Small Businesses Mismanage Sales Tax

When Strategic Funding was in its early days we began to look for bank lines of credit so that we could expand our business of financing small businesses across America.  The banks liked the idea of working with an alternative lender as it gave them a way to indirectly serve that market without the direct risk of lending to Main Street businesses. Strategic became the borrower and, in turn, provided working capital directly to the individual small business.  This was necessary because so many small businesses lacked the financial management skills to provide adequate financial statements and cash management disciplines to qualify for bank loans.

Because many of us were once small business owners we understood our typical small business customer better than the banks. Cash flow determined how sound their businesses were, but certain traits were common amongst our applicants.  Many of the applicants had tax delinquencies, liens and judgments against them.  This was unfathomable to bankers who assumed that paying your sales tax was a priority – not understanding that keeping the lights on, meeting payroll and inventory took precedence. We also know that how the business owner managed their tax payments and general cash flow was as important as how much it was. We understood these customers well and could help many of them through education and often an injection of working capital to get them on the right path.

When I owned my first restaurant a hundred years ago, I experienced the wrath of the taxing authorities when I missed successive tax payments as I was trying to survive my maiden voyage in this business.  I was so busy managing, cooking, covering vendors, paying utilities and keeping the place clean and well staffed that I didn’t pay much attention to the mounting taxes. I thought it could wait and thought the state would offer me an easy and manageable payment plan. I’d be happy to pay reasonable fees and interest since I hadn’t put the funds aside. I looked at it as a loan from the government. That was just delusional on my part.

One day just before Christmas, I got a call from my bank telling me that revenue officers had come to the bank and levied my accounts. They grabbed everything in them and everything I had just deposited from the previous business day – including the revenue from that big fat holiday party I did.  I had never even heard the word “levy” until that day.  Now I was in real trouble as I had no money for my vendors, landlord or payroll. I was dead in the water. All my credit card receipts were being processed and were going directly to pay the taxes. By this time I woke up – the judgment amount had doubled my outstanding balance as penalties, interest and fees surpassed the liability.  As a new business owner I was in trouble and realized I had made a dumb move that I vowed would never happen again.

Over the years, I opened up more businesses in a variety of industries. Each state I operated in had it’s own system for collecting sales tax and, of course, you always had the Feds to deal with on payroll taxes.  Regardless of the state or the payment schedules, I put procedures in place to prevent this costly error from ever happening again.

RULE #1 – SALES TAX COLLECTED IS NOT YOUR MONEY!!  You need to realize that you are just holding this money for someone else – as if a customer left her purse at your business. It’s not yours and you will return it to them.  Many small businesses charge and collect sales taxes as they are required to do. The real mistake comes when owners use the sales tax revenue as part of their operating capital.  They float their operations with sales taxes money to keep them from going negative. They do this until taxes are due and hope the funds will be available when they have to file. Well, guess what?  Very often they can’t scrape together everything they owe and end up either not filing the return (really bad) or filing the return and sending a partial payment (better – but still bad).

If you need to use this money to steady your financial boat then you really need to evaluate the health of your business.  Without using tax money, is your revenue enough to cover your expenses, payroll and direct operating costs while yielding you a profit? If you are using tax money you aren’t making it and need to take a hard look at your business and figure out how to fix it.

I recommend that you immediately separate and impound the sale tax funds in a dedicated “tax account” – every single day.  That means when you close out your register for the day – identify the sales tax charged to customers and collected by your staff and separate it.  That amount includes any taxes charged to a credit card even if you have to write a check to cover it. Impound those funds and deposit them directly into the separate dedicated tax account.  Get it out of your cash flow. This makes it available and easier to track, audit and account for.

Resist temptation. Do not raid this account if your operating account is short.  Set up a relationship with your bank or an alternative lender to provide working capital  when needed. It’s easier and less costly to work it out with them and pay their fees then risk being short on tax payment day.  The other dark truth is that liability from tax delinquency will also follow you personally even if your business fails and you have to file bankruptcy.  Tax obligations are not discharged in bankruptcy so you are on the hook forever. They will never go away and will compound at an astronomical rate. A very expensive mistake.

