Skip to content

Lessons from the Shark Tank: Episode 14

31 January 2010, 3:37 pm

This week Kevin H. makes up for many episodes of limited investing by putting $235,000 to work in both of the successful pitches.  He also takes Kevin O by surprise and undercuts Robert in a deftly handled negotiation maneuver.  All together, the Sharks invested $305,000 and snagged an average stake of 50%.

Lipstix Remixcaptainicecreamcaffeindicatorlegalgrind
Tonight’s first casualty was the unfortunate Captain Ice Cream.  Although it was very hard to criticize his whimsical business, there was unfortunately barely enough to sustain a meager living and definitely not enough to attract franchisees.  Franchisors make their money from an annual franchise fee charged to the franchisees for the right to continue to use the brand name, business model, and other support for the business in their localized market.  Captain Ice Cream could only produce about $25/hour as a wage so how could an owner afford to pay a franchise fee out of such limited returns?  Tim Gavern has indeed built a job for himself but unfortunately does not yet have a highly profitable, attractive business.

Another lesson comes courtesy of Legal Grind, the curious merger of low cost legal services and coffee house.  Yet another attempt at franchising, these poor folks have been working for 14 years and still had to come crawling before the Sharks to drum up capital.  If that isn’t a bad sign in itself, Barbara asked what the money would be used for and there was initially no answer.  Finally Jeff Hughes says he would hire legal counsel, even though he is a licensed attorney!

The real lesson comes from Daymond, though.  He mentions that he’s skeptical the franchise will attract interest and Jeff responds that they already have over 200 franchise requests.  An incredulous Daymond responds with an easy solution: take $20,000 down payments from 10 of the requestors and they would have the $200,000 they’re trying to get from the Sharks.  Indeed, if you already have orders, there are far cheaper sources of capital than selling equity.  See my post on Innovative Funding Strategies for a few ideas, including asking customers to prepay or borrowing against purchase orders.

One final suggestion for Annie and Jeff Hughes: it’s the Shark’s money, treat them with respect.  Whether Annie was nervous or angry at the way things were turning out, neither is an excuse for arguing with your potential investors.  These people are buying something from you, taking a risk on you, and tying their financial future with yours.  They have their reasons for joining you or leaving you and you will have to accept them or change their minds.  Trying to beat them into submission is not a good negotiating tactic.

On the positive side, Caffeindicator was one of the most polished business plans I’ve ever seen.  He narrowly targeted an extremely structured industry and planned to pit the four most common sweetener brands against one another in a war to either increase their own market share or suppress their competitors from increasing theirs.  He didn’t even care if people used the actual sweeteners!  By using the caffeine indicator on the packet, the customers would waste a packet that would increase the amount purchased by the restaurant and in turn increase sales for the sweetener manufacturer.

His presentation clearly indicated how he planned to leverage his patent in this space and it left the Sharks free to calculate their risk of success and return on investment, which is precisely where you want them to be.  Kevin H. pulled an amazing negotiation trick by rushing an answer from Michael Schiavone before Kevin O. had a chance to make an offer and while Robert’s offer was still on the table.  Pushed for an answer, Michael accepted Kevin H.’s offer which was the best on the table.

________________________

The next episode of Shark Tank airs Friday, February 5 at 9/8c on ABC

  • Share/Bookmark
Tagged , , , ,
Comment

Often Overlooked Steps to Take Before Selling Your Business

29 January 2010, 9:28 pm

If you’re not already aware of Matt Barrett of the Colorado Springs Small Business Development Center’s Small Business Blog, go on over and check it out.  His most recent post is on a few of the often overlooked steps an entrepreneur should take before putting their business up for sale.

  1. Assemble a team to help you sell
  2. Get your family out of the business
  3. Report all income for at least three years
  4. When trust is involved in a decision, it’s always better to be trustworthy
  5. Begin to document everything

Please check out the full article for all the details.

