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What is money to you?
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Overview Transcript Case Study Video
Hattie Bryant, our host and producer since 1994.
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Hattie asks us to consider carefully what each of these very successful people are telling us.
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Key Ideas of this episode
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1. Small Business School Prepare To Invest Personally
2. Get Out Of The Office And Sell
3. Make A Little Go A Long Way
4. Widen The Net With Friends And Family
5. Use OPM To Build Beyond Yourself
6. Take Dozens Of Investors
7. Learn Bank-Speak
8. Consult With Experts
9. Go To Wall Street
10. Small Business School Bonus: Accelerate Collections And Defer Payments
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Key Idea #1: Prepare To Invest Personally
At first, it is all about MOM. "It takes money to make money." And, we all know that truer words were never spoken. And in the earliest stages of starting a business there is only My Own Money. You can not ask anybody to put "skin in the game" until you do. That is a basic reality.

MOM has simple analogies to your own Mom. MOM gives you all the basic motivations to stay focused and to carry your own weight. And, if it only takes nine months to incubate your business (create the foundations for a sole proprietorship), you will be one lucky person.

Not only do you need some cash to start a business, to purchase the stuff of your business (whatever your particular business requires), you'll need cash throughout your entire start-up period. For some of our people that was as long as ten years! Even if everything goes better than you imagined -- you're immediately profitable -- most customers will not pay you in advance and you'll at least need enough cash to fund the gap until the money starts coming in and your business becomes profitable.

Topic for discussion: What sources of MOM, (My Own Money), are available to the small business owner?

Answer: Some business owners started their businesses with personal savings. Others sold assets, such as their homes, to obtain the necessary start-up funds. Tom Gegax and his partner quit their jobs at Shell so they could get their hands on the money in their profit-sharing accounts. If you currently work for a company with some sort of deferred compensation plan, which is what a profit-sharing plan is, this might be a viable alternative to you. You may have 401(k) plan that permits you to borrow against it.

One of the worst MOMs is a withdrawal from your retirement plan. Because the penalties are very steep, it is also an expensive source of MOM. If you have no alternatives and just "know" you are on track, make sure you hold back what you'll need to pay the penalty and the taxes.

Most new business owners keep their "day jobs" and start their ventures in the other eight hours of the day. Some take on new jobs that complement the schedule. Albert Black worked the night shift for 10 years while running his business during the day.

Not all of the necessary funds have to be available at the inception of the company but the business owner does have to have a plan to meet his or her personal financial obligations while (s)he is building up the business. Many business owners take little or no salary from a newly formed business relying on other family members to fund the household expenses.

Be appropriately conservative in forecasting the amount of time it will take before your business can provide you with the level of income you need. Don't start a business without the necessary financial resources for the business and for you, personally, to support both until the business is profitable and generating adequate cash flow. This can take years.

You think about it: If you are thinking about starting a business, how much money will you need to carry you through the point in time where you can support yourself entirely from your business? This is your "gap." How will you close it?

Editor's Footnote: There is more within the discussions about the eight steps to start and grow a business. Particularly look at Steps 1 - 4. Also in that same area, there are discussions about money. Work through all four stages about startup money.

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Key Idea #2: Get Out Of The Office And Sell.

Topic for Discussion: What did Ken Duncan do that most artists are not willing to do?

Answer: He sold his work himself and learned how to build a strong, sustainable company. Several months after Ken told his New York agency to get lost, he went back to the bush of Australia to take more pictures. To fund this second trip, he sold his house. He put every penny and then some into developing a product line. Next, he and his wife and business partner, Pam, convinced an upscale hotel to allow them to run an exhibit in their lobby.

Ken's enthusiasm for the project won over the hotel management. They gave Ken and Pam a room to stay in and complete access to the hotel lobby for the show. The hotel took no money for the space and took no sales commission. They figured the people to coming the exhibition would spend money in their restaurant and bar and maybe even come and spend the night in the hotel. The "overnight" success of this exhibition emboldened the couple and they have not looked back. They have become fine business people who know how to hire and keep great employees. They know how to manage cash and when to invest. They divide and conquer the tasks and they love and respect each other.

Topic for Discussion: What can passion and enthusiasm do for your ideas?

Answer: To grow your business, try Ken's passion on for size. You can see in his face today what the hotel managers saw back in 1981. He has something to share. He is convinced that people need the beauty of God's creation in their lives and he is going to give it to them. Ken reminds us that we will all hear many people tell us, "No." This he says is normal and you can't take it personally. Passion for what you are selling will overcome any feelings of failure and serve as the match to start your fire everyday.