A good tax policy and strategy will help your business stay healthy and grow.  If you want to discuss your business questions, you can email me at dsederholt@sfscapital.com


Decoding the Investor Pitch for Small Business Owners

As a serial entrepreneur and retired COO of a small business finance company, I am most often asked WHERE business owners can obtain financing.  Most of these folks believe that if they are pointed in the direction of capital, they can knock on the door and simply ask for it.  There is a profound lack of understanding about the fact that how one presents their investment opportunity (their business), along with how well prepared they are for this presentation, can significantly affect the outcome in their quest for financing.

I’m not going to talk about the creation of a solid and understandable business plan, or possessing professionally prepared financial statements and projections. My goal is to decode some of the subtleties of the pitch you must make to investors.

The process begins long before you get in front of investors, fund managers or investment bankers. You have so much that you wish to convey and understand the concept of the “elevator pitch” that you were taught in business class, but now the game is real and you are going out there to raise money.

Over 40+ years in business – as both the person pitching a deal and someone being pitched to – I’ve learned some very valuable tools from being beaten up by the best and, ultimately, obtaining financing for my businesses…including an IPO.

It’s fairly universal and simple – all developing businesses need capital to start and grow.  The initial investment may have come from your savings, friends and family, or an Angel Investor –  it doesn’t really matter.  But once you’ve broken free from that close orbit, you need to learn ways to negotiate the new frontier of obtaining capital in a highly competitive world.

When I first started out, I thought I would go in front of a potential investor with nothing more than my smiling face and enthusiasm and convince them to write a check for my budding venture – just because “they got it”.  Not so.  I met a lot of people who were very nice and some not so.  None of them saw my vision and I ended up raising zero dollars to start my new venture. As with most entrepreneurs in this position, it was ultimately my home equity line and family members who put up the seed round to get me going.  Nice to be in business, but I learned nothing about raising money from outside investors.  That came later when I built out a multi-unit restaurant chain and was convinced that the way to grow exponentially was to “take it public”.

We were lucky that our Investment Banker was well versed in our industry and that the partner in charge of our offering was patient and an excellent coach.  My partner in this venture thought of himself as a PT Barnum type promoter and salesman who would ramble on for days if allowed to but was lazy when it came to facts and financials.  He would talk about the showbiz aspects of this great casual theme restaurant concept that we created and all the sizzle but not the steak.  Keeping him on the rails was a task for the banker in charge, which frustrated him to the point where after one presentation he blurted out – “just shut up, and speak only when I tell you to, then stop and say nothing else”.  I originally thought that the colorful way my partner told our story was a plus not a minus.  I was wrong.

To paraphrase Franklin D. Roosevelt, it is far more valuable to “Be sincere, be brief, then be seated”. Professional investors see hundreds of business plans, many of them with interesting ideas or strategies, but unless there is something that grabs their interest they will not want to hear your life story.  The idea of the classic elevator pitch applies.  How do you get the investor interested in just a few short minutes?

One of the prime directives that I learned was not trying to accomplish a major data dump or an expert level understanding of my business model in my first pitch to a potential investor. My goal was to get a next meeting, not close a deal.  A few years ago, I was introduced to an interesting concept for effectively communicating your business vision, which after I heard it produced one of those silly “ah ha” moments as it was quite obvious.

A young professor at Columbia University named Simon Sinek, introduced a unique concept in communicating their vision.  Simply put, he argued that businesses shouldn’t be presenting what they do or how they do it – they should start the discussion with WHY. Presenting WHY this business is important and an outstanding opportunity for investors focuses them on WHY they should take their time to listen to you. At first it may seem that return on their investment answers the “why”, but most investors are seeking more. Does your why statement express what makes your business unique, scalable, market ready or any other trait that should arouse the interests of the investor? You may want to get down to the details of how you make the sausage, but the investor wants to know why this sausage is so special that they should listen to your story.  If they like what they hear – you will get invited for a follow-up meeting.  Goal accomplished.