___________________________________________

Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

  • Share/Bookmark
Tagged , , , ,
Comment

10 Benefits of Using a Business Intermediary When Selling a Closely Held Company

29 January 2010, 4:46 am

So you’re thinking of selling your business and you’re wondering whether you should engage a business intermediary, broker, or mergers & acquisitions professional to help you through the process.  Why should you?  What value will they add to your transaction?

Here are 10 reasons to engage a business intermediary:

  1. In-depth knowledge of the tax consequences. There are many ways to sell your business and each structure can have very different tax consequences to you and to the buyer.  Knowing what the tax man will require of you under each scenario is critical to your negotiations and to your ability to pay all your obligations and still have cash left over.
  2. Knowledge of your business and its industry. If included in the preparation process prior to the actual sale, a business intermediary can provide insight into your industry and help you find ways to maximize the value of your business.  Most value maximizing strategies will take time to implement.  Therefore, it is important to communicate with all of the experts you plan to use during the transaction as early as possible.
  3. Awareness of market conditions. An M&A professional is constantly involved in the market and learns when the timing is right to buy or sell a business in a variety of industries and to a variety of buyers.  Sometimes private equity groups are extremely active while other times corporate strategic acquisitions are more popular.  As the economy surges in certain areas, some industries will benefit from higher valuations and more M&A activity.  Other times, it will be wisest to stick it out and wait to sell your business if at all possible.
  4. Marketing your business for sale. Marketing a business for sale involves preparation, analysis, and a unique mix of technical and creative skills.  Unfortunately, it is nothing at all like marketing your goods or services.
  5. Exposure to create competition for your business. You will receive the maximum value for your business when several buyers are competing with each other to acquire your company.  A good business intermediary will know who the players are in your market and will be able to craft this competitive environment through research, skillful timing of marketing materials, and deft negotiation.
  6. Confidentiality. Many times, even the news that you might be interested in selling your business can cause ripple effects that are far reaching and uncertain.  How will your key employees react?  What will your key customers think?  A professional M&A advisor can be engaged in a confidential manner and control who receives information about your interest in selling and with whom they can communicate that information.
  7. Removal of distractions. Selling your business will not happen overnight and you will be needed to keep your business profitable and growing.  If you are spending too much time mired in the details of selling your business you will not be effective at managing it and vice versa.  Having a dedicated advisor to work on selling your business will free up your time and energy to continue to run it.
  8. Emotional buffer. Most of the time, buyers and sellers of businesses will not agree on everything.  When that happens, an emotional buffer in the form of a designated negotiator can be extremely helpful to keeping the deal on track.  In addition, since the M&A advisor has less “skin in the game”, he or she can be more objective and help you to make decisions based on the facts and not in the heat of the moment.
  9. Facilitation of the process. The process of selling a business is incredibly complex and involves many moving parts.  A qualified business intermediary can successfully bring together attorneys, bankers, accountants, insurance agents, key customers, suppliers, employees, buyers, sellers, and everyone else who may be a stakeholder to make sure their needs are met and the process can move forward.  Not having this point of contact generally means the task is up to you.
  10. Negotiation ability. Almost anything can be negotiated during a business sale.  How much working capital will you leave in the business?  Will this be a stock sale or an asset sale?  Will the buyer assume any debt?  Which ones?  What is the final closing price?  How will the closing price be allocated among the assets?  The best M&A professionals are tirelessly working to produce the best possible outcome for you, knowing your goals and needs.  They have the skills to negotiate in your favor.

___________________________________________

Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

  • Share/Bookmark
Tagged , , , ,
Comment

SBA Lending when buying a small business

23 January 2010, 9:35 pm

Everyone knows the housing market has tanked and that “banks aren’t lending”.  What is less commonly known is that the lack of debt financing has been a key factor in making it more difficult to buy or sell a small business.  Recently, I had the privilege of sitting down with Melissa Knutson, a business banker from Chase in Colorado Springs and asking her about the state of small business lending in Colorado Springs.

