Emotions and adrenaline are usually on a high when one is looking to buy a business or start a new business. Sure enough, being you own boss is the American Dream, so we can understand. However, very often, people get carried away by an opportunity gaping at them, that desire to succeed or the high confidence levels, which at times, become blinders, where they lack the ability to look beyond the rosy-new, ambitious journey that they are about to embark on.
That is all great! But what we want to talk about today is the “what ifs” referred to as “risks”, a word that is so very existent in the financing world but most small business entrepreneurs don’t acknowledge or accept it. It’s like that axe that’s always sitting above our heads, and we know it, but we just don’t see it. One wrong decision and everything we created, blows up in front of our face.
Projections, that show the ability to pay back, are mixed with that same desire, opportunity and confidence that so often, banks discount a certain percentage of, because they know it.
People put a big part of their life savings into starting or buying that business without even thinking about the dangers of running into a wall. What if consumer spending takes longer than expected, will sales be at the projected levels? What if competition opens up within a 3-5 mile radius and slowly there is attrition in sales. What if you didn’t have the experience in that industry and as an absentee owner you relied on the manager who ran your business down or into a hole. All this has happened many a times and it can happen to you too.
I am talking about Exit Strategy. It’s important to be prudent, be prepared, and use caution. Once someone told me, usually everyone wants to run through that amber traffic light but sometimes its turns red and that’s when we get a ticket. In this volatile economy that seems to be crawling back slowly, there still is that need to be careful, cautious, and practical. Seek guidance from a professional so that you have the ducks in the row.
Let me share a few examples of what I have seen. Once I had a client who wanted to buy a property with existing tenants, however the rent roll wasn’t quite enough to service the mortgage on it. After asking my client the reason, he said rent from one unit was not being “reported”. At this point we had to look beyond the numbers to understand what this client’s long term plan was, why and how long he was going to show negative cash flow because every year a bank would have a problem with that.
I learned that the owner was looking to flip the property in a couple of years once the foreseeable price went up. So I structured the project where the client was ok “over collateralizing” the loan and build a reserve for cash flow (luckily they had liquidity) to secure the financing. Bank loved it. Why? Because there was a definitive finish line, an exit strategy. The finish line was flipping the property. But I wouldn’t see all this if I didn’t put the numbers aside and ask them a few more questions.
In another instance, I had an owner with no relative experience and wanted to buy a business with a manager running it. Well, if the manager got a better job and left, the owner would be sitting in a boat in the middle of the river with no paddle to get back home. I made some changes to the contract, and structured a strategic, logical and legal approach (with SBA regulations) to the given situation, and helped them form an exit strategy after which the bank was happy with the result and we closed on the project.
To summarize this article, remember that an exit strategy is equally important, along with what seems to more blinding – the interest rate – which usually is the only thing that people look at, because in my opinion, that’s probably what the sales driven folks do all the time: sell. The more credit-focused loan officers look at the overall risk in a project. That risk is miles away from just the interest rate, at least initially.