Trying to get a sense for what hot buttons can trigger interest in a particular investor are key to a successful pitch.  Listen as much as you talk when going to pitch – as you may have to change strategy on the fly.  The return on investment is always attractive, but what other features of your pitch make your business attractive?  Is it technology? A large underserved and growing market? Is your process patented? Is there a grand obstacle to entry for competitors?  Feel them out and things they say will lead you in the right direction.

Your presentation can also set the tone for success. Confidence is good. Arrogant, know it all attitudes often go down in flames. Too often, presenters try to sell the opportunity too hard as opposed to making the investors “feel” that the business has real potential.

Being succinct and focused is another prime element. Tell the story beginning with why this is important without rambling all over the place. A beginning, middle and end to the story done as briefly as possible. Details can be added but your goal is to get to a second meeting where you can take a deeper dive. Make sure your representations and projections are accurate and realistic because you are done if you can’t defend your presentation. You cannot be oblivious to the facts, so know what you are talking about and if you don’t know – say so.

Many investors want to determine if you see the potential flaws and weaknesses in your business and if you actually thought it through. Be honest and transparent because truthfulness and candor are valued.  Along the same lines investors will typically ask how much money you have put into your business.  They want to know hard dollars not sweat equity.  If you haven’t put any cash in, you need to honestly explain why. Many investors believe that founders must have skin in the game in order for them to back you.  After all, if you don’t believe in your business enough to put hard dollars in – why should I?

Two other key elements may trigger strong responses from investors.  The first is having a realistic valuation for your business.  What is the basis for your belief that your company is worth X?  Don’t pull it out of the sky.  Your assumptions should be tied to comps in your industry that reflect revenues, earnings, time in business – not pie in the sky assumptions.  In an early-life negotiation on valuation I had a go round with an investment banker.  He gave in on my price but came back with some very aggressive terms that yielded far more to his side than I anticipated.  He said, “OK, your price, but my terms”.

Most important to any investor is the management team. If you are a startup or have a small company, investors are really getting behind the management and growth of a good idea.  If you have an experienced management team that can deliver results…you win.  If someone on the team falls short, don’t be surprised if a condition of investment is the replacement of that person.  This could also include you, as the head of the company.  To grow your equity, they may want you to step aside for a more seasoned executive.  Not common, but it has happened.

You should hope for an investor that will be eager to work with you and for the benefit of the business, not just themselves. It’s not just money that you are seeking, but also support, experience and connections to help grow the business. You need to come to grips with control issues and shareholders rights and remember that your new investor will be with you for a long time, so choose wisely. When working with investors it’s a good idea to remember the Golden Rule of business… “He who has the gold rules”.


How to Get Funding for a Small Business

It is a well-known fact that small businesses (SMBs) are at the core of the US economy and are the largest employer in almost every sector.  Despite this, it has been proven to be extremely difficult for business owners to find favorable financing to sustain and grow their business.  In fact, many have found that it is far more difficult to finance their operation than it is to run it.  In this piece I’ll discuss how to get funding for a small business and the many financing options that are available to SMBs.

Recently, a business owner asked me about which type of financing was best for him.  The obvious answer is: the type of financing for which you will qualify.  But this answer not only creates the first obstacle you’ll encounter on the road to funding, it will also set the tone for your capital search. Obviously, the primary goal is to find the type of financing that offers you the most money for the lowest cost and the longest repayment terms – with the fewest downsides. The reality is that this set of terms will vary wildly depending upon the credit quality of the applicant.  A problem for many SMB owners is that they develop a preconceived notion of what their financing SHOULD look like as opposed to what it will REALLY look like based on the credit quality of the borrower.

