get to subordinated debt, your balance sheet is starting to get leveraged.
- Unsecured – A loan typically given on the recognizance and prosperity of the business, entity or person
- Term Loan – Generally fixed terms, short duration, use specific such as buying hard assets.
- Debt Facility – A revolving facility that provides flexibility for the business. Operates similar to a credit card.
- Bridge Loan – Often overlooked, the bridge loan can be a very useful tool, provided the bridge is to something definite, such as delivery of an asset or cash. Bridges are meant to “bridge the gap” between signature and delivery.
- Mezzanine Debt – A hybrid of debt and equity. It starts as debt, but the intent is convert to equity as remuneration. The owner of the debt typically has the option, and exercises that right at a given point in time.
- Working Capital – Simple, easy loan, most likely based off cash flow. Gets cash now against future sales later.
- Asset Based/Purchase Order -Utilized for a specific transaction, such as equipment purchase of financing a large order.
There surely are other forms of loans and lenders. Knowing a few basic types will help you tailor your pitch to the respective audience. Spend some time learning about the lender before approaching. The more you know about them and if they are a fit, the better chance they will show interest to lend.
All the Best,
Matthew L. Schissler