You think about it: When was the last time you closed a sale?

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Key Idea #3: Make A Little Go A Long Way. One of the ways you can minimize your gap is by cutting expenses to the bone.

Topic for Discussion: How does a business owner minimize the expenses of the business that requires a cash outlay?

Answer: Two ways: reduction and elimination. There are some things that you just have to have, but the cost of getting them can be minimized:

  • Comparison shop, including shopping online.
  • Take into account any taxes and/or shipping and handling fees so you know you are making an apples-to-apples comparison.
  • Look for generic brands that don't have the manufacturer's marketing cost built into the price but will serve you just as well.
  • Buy only the quality that you need and in minimal quantities.
  • Eliminate any costs of service you can by performing the service yourself or asking a family member to do it.
  • Accounting and janitorial services are the most commonly done by family members of business owners of start-up companies, but there are a myriad of administrative tasks that need to be done that family members can help with.

You think about it: If you are going to fund your gap with MOM then you want MOM to carry you as long as possible. How can you minimize the costs of your new venture? How can family members participate in the business without compensation?

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Key Idea #4: Widen The Net With Friends And Family.
You did the best you could in your gap analysis but you're out of cash. Perhaps your financial projections were not as accurate as you had hoped, or perhaps you're business is growing slower (or faster!) than you anticipated. For whatever reason, you need money and you need it now.

Topic for Discussion: What's the first source of additional funds for the growing small business which is running short of MOM?

Answer: Every business has a life cycle. It is conceived, embryonic, newborn, matures, ages, and dies. At a point in that cycle, a business becomes bankable. Frequently, before that point is reached, the owner runs out of MOM. The good news is that you either have a "proof of concept" of your business or you are at least closer than you were when you started.

This is the time to go to family and friends and ask to borrow money.

Give them a copy of your business plan (yes, you do need that business plan), financial projections, and a "use of proceeds" sheet that explains how much you are trying to borrow and what you intend to do with it. If you are still incurring operating losses and some of the funds will be used to close that gap, call this "working capital requirements" on your use of proceeds. Borrow the money, and expect to pay a premium interest rate for it. In the earliest stages of your business development, be very reluctant to "sell stock" in your company to friends and relatives until you have studied and are beginning to execute on the various forms of a Direct Public Offering. Even then, it is often very difficult for earlier investors to get liquid, or harvest that investment.

Also, you just have to commit yourself to paying back these loans even if your business fails. There are numerous stories throughout all our episodes where people did just that and the exercise of doing it stiffened their resolve, opened new doors, and became the groundwork for their current successes.

You think about it: If you needed to approach family and friends to augment your MOM, who would you approach? How much could you raise? How quickly could you pay it back?

Editor's Footnotes: Business Plan. If you do not have a business plan, check out this template. For your first draft, just do what you can. You will be working on this document for the rest of your days. Just get the first draft done by yourself. The second draft will come more easily. Within a few years, it'll be "a piece of cake."

Commitment to Financial Integrity: Read the story about Chris and Sarah Fortune or John Stockbridge.

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Key Idea #5: Use OPM To Build Beyond Yourself.Other People's Money should engender the same respect as your hard-earned cash. If you have big plans for growth and your business is sustainable beyond your involvements, and you are sure that you require a substantial infusion of cash to your business, consider equity financing. Equity financing means you are actually selling a portion of your business for a price based on what the value of the business will be after you use the proceeds from the sale of your stock to achieve your business plan.

Topic for Discussion: What kind of equity financing is available to a small business owner?

Answer: As with bank financing, there are a variety of different sources of equity financing. Venture capitalists, angel investors, qualified investors, and the general public all invest in small businesses. To seek equity capital, you'll have to prepare some sort of offering memorandum. You are offering to sell your stock at a certain price. The offering memorandum will include your business plan, financial information, anticipated use of proceeds, and the risk factors to the investors. Both the form and content of offering documents are regulated by Federal and State securities laws.

Topic for Discussion: How does a small business obtain equity financing?

Answer: You will have to prepare a written document that tells your story effectively and in great detail. If you are successful, much of what you write may well be incorporated in an offering document.

Get working on that document, and begin weighing the "costs" of each type of equity partner. All but the SEC's SCOR, a private placement memorandum, requires what are known as qualified investors. The most expensive is the initial public offering on a securities exchange like the NYSE (Wall Street) or the NASDAQ.