The first thing you should do when embarking on your search for financing is ask yourself one question – Am I bankable? This is a broad term that indicates if you can go to your bank and obtain a loan or equipment financing under traditional terms or with the benefit of an SBA Guarantee.  In my years of experience in business finance and as a SMB owner, I can say that the vast majority of SMBs are NOT bankable, even when they have heard their banker say that they could obtain a loan.  Terms for traditional financing are rarely presented realistically during the application process and most applications are rejected because the borrower cannot meet the requirements of the lending institution.

The second thing you need to do is to remember to be objective and determine exactly where your chances lie for approval on various products and with the different types of lenders. You must accept that there is a risk pricing differential with different types of financing and with different lenders. The easier the credit terms and the quicker the origination usually spell out more expensive financing. In many cases, it is worth the cost – as other lenders wouldn’t fund you at any cost.

The third thing you need to do is obtain as many offers as possible –  don’t be insulted by an offer to finance even if it is onerous and seems outrageous.  You can always pass.  In evaluating the offers, you must remember the Golden Rule of lending applies – “He who has the gold – rules!”

Obtaining Small Business Financing That’s Best for You.

The basic understanding for this guide is that you are already an operating business. Start-ups are an entirely different discussion. So, if you have been in business for at least 1 year, read on!

SMB financing options cover a wide spectrum – from traditional banks, credit unions and non-bank institutional lenders to non-traditional lenders, alternative finance companies, crowdfunding platforms and friends and family.

Banks, Credit Unions and the SBA may offer lower rates and longer terms, but the obstacles to obtaining one of these loans are considerable. On the other end of the spectrum are alternative finance companies, equipment leasing firms and even your personal credit cards, which all share the same features.  They are far more expensive than traditional bank financing – but they are readily available and far easier to get approvals.  The true value of money is in its availability.  What good is a 6% loan from your bank if you can’t get approved for it? On the other hand, if you are a high credit quality business – why should you short cut yourself for high cost financing?

Let’s see if we can help you manage your expectations and give you some insight into the lenders perspective.

What do the banks and SBA want?

I have spent many years around bankers and have asked a number of them what qualifications are needed for them to consider lending to an SMB owner.  They always offer the obvious response: everyone has their own unique circumstances underwritten at application. But almost every banker I have spoken with talks about the “Five C’s of Credit”.  This is a basic set of criteria that they all use when evaluating a company for a loan:

  1. Capital – Lenders want to see that you have skin in the game. How much hard capital have you put into the business? They don’t care about sweat equity – they want to see the cash.  Most lenders want to see between 10 – 40% of the total capital in the business coming from the owners. They want to see that there are hard and soft assets from machinery, equipment, real estate and some will even consider proprietary IT technology. They want to share the risk with you, and your investment insures you will suffer too if the business fails.
  1. Collateral – these lenders are “risk averse”. They want to know that if, for some reason, your business fails to pay back the loan that they can attach assets and liquidate them to offset the debt. This is one of the reasons that they want to see meaningful assets in your company before lending to you. Not all loans require collateral, but if you want favorable terms, you should expect it.  In the case of SBA Guarantees, you will be required to pledge not only the business assets, but all owners holding 20% or more of the business must pledge their personal assets as well.  Homes, cars, cash, jewelry – everything. If you can’t pay back the loan, you could lose everything.
  1. Capacity – This is a measure of your ability to pay the loan back. A lender must have a realistic expectation that the borrower does indeed have the capability to repay. Lenders rely on numerous metrics and factors in determining your “capacity”. First among these is your personal credit score. Even though this would be a business loan, the main driver of an SMBs success is the owner. If you don’t pay your creditors for personal debt, it is a reasonable conclusion that you won’t pay your business debt. To get to the next step with a bank you will need a strong FICO of over 700 with no liens or judgments. This is very rare among newer or struggling entrepreneurs.  The bank will also look to your current vendors for your payment history. A prime factor is the Debt Coverage Ratio demonstrating that you generate more income than necessary to pay off your debt. Most lenders look for 1.25x or higher, which relates to the big driver of cash flow of the business. They will look at average daily balances, number of NSFs and general liquidity. If you have cash, then they know you can pay back.
  1. Conditions – This looks at the reason for the loan (what the money will be used for) and if the bank feels that you will be successful in reaching your goals. The bankers will look at everything from the economic conditions in general to those in your local area. The industry you are in is also a strong indicator of success. The “SIC code” of your business provides risk assessments for your business – and it can work with you or against you. Most importantly, the bank wants to understand the purpose of the loan and if the proceeds will help you grow the business as opposed to adding to your debt load. You will need to provide an explanation for the amount you need, why you needed it, details on how you plan to spend it and the benefits you expect to gain from the loan.
  1. Character – This is a difficult factor to evaluate, but the bank is basically trying to determine if you are of good character and can be trusted to perform. This can be very subjective and often determined by the bankers that you speak with in preparing your application.  They want to know as much as possible about the person behind the business. Are you a novice or a seasoned professional in your field? What is your background? Did you have prior achievements they should know about? Do you have strong professional references from vendors, customers or credit providers? Do you have any blemishes that would influence the decision-making process like arrests, DWI or old tax problems?