NextExit: Let me ask you the obvious question: is Chase still lending?
Knutson: Yes!  Throughout the “credit crunch”, Chase never stopped lending to small business owners.  In fact, we recently announced that Chase plans to increase its lending to small businesses by up to $4 billion in 2010, boosting expected new lending to about $10 billion to this vital segment of the U.S. economy.  Obviously, our new loan volume will reflect demand from qualified businesses. Total outstanding loans and lines to this segment are currently about $29 billion.
NextExit: If you’re still lending, how has business acquisition loan criteria changed in the last year?
Knutson: There have been significant changes as recently as October 1, 2009.  For example, Chase can only utilize preferred lender program (PLP) authority if:

a)      The amount allocated in the business valuation to intangible assets is less than or equal to $500,000 OR

b)      The amount of intangible assets exceeds $500,000 but the borrower or borrower and seller inject at least 25% equity into the project (seller financing is considered equity if it is on complete stand-by, with no principal or interest payments allowed for at least two years).

President Obama has announced new proposals that would be added to the Stimulus Plan approved earlier in 2009.  One of the most interesting is a proposed increase of the cap on 7a loans to $5 million (from $2 million).  All of these new proposals require Congressional approval and then implementation time by SBA.  We are hopeful that the changes will occur soon.

(Note: Here is a press release from the SBA on Obama’s proposals)
NextExit: What are the key features you will look for when making an acquisition loan?  In other words, if I am a potential purchaser of a small business, how should I structure the transaction to get financing from you?
Knutson: The first requirements we look at are the 3 C’s: Credit, Collateral, and Cashflow just like we do for any other loan.

Credit: We look at both the borrower and the business to determine if there has been positive credit and management history.

Collateral: Is there sufficient collateral as a secondary source of re-payment? Collateral requirements are highly effected by the industry of the business.

Cash Flow: Does the business (and the borrower) have sufficient cash flow to support the business as well as the additional debt payments?

Specifically for the SBA program, there are additional restrictions on the structure of the transaction:

  1. The Small Business Applicant must purchase 100% of the ownership interest in a business.  For example:  Individual A, who currently has no ownership in the business, wants to buy out Individual B (50% owner) and Individual C (50% owner).
    • The individual CANNOT buy into an existing business.  For example: Individual A, who currently has no ownership in the business, wants to buy out Individual B (50% owner).  Individual C will retain 50% ownership.
    • An existing owner CAN purchase the stock of another owner resulting in 100% ownership by the purchasing owner.  For example: Individual A, who currently owns 50% of the business, wants to buy out Individual B (25% owner) and Individual C (25% owner).
    • The existing owner CANNOT buy less than 100% of the other ownership interest. For example:  Individual A, who currently owns 50% of the business, wants to buy out Individual B (25% owner).  Individual C will retain 25% ownership.
  2. The seller can remain as an officer, director, stockholder, or employee of the company for up to 12 months.
  3. Loan cannot be made solely to the individual purchasing the business.  The business must either be the borrower or a co-borrower on the transaction.
  4. The business must also be included as a buyer on the executed purchase contract.
  5. The borrower is required to have a conversation with the seller regarding the seller’s willingness to finance any intangible assets being purchased (i.e. goodwill).

On a personal note, I want to know that the buyer has done their homework on that business.  It is critical that buyers take the emotion out of their decision as much as possible and truly understand the business, its financials, obstacles and what effect they will have on that business.

Melissa Knutson is Relationship Manager with Chase Business Banking RM Channel in Colorado Springs, CO.  Melissa can be reached at (719) 227-6497 or by email at melissa.j.knutson@chase.com.

  • Share/Bookmark
Tagged , , , , , , ,
1 Comment

BiggsKofford.com has a new look!

23 January 2010, 6:58 pm

As many of you already know, I went to school initially interested in computer information systems and ended up finishing a bachelor’s degree in computer science (in addition to accounting).  That led to me starting a web design company and building websites for a few years. I know I’m probably the first accountant you’ve ever heard say this, but sometimes I miss the creative process.