It all depends on how much money you need and how the stock in your company will be marketed. Whether or not you will be successful is dependent on the soundness of your business idea, the strength of your management team, the size of the target market and your ability to capture that market, the all important numbers and potential return on investment, and, of course, the risk factors. If you believe you can excel in each of these areas and you pound on enough doors and make enough telephone calls, you will find the OPM you need.

You think about it: Do you have big plans that require big bucks to turn your dream into a reality? Could you give up part of your business to make that happen? For more discussions and links to other shows, explore Steps 6, 7, and 8 on the pathways of growth. Also, be sure to look at the corresponding pages about money: 6, 7, and 8. This page is linked back from each of these pages.

Go to the transcript

Key Idea #6: Take Dozens Of Investors.
With the help of his attorney, a broke Thomas Keller put together a sophisticated financial package.

Topic for Discussion: Where did the money come from?

Answer: First he borrowed money against his own credit cards. Second, he put his plan in writing in such detail that the attorney trusted Thomas to make what he had written about happen. Third, a bank was willing to finance the property and on top of that, the SBA backed an additional loan for operating funds. And fourth, he convinced 48 separate investors to join him on the the venture.

Topic for Discussion: Since most businesses are launched with less than $10,000 why did Thomas need four cash sources?

Answer: Mainly because he was buying real estate but also because his experience had taught him that a startup needs plenty of cash. In fact, there is usually never enough. In the first year, even with servicing all of the debt, he was able to eke out a $6 profit. Yes. Six dollars. That was a victory for Thomas and he took it as a sign that he would succeed in Yountville.

Topic for Discussion: Why so many investors?

Answer: This was intentional. Thomas told us he didn't want to take a large amount from any one person for two reasons. First, if he failed no one person would lose too much. And second, Thomas didn't want to have to coddle a single large investor. This is time consuming and draining. We think this is brilliant.

Topic for Discussion: Do you have to use an attorney to help raise money from investors?

Answer: No, but if you take money from an investor, you should have an attorney structure the deal. Borrowing from family or getting a loan from a bank doesn't require you to have your own attorney, but if you do seek investors, use an attorney.

Topic for Discussion: Is Thomas Keller a salesman?

Answer: Yes and no. He said, "I wanted it so bad that I made it happen." This means that, even though he doesn't consider himself a salesman and he doesn't enjoy asking people for money, he did it anyway to make his dream come true. So, he had to be a salesman to achieve his goal.

You think about it: What could you do with a large injection of cash? Is it time to take on investors? Is it time to buy your own building?

Go to the transcript

Key Idea #7: Learn Bank-Speak.
When your business becomes profitable and is growing, you may find that your cash flow is tighter than ever! You have profits, net income, but no cash. This is because you are increasing your investment in inventory or receivables. One way to ease this situation is to leave the profits of the business in the business to provide the working capital the business needs. Another way is to borrow money from a financial institution.

Topic for Discussion: What kind of bank financing is available to a small business owner?

Answer: The most expensive money to borrow is the money you get for factoring your receivables. Almost all factoring arrangements are "with recourse" which means you have to pay if the customer doesn't. Basically, you sell your receivables, at a deep discount, to the bank. The bank or factoring company advances you the discounted amount and you advise your customer to pay the factorer directly. In addition to the discount fee, the factorer withholds an amount as a reserve against uncollectible accounts receivable. If not utilized, reserves are distributed back to you. Although factored funds are expensive, the lending institution rarely has credit or reporting requirements so factoring can be a solution in small businesses with high gross margins that can absorb the cost of factoring.

Less expensive is conventional bank debt. There are basically two kinds of bank borrowings: lines of credit and term financing. Lines of credit are available up to a maximum negotiated amount, through a period of time, at a certain rate, generally collateralized by inventory and/or receivables. The amount that can be borrowed at any one time is based on the borrowing base, a certain percentage of assets.

For example, a borrowing base might be 35% of inventory and 80% of accounts receivable less than 90 days. The percentages are negotiated at the time the loan is applied for. Frequently, lines of credit are renewed as they mature, but the terms may change as the economy changes and as your business changes. These lines require interest only payments although the bank likes to see principal payments and additional withdrawals, the line going up and down, based on the seasonality and growth of the business.

Mature businesses with constant line of credit amounts make bankers nervous; the bank generally considers the note "evergreen" and, when it comes up for renewal, they'll want to convert part or all of it to term. If you obtain a line of credit, don't leave cash in your checking account, pay down on the line and borrow it back. This minimizes your interest expense and convinces your bank that you really are using the line as a line.