What types of Lenders do I have to choose from?

  • Large Commercial Banks- These are the big guys. You know them – JP Morgan Chase, Citibank, Wells Fargo, Bank of America. These banks all have assets greater than $10 Billion and are large bureaucratic machines. While the largest banks account for about 40% of SMB loans, they do very little lending to Mom and Pop businesses or those that fall within the agriculture industry. Community banks are far more active in those sectors. Large banks are better for bigger, more established companies who seek over $250k in loans. This is their true minimum lending floor – it’s simply not worth their time processing smaller loans.
  • Mid-Tier Regional Banks- These multi-branch banks have a great deal of local power and are more receptive to the needs of their SMB customers. They have strong asset bases but practice the same strict underwriting practices as the larger banks. Their local knowledge makes it much easier to communicate with them and many are strong SBA partners which can be immensely helpful.
  • Small Community Banks and Credit Unions – These are the grassroots institutions for true SMBs to work with. They still believe in the value of knowing their customers and their community, and work hard to build strength in all. This is where most of the US agriculture loans are originated. However,, smaller community banks are finding it hard to compete and are closing at a regular pace. This requires them to be more conservative, which can influence the outcome of your loan request. Only 40-45% of their loan applications are approved.
  • Non-Bank Financial Institutions – Access to these lenders is usually limited to higher growth specialty finance. These groups rarely, if ever, consider Main Street businesses. Large firms like CIT or Apollo will provide multi-unit franchise financing for restaurant or hotel chains, but not loans to single unit operators. These groups include private equity firms, hedge funds, family offices and high net worth individuals. You must be well prepared with strong documentation and the ability to pitch your deal and defend your representations with facts. This is not for financial amateurs or novices.
  • Alternative Finance Companies – Over the past 15 years, this has been the fastest growing sector for SMBs to access capital. Factoring companies, merchant cash advance, FinTech online lenders and equipment leasing firms all fall into this category. Most of these companies lend from banks and take on the credit risk for the performance of their clients in return for higher fees.  The main attractions are speed, less documentation and higher approval rates. They will often look for a blanket UCC security agreement over the assets of the company, but do not require the hard-collateral pledges that banks and SBA require to provide loans. Their cost of capital is high because they take considerably more risk to provide financing than banks do.
  • Crowdfunding – Crowdfunding appears to have key advantages of being quick and easy to raise money, but it really isn’t as easy as it appears. First, you need to determine the type of crowdfunding you wish to pursue. Rewards based platforms solicit donations for worthy projects or companies in return for “rewards” that you provide. Typically these are discounted products or services that your business normally sells. Debt and equity crowdfunding involves high levels of transparency and reporting as well as time consumption and expense. Depending on the platform you choose, you can have access to thousands of investors, but you will need to give up a chunk of ownership if you succeed in raising the capital. Many Crowdfunding platforms have specific rules governing time limits and funding goals. If you don’t reach your goal after a specified time, you lose. Or you may encounter an “all or nothing” funding policy, precluding you from accessing capital raised beneath your goal. Some users have been disappointed to realize that often the success of the campaign revolves around their social network. This means that you are really doing a “friends and family” round – but incurring fees.
  • Independent Brokers – There has been a dramatic explosion in the number of independent brokers/“finance advisors” who are marketing loans, lines of credit, invoice factoring, receivables financing, cash advances, equipment leasing and other products to the SMB community. Some brokers are reputable and can be extremely beneficial in expediting the process of finding financing. They can look at the overall parameters and know where to place the application for fastest approval. On the other hand, there are bad players who are only interested in their own enrichment. Some ask for retainers up front and fail to deliver. Buyer beware. Know who you are dealing with. Look for complaints and ask a lot of questions before trusting your financial information to an unknown outsider.
  • Friends and Family – This is one of the most common places where SMB owners seek seed money or general working capital. While this can offer few obstacles to funding since this is a supportive and familiar lender, failure to perform can negatively impact your relationship with these people for the rest of your life.
  • Personal Savings, Home Equity and Credit Cards – Before draining your savings, your business plan should reflect cash reserves to carry both you and your business through hard times. Most businesses have ups and downs. The failure to plan for this can be catastrophic. The use of funds from a Home Equity loan or Line of Credit can be a very useful tool in supporting your business.  Interest rates are relatively low and the money is not being lent on the qualifications of your business. It is being given to you against the equity value of your home. The downside is that if your business fails, you could lose your home as well. Also, some SMB owners feel it is reasonable to finance their business with their personal credit cards. This can cost upwards of 29% compounded, which is a formula for disaster.
  • Landlords and Real Estate Developers – If you have a brick and mortar business and you need to make improvements to the space you are occupying, landlords and developers often provide “tenant improvement allowances” or TIAs for businesses to enhance the overall building. This is usually paid back in the form of additional rent or larger escalations in annual increases.  This can be a good way to access capital for betterment and improvements, but sometimes the escalations exceed the business’s ability to pay.
  • Wholesalers, Suppliers, Purveyors – Every time a Wholesaler/Supplier extends you terms to pay for your supplies, you are receiving a de facto loan. This allows you to pay for goods after you have had the opportunity to sell them at a marked-up rate. There have also been instances where primary suppliers have made direct loans or investments in SMBs that are material to their business.
  • Government Business Development Agencies – Depending on the type of business you have and the location, various state and local economic development agencies offer loan programs and grants. These opportunities are often very specific in their requirements, including formal financial statements and reporting. Most have extremely favorable rates.