So it was a lot of fun to get the opportunity to be part of BiggsKofford’s website redesign process.  That’s right, if you haven’t seen it already, BiggsKofford has a completely redesigned website.  We’re planning on keeping the new website current with news articles, helpful resources for businesses and entrepreneurs, links to our team bios and LinkedIn profiles, and eventually a company blog.  Please head over to www.biggskofford.com and let me know what you think!

Kudos to Dan Decort of Decort Interactive and his team for their excellent design and template coding work.

  • Share/Bookmark
Tagged 
Comment

Innovative Funding Strategies: Alternatives to Injecting Cash into Your Company

14 November 2009, 12:56 am

Although dragging myself out of bed to attend the Peak Venture Group’s breakfast by 6:30am was a challenge at first, the experience proved to be entirely worth the effort.  Today’s topic was designed to offer alternatives to the traditional funding path of Friends & Family – Angel Investors – Venture Capital – IPO/Strategic Buyout.

This morning’s panelists:

The moderator for today’s featured presentation was Jeff Chapman of Pivotal Path, LLC.  Each of the panelists was asked about creative ways for entrepreneurs to fund their companies.  Below is a brief list of their suggestions.

Investor-backed Bank Lines of Credit: Although this is a traditional line of credit from a bank, the difference is that a business that might not otherwise qualify on its own can achieve the same result by getting an investor (or investors) to sign a guarantee for the bank.  Provided the investors qualify for the line of credit, the business owner can generally get approved.  In exchange for the guarantee, the investor usually receives stock warrants.

Strategic Investments: These are investments made by other companies, generally strategic partners such as a key supplier or customer.  If your business is critical to another business or vice versa, consider exploring a strategic investment to support one another.  Another way to structure a strategic investment is for a manufacturer to build your first shipment in exchange for equity.  After that, cash flow can keep them paid.

Letters of Commitment: So, Wal-Mart is excited about putting your product in 500 stores as soon as you can produce 10,000 units.  Unfortunately, you’ll need a large amount of cash to ramp up manufacturing operations.  If your key customer will sign a commitment letter promising to purchase a certain amount of product, investors and others will generally loan you the money to get started.

Factoring Accounts Receivable: There are investor groups and factoring companies that will purchase your accounts receivable at a discount in exchange for giving you cash up front.  For example, if customers owe you $500,000 over the next six months, a factoring company may give you $400,000 in cash now in exchange for the cash flow from the customers as they pay off the receivables.  Factoring has a bad reputation with most business owners because it is extremely expensive.  However, it is ultimately less expensive than giving up equity and you may have few other options if you need cash.  Be careful with factoring: one of the panelists related a story of a client factoring their receivables and then offering a discount if customers paid early.  Unfortunately, the client ended up receiving no additional benefit from early payment but was forced to reimburse the factoring company for the cost of the discount for a double whammy.

Patriot Express Loans: This is a guarantee program through the Small Business Administration (SBA) for veterans and their spouses.  One interesting note about these government guaranteed loans is that banks still have the ultimate authority over whether they will lend you the money.  In most cases, banks are most interested before the business is actually formed and after the business has at least 2 years of history.  If the business is less than 2 years old it is considered much higher risk.

What about Grants? In general, the SBA offers no grants.  There are other government organizations that have grants available, but they are usually for very specific uses and have strict qualifications, such as the business being located in a rural area.

Enterprise/HUB Zones: These only apply if your business is located within an area defined by the U.S. Census.  Most of the time businesses are incentivized to relocate to otherwise underserved parts of the country in the form of tax credits or other reduced fees.

Alternatives to Cash: All of the above options are creative ways of producing cash for your business.  Below are several ways to achieve the same effect without actually using cash at all.

  1. Joint Advertising: Perhaps you own a fresh new technology or product but lack the cash to advertise properly.  Joining with a larger company that has a well established marketing budget that may benefit from being associated with your “freshness” and “newness” can get publicity for you while the larger company still spends the same marketing dollars.  For example, if a startup condiment manufacturer teams up with Wells  Fargo Bank, the bank’s new ad could read “We’ve got the special sauce” and a free bottle of sauce for all new accounts.  The startup benefits from a national ad campaign while no additional cash is actually spent or transferred.
  2. Equity in Lieu of Salary: Often, a startup is selling stock to raise the capital to hire top talent.  Why not give that equity directly to the new hire instead of salary for the first year?  The effect is the same but the business avoids the hassle and expense of preparing presentations for investors and managing diverse groups of stakeholders.