Term financing is just like your home mortgage or car payment. Each month you pay a fixed amount of principal and interest. If your business owns land, buildings, or equipment (capital assets) these can be used as collateral for term financing. If you own such assets personally, you can contribute them to your business as equity and then use them as collateral for a cash infusion in the business from a term financing.

Topic for Discussion: How does a small business apply for bank financing?

Answer: Bankers are vendors; they sell the use of their money. They do this for a relatively modest return and they take modest risks. Shop for a banker the same way you would shop for anything else you buy, look for the most value at the lowest cost. Interview lots of bankers, preferably before you need one, and keep them informed of how your business is growing. Before you submit a loan application, make sure you are aware of the following: Who will prepare the loan package and what will it contain?

The loan package should not be confused with the loan application. The loan application can be as little as a one page administrative document. The loan package could be 3 feet high! It contains all the documents that you provide and other documents that the banker obtains to present to the bank's Loan Committee.

For example, the Dun & Bradstreet report is almost always considered as part of the loan package and the credit decision.

Who's on the bank's Loan Committee? What is their lending limit? If they recommend the loan be approved, is that the final word or does the loan package go on to an even higher authority? You'll probably be dealing with one banker; he or she will present your case to the Loan Committee. Your banker will be motivated, because one's compensation and career depend on making money for the bank which is only accomplished by booking loans. But nobody can tell your story as well as you can. Find out who is on your Loan Committee and invite them out to see your business and meet with you.

You think about it: Do you need to borrow money to grow your business? How much? Do you have the collateral and the capacity to repay the debt?

Editor's Footnote: If you really want to learn the language of banking, get familiar with the Risk Management Association and their credit scoring. It is the professional association for banking (over 3000 banks are members as well as 18,000 other financial institutions). If you are fully committed to making your business successful, you'll learn the key critical ratios within your industry and know where your business stands among the businesses within it.

Go to the transcript

Key Idea #8: Consult With Experts. Small business owners are in-charge of operations, administration, finance, marketing, human resources, technology, and everything else! No one can be expert in all of these areas. Each of us needs to "know what we don't know." If part of what you don't know is finance, find a CPA who can help you. And if you decide you want OPM to really grow your business, you'll also need an attorney and perhaps a venture capitalist, angel investor, business broker, underwriter and/or investment banker.

Topic for Discussion: Where does a small business owner find these experts?

Answer: Of course, talk to those who have done it! Other small businesses in your community that have been successfully served by their financial experts are a great source of referrals to you. If you have one expert, e.g., an attorney, whom you are really pleased with, than ask the attorney for referrals for the experts you need. You should interview several candidates for each role. You are looking for technical competence and a feeling of comfort in dealing with the expert. Look for experts that are able to explain complex terms in layman's language. Remember that ultimately you will have to make the decisions; the role of the expert is to explain your options to you and make recommendations. Ask each expert you interview for references and call them.

You think about it: Do you have the financial experts you need to assist you in finding money for your business?

In each state (and eventually every country) we are compiling our own list of good small business advocates. Check with some of these people in your state if you are coming up with no solid references to help you.

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Key Idea #9: Go To Wall Street. To win on Wall Street you must tell your story well. Sounds too simple but great ideas are simple and simple to explain.

Topic for Discussion: You have to have a great story to tell and you have to tell it with passion. But there is more. What else did Andy say you need in order to take your company public and actually convince investors to give you money?

Answer: Timing. If you think back about what was happening in 1996, the dot com flurry was just beginning. Andy admits that it was a good time to go public since his business was so different from the high tech, cyberspace-driven upstarts mainly from Silicon Valley. Andy's story was about a company that would turn around and put money into people who would otherwise never be able to start a business. Can't you hear the violin playing? Yes. The Medallion Financial story is tugs at the heart strings of successful people.

We know that we are successful because other people believed in us. It may have been our parents or a grandmother who loaned us a $1,000 to get started in business. Immigrants don't have connections to people with means with they arrive in the US. Medallion Financial is an oasis in the desert.

Also, by the time Andy took the business to Wall Street, it had a perfect lending track record. Andy raised $50 million with his first offer then went back a year later and raised an additional $50 million. Even though they did not need the money, because the stock price had gone up 50% and more investors wanted to be part of the success, advisors told Andy to make a second stock offer.