Running the Process

The search for financing should be run as an organized process. Knowing what you know about your qualifications, your first decision is to target the groups to which you should be submitting applications for financing.  In this process of elimination, the lenders will decide to approve or decline your application. Depending on the offers, you then must decide to accept an approved offer or continue to shop – or if declined, where to apply next.

While each lender or equity investor assesses applications differently, there are numerous reasons why an application is rejected. Below are a few key reasons:

  • Poor Credit Quality of the Owners and/or Business
  • Poorly Prepared or Inaccurate Financial Statements
  • Industry is a Poor Credit Risk
  • Geography / Region has Economic Challenges
  • Insufficient or Inconsistent Documentation
  • Negative Cash Flow / Insufficient Sales
  • Tax Liens and Judgments
  • Undisclosed Negative Information about the Business or the Principals
  • Seasonality of Business / Sales Instability

 If you have the time to actually shop for the financing you need, it is often best to aim high and hope for approval, then work your way down the waterfall. It may be labor intensive, but could provide you with lower cost, longer term and more favorable options. Your goal is to find the best deal you can, but be realistic and objective

In cases where any one offer is insufficient to satisfy your financing need, combining a number of approved options into a blended structure can give you a better cost structure. Smaller but lower cost personal or commercial loans can be supplemented with higher cost cash advances and equipment leases to give a blended rate that is much lower than the more expensive products.

Do your homework and be realistic in your expectations. Take the application process seriously and be as meticulous as you can. Good hunting!


en_US
es_ES en_US