___________________________________________

Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

  • Share/Bookmark
Tagged , , , , ,
Comment

7 Entrepreneurial Tips from Jeff Schneider

13 November 2009, 12:23 am
Jeff Schneider

Jeff Schneider

Laura Benjamin interviewed Jeff Schneider, president of Entrepreneurial Finance & Accounting Services to get his top tips for entrepreneurs and small business owners.  Although you might recognize these tips as the very basics it is definitely worth a reminder.  Take a look at Benjamin’s Business Blog for the full article.  There is also an audio interview.

With the recent economic downturn, more of my clients have been asking themselves the hard question of “will I survive this?”  That is leading to a lot more of what Schneider recommends: Plan, plan, plan.

Nearly all business owners can project revenue or even just sales for the next 12 to 24 months.  Some financially savvy entrepreneurs can take this a step further and project all revenues & expenses to produce net income for the next two years.  Very few have the time or the skill to produce an up-datable financial model that not only projects Profit & Loss, but also projects the Balance Sheet and the expected Cash Flows for 24 months.

It is important for business owners to understand their cash flow needs, but in lean times it becomes critical.  If you want more information on financial modeling and the services we can provide at BiggsKofford, please give Etienne Hardre a call at 719.579.9090 or use our handy contact form.

  • Share/Bookmark
Tagged , , , ,
Comment

Colorado Springs City Budget Markup Session: November 9, 2009

10 November 2009, 6:58 pm

This is the first time I’ve been to a city council session and it was a rather enlightening process, if mostly to see what each member of council found most important and why they supported cutting or not cutting in certain ways.

The 1,000 foot view on the process yesterday is that the passing of ballot initiative 300 produced a $3.6 Million deficit in an otherwise balanced budget.  Each council member had redlined the budget to find $3.6 million and to approve or reject city staff’s recommendations.  They reviewed a list of expense and revenue recommendations each member proposed and kept a tally of the cumulative deficit/excess at the top as each recommendation was approved by at least 5 members of council.

Reviewing expenses first proved to be a bad idea since they ended up reversing many of city staff’s cuts and producing a $7.3 million deficit before they were even halfway through the expenses.  Most of the reinstated cuts were in public safety.  To keep things moving they skipped down to revenue where the biggest impacts were in salary reductions vs. furloughs vs. layoffs.  They argued so intently on these points with Councilmen Hente and Herpin refusing to consider salary impacts of any kind that they put the topic aside, finished out the list and took a break.  That was 3 hours in, so I ended up leaving at that point.  I’m sure we’ll see a report of what was ultimately approved which I’ll post when it’s available.

They did touch on many of the solutions that have been proposed from time to time to reduce expenses in the budget.  For example, Councilman Small briefly mentioned something to the effect of “…we know we’re never going to change the 4 man fire teams…” and Councilman Hente believes strongly that other municipalities pay their employees better than Colorado Springs does.  Small refuses to even furlough or rolling brownout public safety and  Councilman Herpin believes the entire idea of comparing public sector salaries to the private sector average is misleading because we (as a city) have a higher percentage of low paying jobs.  That’s not the message I get from almost every national survey that highlights our area’s high education, high level of professional jobs, and the like, but it outlines the resistance to these kinds of analysis techniques by members of Council.

The mystery of the moving headcounts came to light again as Herpin tried to understand the cuts proposed in Police.  The Police Chief said that they proposed cutting some specialty positions and moving those people back to patrol.  Then they talked about cutting Patrol.  Herpin asked about the impact of those specialists being moved in to Patrol and wouldn’t it offset some of the cuts.  Numbers were being thrown around that included vacant positions, recruits from the academy, and appeared to ignore moving the specialists into Patrol.  In my opinion, the Chief and his analyst never really answered the Councilman’s question, but the council ended up approving the full amount asked for by Police.

