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Financial: Avoiding an Ownership Cash Crunch

Financial

Avoiding an Ownership Cash Crunch

By Mark E. Battersby / Published March 2022

Photo by iStockphoto.com/ImagePixel

Setbacks in a slowly improving economy combined with the disappearance of many pandemic-related government funding options have left many pressure cleaning operations struggling to survive economically and financially. Making things even worse, today small businesses continue having a hard time borrowing money. 

     After all, shutdowns and the poor showing of so many businesses that remained open during the COVID-19 economic slowdown prompted banks and other lenders to deny loan requests—continuing even now. All of which leaves the question,  how can an owner fund a cash-strapped pressure washing business?

The Right Funding

     Good times or bad, the hardest question for any contractor or business owner to answer is, what kind of capital should he or she seek? Few contractors or business owners are aware of all the options available, and they don’t have time to explore the many possibilities.


  

     Obviously, every business owner should have at least some personal funds at risk to show lenders and potential investors that the owner is committed to the success of the business. Unfortunately, our tax laws make self-funding a touchy—and complex—strategy.

     Using personal or family funds to finance a business is called “boot strapping.” Boot strapping can involve personal investment by the founders, their family, and friends. 

     However, whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated pressure washing business, our tax laws require a fair-market interest rate be included. If not, the IRS will step in and make adjustments to the below-market (interest) rate transaction in order to properly reflect “imputed” interest. How large the tax impact depends on the effect of added interest income to the lender and the bite of an offsetting interest expense deduction felt by the borrower.

Personally Funding The Operation

     Obviously, conventional financing has not completely disappeared; it has just become more difficult to obtain. Much of today’s small business funding requires the “personal” touch, including such things
as the following:


  
  • Personal Guarantees—Today, many banks are willing to lend to small businesses, but they like the safety offered by the personal guarantee of the operation’s owner. A personal guarantee by the owner or share-holder to repay funds issued to a business reduces the lender’s risk. Providing a personal guarantee means that if the business becomes unable to repay a debt, the owner, partner, or shareholder will be personally responsible.
  • Secured Loans—With a secured loan, the bank or other financial institution lends money, but it is collateralized by an asset such as real estate, a home or car, or even insurance policies that can be used as payment to the lender if the loan is not repaid.
  • Home-Equity Loans—A home-equity loan, or second mortgage, is a type of consumer debt that allows homeowners to borrow against the equity in their residence. The loan amount is usually based on the difference between the home’s current market value and the homeowner’s mortgage balance due.
  • Other Equity Loans—As mentioned, many business owners and shareholders frequently put their own money into the operation in the form of equity or an outright loan. Best of all, not only can the business owner or shareholder invest in or loan money to the business, the business can also lend funds to a financially strapped owner, partner, or shareholder.

Personal But Not Personal

     In the absence of many pandemic-related government funding programs, borrowing, even with a personal guarantee, is not the only option. Following are other fund-raising options:  

  • Equity Sales—Selling an interest in the pressure washing business means giving up control to an interested party willing to invest in the operation. An equity sale refers to the sale of the common shares of a business instead of only the assets.

And, don’t forget the return of standby funding options such as these:

  • Line of Credit—Best created in advance, a line of credit is an arrangement between a financial institution—usually a bank—and a customer who allows the customer to borrow in increments, repay it, and borrow again as long as the line remains open.
  • Short-Term Loans—Before the pandemic, banks provided short-term funding. Unfortunately, short-term loans are usually more expensive because lenders want to profit from their loans, even if a borrower defaults. Funds from short-term loans can often be delivered into a borrower’s bank account in as little as one day when speed rather than expense is important.
  • Credit Cards—It is a common refrain: “We maxed out the credit cards to get the business through a tough period.” With credit card interest rates so high, this is rarely a viable option since personal loans tend to offer lower interest rates.

Today’s Alternatives

     Thanks to changes by both the IRS and the Securities and Exchange Commission (SEC), crowdfunding is helping many small businesses. Crowdfunding that relies on investors can help get an idea, project, or business off the ground, often rewarding investors with perks and/or equity in exchange for cash.

     With equity crowdfunding, where investors are given a stake in the pressure cleaning business, there are strict SEC regulations both the business and investors must follow. Somewhat less regulated, so-called funding “platforms” are an increasingly popular door to internet financing. 

     With the government programs exhausted or gone completely and traditional banks continuing to limit access to capital, online lenders have become popular—especially for small businesses and their owners struggling with bad credit.

     With an online or alternative lender, bad credit is not always a barrier to getting the needed financing. However, while these lenders put up fewer barriers, the drawbacks include significantly higher interest rates, risk, and lower loan amounts.

     An often-overlooked internet option is so-called peer-to-peer (P2P) business lenders. These lenders eliminate the middleman, such as banks, to connect borrowers with individuals and institutional investors. Unfortunately, the cost of borrowing with peer-to-peer financing is usually higher. 

     Still, alternative lenders are an option when the bank says no. Online lenders also offer fast cash with a number of online lenders able to process funding within 24 hours. Financial technology, or FinTech, interacts with a major bank minus the human element or is offered by independent companies working outside traditional banks.

     Alternative funding options may be a good fit in many situations. Strong, positive cash flow generally matters far more to alternative lenders, easing the path to secured funds with less friction. 

Cash Flow Planning

     Unfortunately, growing any pressure cleaning operation with any type of funding can be a very difficult and expensive process. The main consideration, obviously, is whether the business has sufficient cash flows to pay for growth or expansion outlays.

     Cash flow is the lifeblood of every business. Having too little cashflow hampers the pressure cleaning operation’s ability to pay employees or suppliers—or repay lenders—on time, while having too much indicates the business should be making an investment in much needed renovation or new equipment. Analyzing the operation’s cash flow aids in knowing the amount of money available in a given period of time.

     In order to analyze cashflow, a statement tracking the amount of cash the business has coming in and how much is going out is necessary. It is essential to monitor how cash flow increases as sales increase since it’s important that they move at a similar rate over time.

Do-It-Yourself

     A surprising number of small businesses today have funds available after paying all of their bills including taxes. Seldom, however, are all earnings paid out as dividends. Usually a portion is kept to finance future growth.

     Also, as already mentioned, there are equity sales. An equity sale refers to the sale of the common shares of a business instead of only the assets. Of course, selling an interest in the pressure cleaning business involves giving up control to an interested party willing to invest in the operation. 

Better Credit

     Things go a lot easier when potential lenders, investors, suppliers, and partners can decide to take a risk based on the pressure washing operation’s credit history and its capability to repay those obligations. With strong business credit, a business can usually borrow at a lower cost with more favorable terms. In fact, many small  businesses with good business credit have discovered it is possible to get loans without a personal guarantee even today.

     Obviously, a business owner seeking to borrow faces many challenges. Will the money be available and, if so, at what cost? What will be the actual cost, including fees? Is the loan good for an extended period of time or can payment be demanded early?

     The owners, partners, and share-holders of every pressure cleaning business admittedly have options, but their first stop should be their local bank. If practical, comparison shopping for lenders, rates, and terms is strongly recommended as is seeking help from the pressure washing operation’s tax and accounting professionals.

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