Two years later, Medallion had people clamoring for the stock so they made a third offer and raised another $50 million dollars. Andy said, "We didn't really need the capital but again the economy was good and our stock was doing well." So, the lesson is, you raise money when you don't need it.

You think about it: Should you sell stock in your company? Did you know that you can do what Andy did and go to Wall Street or you can do a Direct Public Offering?

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Key Idea #10: Accelerate Collections And Defer Payments . Managing cash flow from operations is a great way to extend the life of MOM. Any amount will go further if you can get cash into the company quicker and postpone disbursing funds from the business.

Topic for Discussion: How does a small business owner manage cash flow from operations to his or her advantage?

Answer: In addition to the money you put into the business, debt financing and equity financing, there's cash flow from operations. Primarily, this consists of cash receipts from sales, generally the collection of receivables, and cash disbursements related to inventory and other accounts payable purchases and, of course, payroll. Let's look at cash management strategies for each of these:

Cash Receipts from Sales

If you are not in a business where your customers pay cash for goods and/or services received, then you will have accounts receivable. The sooner your customers pay their bills, the better your cash flow. To encourage them to pay promptly:

  • Collect advance deposits on sales if possible.
  • Get your invoices in the mail quickly, preferably delivered with the goods and/or services.
  • Offer a small discount to customers who pay the invoice substantially before it's due. Put this clearly on your invoice, e.g., "2 10, Net 30" means the customer can take a 2% discount if (s)he pays in 10 days, otherwise payment is due in 30 days.
  • Charge interest on amounts not paid on time, i.e., according to the terms of the invoice. Prominently display the interest rate and terms on your invoice.
  • Call each customer on THE day that his or her invoice is past due.
  • Mail monthly statements summarizing outstanding invoices.
  • Most accounting software packages used today have this capability. Most importantly, minimize your bad debts. Get credit references and do credit checks on all new customers. Monitor your accounts receivable aging daily and stop shipping or serving problem accounts until collection issues are resolved.

Inventory Purchases and Other Accounts Payable Items Here, our strategy shifts. While we do everything we can to accelerate the flow of cash into our businesses, once it is there, we do all we can to hold onto it as long as possible. Don't cross the line of affecting your credit rating or vendor relationships, but walk right up to it. Here are some specific things you can do:

  • Practice JIT inventory control. JIT stands for "just in time". Order what you need to be available when you need it, but don't stockpile goods. Inventory investments tie up MOM.
  • Ask your vendors for extended terms. Tell him you are starting a new business and you could build it up faster if you could match your payments to the vendor with your collections from your customers. Take the time to explain your business to your vendor and then ask for terms of 30 days more than your normal collection cycle. In other words, if most of your customers pay in 45 days, then ask for 75 days. Remember, your vendors are like you, they are looking for new quality customers. And who can better sell the idea of your business' promise than you?
  • Deposit your funds locally and then arrange to have them transferred at the end of each day to an out-of-town bank. Write your checks on the out-of-town bank. This usually gains you about three days of "float" where the vendor records your payment before the funds are actually available to him or her. Writing a check without the funds to back it up is against the law and we are certainly not advocating anything illegal but good cash management systems take advantage of the float.

Payroll If you are one of those rare small businesses who have started your business with employees, you have special considerations.

Meeting payroll is one of the biggest responsibilities and expenses of most businesses. You do have to pay your people and you certainly have to deposit your payroll taxes on time. Still, there are some cash management opportunities here.

Outside payroll services and staff leasing companies provide a wonderful service to small businesses. In addition to handling all the required filings, they offer the opportunity to procure certain employee benefits, such as workmen's compensation insurance, at reduced rates since you are purchasing as part of a large pool. But these services may be a luxury you cannot afford in the early years. In addition to the cost of the service, because the payroll service company is writing the paychecks for your employees on their account, they'll require that you fund that account several days in advance to ensure the funds are available as they process the payroll. They also draft the payroll taxes from your bank account, including the employer portion of social security, as the payroll as processed.

In fact, you are required to remit payroll taxes, those withheld from your employees and the portion the employer pays, at varying times based on the size of your payroll. The smaller the company, the more the deposit can be delayed. You can research the statutory requirements in your State on the Internet. The point we are making here is there are cash management opportunities in processing your own payroll.

You think about it: What can you do in your business to improve cash flows from operations?

Questions? Drop us a note.

GO FURTHER: Go to the transcript, the overview (or executive summary), the video or the homepage for this episode of the show.

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