Councilman Gallagher brought up an interesting trend when he pointed out that Transit had 1 FTE from the General Fund in 2005 and now has 7.  Grants supported 9 FTEs in 2005 and now support 16.  Since most of the department is covered by grants and contracted out, he refused to support anything more than 1 person in Transit saying that if it could be done 4 years ago that way, it could be done again now.

There were other discussions on LART, Pikes Peak Enterprise (and the impact of ballot initiative 300), the fact that 70% of the budget is salaries, and a lot of talk about partnerships with the community over the parks.  When I left, the budgeted expenses stood at about $213.7 million.

Overwhelmingly, this process was a political one with very little cost-benefit analysis and a whole lot of “I think…” and “I’ve always believed…” statements in support or opposition to certain budget items.  It certainly begs the question: would cities be able to handle these challenges better if they were managed more like businesses?

Resources:

  • Share/Bookmark
Tagged , ,
Comment

The Rise and Fall of a Software Startup

8 November 2009, 2:52 am

Who hasn’t heard of a great idea going belly up, especially in the volatile world of software startups? Ever wish you could get a download from those entrepreneurs about what went wrong and how to avoid the same fate in your business? The fine folks at the Tech Incubator brought us a presentation by Al Davis that proved to be a candid and unassuming walk through the rise and fall of a software company that ultimately closed its doors returning a mere fraction of shareholders’ capital. Here’s a quick overview of what Davis and his management team did wrong as well as a few things they did right.

What Happened

After several successful tech companies, Al Davis started a company that developed a software product aimed at assisting engineers with calculating the optimal mix of features in a product. After four years and several investment rounds, the company liquidated, paid its remaining debts, and returned pennies on the dollar to its shareholders. So what went wrong?

What Went Wrong

According to Davis, the company’s most visible failure was the late addition of a qualified marketing & sales executive. His company went through three marketing/sales directors, each with a dramatically different focus and with varying levels of understanding of both the company’s product and its customers. The first involvement from marketing wasn’t until 6 months after the company was formed and by the time they found a marketer with a deep understanding of their customers and technical knowledge of the product, it was too late. Davis’s hindsight advice is to involve a professional marketer at the very beginning, along with the rest of the skill sets generally considered critical to your success such as financial, management, and legal professionals. Make sure this person understands your customer and your product and knows the appropriate sales methods to utilize.

Another failing was the attempt to create a complete “Cadillac” solution right out of the gate. The software product they developed contained all the bells and whistles they could think of and was priced accordingly. They had trouble selling the product because their customer didn’t even realize their need for all that software. Davis calls it a “solution looking for a pain”. Instead, they ended up stripping many of the features and selling an entry level tool at an entry level price.

Starting with a simple product has several advantages:

  1. It is less expensive to develop
  2. It is faster to develop, allowing you to reach your market sooner
  3. It is easier to explain lowering the average time to close a sale
  4. You can add the more complex features your customers really want by soliciting their feedback
  5. It brings cash in the door today

Finally, spend according to your means. Davis developed a detailed business plan for his company that included targeted levels of investment at each round and expected uses of that capital to meet growth targets. When one of the investment rounds brought in less than projected, Davis chose to continue hiring personnel according to the plan to drive growth. Looking back, he recommends scaling growth investment to the level of available capital, especially if sales are less than expected. In addition, the company was renting Class A office space, and he had personally guaranteed the lease, when their customers rarely visited headquarters. A much less expensive location would have met their needs and freed up cash for reinvestment.

What Went Right

Al Davis has actually been quite successful over his career and the reason he attracted investment in the first place was because there are many things he did right. In fact, a major contributor to this particular failure was the market downturn in 2001.

My favorite positive feature is his employee and investor friendly equity structure. Davis reserved 1/3 of the equity for the founders, 1/3 for future investors, and 1/3 for his employees. Nearly everyone to whom he presented his plan applauded his balance of employee motivation and investor reward.

Davis went even further for his employees and removed nearly all symbols of hierarchy in his company, down to maintaining the same size offices for all employees (including himself). He also went out of his way to keep them informed, even as the company was on its way down. This style of management kept panic to a minimum and employee involvement high which turned what could have been a precipitous plunge into a quiet exit.

Another powerful decision was for the principals to personally invest in every round. Other investors will ask you two questions and personally investing allows you to truthfully answer both questions correctly:

Question: Am I the first investor?
Answer: No, you are not.

Question: Do you have skin in the game?
Answer: Yes, I do.

Finally, and probably most importantly, Davis organized powerful external boards to oversee his company. Not only did he find a qualified board of directors with a variety of useful experience (except marketing, of course), but he also developed an external advisory board in addition. The combined experience and knowledge of these individuals might have prevailed even as the company learned the lessons above had the market not also contributed by reducing the capital expenditures of their customers.

Thanks to Al Davis for his frank and humble commentary. If we are wise, we will let his experience teach us how to become more successful entrepreneurs.

Resources:

  • Share/Bookmark
Tagged , , ,
Comment

How to find the real interest rate

10 September 2009, 1:39 pm

My wife received one of those promotional check offers on her business line of credit today.  She’s a wedding photographer and owner of Megan Hardre Photography.  I’m sure you’ve seen the offer though: 3.99%* for 12 months! Convenient! Flexible!  Write yourself a check today!

Being a CPA, I always read the fine print attached to the asterisk and these offers are just never as good as they initially sound.  I thought I’d take the time to calculate exactly how much interest a business would really end up paying if it utilized this “line of credit” under a couple of scenarios.  I’ll give you a hint: the hidden killer is in the fees.

Let’s take a look at the fine print.

…For each check posting to your Account, we will assess a Promotional Discount Transaction Fee (FINANCE CHARGE) equal to 3% of the check ($5 minimum).

Well, that’s not so bad, you say.  A little transaction fee will at least be offset by the low, low interest rate, right?  Maybe, but probably not.  A 3% fee sounds an awful lot like an additional 3% interest and since this offer is good for exactly one year we can just add the two together to get a real rate for borrowing money under this program and paying it off as late as possible (before the rates rise, of course).  If a business borrowed $1,000, paid $30 in fees (3% * 1,000) and paid it off in a year, there would be $39.90 in interest (3.99% * 1,000).  If you’re paying $69.90 for the privilege of borrowing $1,000 for a year, that’s equivalent to a 6.99% real interest rate ($69.90 / $1,000).

Still not a terrible interest rate for a line of credit, but what if you pay it off sooner?

If you paid it off in 6 months, that $30 fee turns into the equivalent of a 6.00% interest rate (3% / 0.5 for half a year).  Now you’re paying 9.99% annual interest when you add back in the 3.99% interest already being paid.  That sure grows quickly.

Let’s max this program out and assume you borrowed the $1,000 and paid it off in just one day.  3% paid for the privilege of a single day’s worth of credit is a staggering 1,095% annual interest rate! (3% fee * 365 days in a year)  That means if you were to borrow that same $1,000 each day and pay it off a day later for one year you would pay $10,950 to essentially borrow $1,000 for just one year.  And that isn’t even counting the fabulous 3.99% interest they’ll charge you on top of those fees.

Businesses are faced with these kinds of hidden interest costs on a daily basis.  Discounts for paying vendors early and penalties for paying vendors late are among the most common examples.  Overdraft fees due to poor cash management, payday and bridge loans from loan sharks, points and closing costs to refinance, and profit sharing with investors are all components of the real interest cost of borrowing money for a small business owner.  If the real cost of capital is more than what you can get somewhere else or, God forbid, more than the profit you’ll make, it isn’t worth it.  Make sure you do your homework with your accountant before accepting the next “deal”.

  • Share/Bookmark
Tagged ,
Comment
« Older Entries