BusinessWeek Online reports a rise in business bankruptcies with more businesses filing for the month of April 2008 than any time since the 2005 change in bankruptcy laws. April 2008 averaged 263 commercial bankruptcy filings per day compared to April 2007 when the average daily commercial filings were 158.

Hedge funds and large banks experienced a huge financial crisis in 2007 when fool hardy sub-prime loans; some economists believe these troubles hit the small business community in 2008, but if these instruments passed on any affect to small businesses, it wasn’t from poor investments, but rather the inability to stay afloat when credit dried up.

Unfortunately, many businesses attempt survival on credit cards. In a credit crunch, interest rates on credit cards take a big bite on monthly cash flow. Banks, after the slaps faced with sub-prime mortgages, tightened their lending standards, making it difficult for small businesses to find additional working capital. It’s a warning to all businesses that conserving capital for a rainy day means survival in hard times; failure to do so means the probable demise of the business.

The number of failing businesses could easily be much larger than shown in the above statistics because businesses without creditors simply close down. More and more businesses also avoid court and the bankruptcy stigma by out-of-court settlements. The business owners simply meet with creditors and work out an agreed settlement. In both of these situations, businesses failed but weren’t reported in the Automated Access to Court Electronic Records (AACER) system reported on by BusinessWeek.

Many of the reported failed businesses may be those involved in residential building and residential real estate in states like Florida and California. With the huge profits realized in residential real estate in these states, building was at an all time high. Don’t expect things to even out for awhile in the residential market. The housing market isn’t expected to settle down for at least another year with some warnings of a housing market down trend expected for about 5 years.

The SBA introduced the Patriot Express Pilot Loan Initiative in June 2007, modeling the program after its Express Program started in 2002. This federal program turns military veterans into entrepreneurs, recognizing their entrepreneurial instincts.

Soldiers and sailors show discipline and a true grit when times are tough. Long hours, hard work and meager facilities equip military men with necessary skills for starting and surviving in business. The “can do” attitude drilled into soliders is just the right skill for starting and building a sucessful business.

The Patriot Express program expedites many of the document processing procedures by reducing the paperwork required and allowing participating financial institutions the approval authority. The SBA program offers guarentees to participating financial institutions, making the financial institutions much more willing to grant business loans.

New small businesses jump start lagging economies for states involved in the program. States also recognize the potential of small businesses become much larger businesses over time. It’s a win-win situation for both veterans and the states in which they live. Military members get the opportunity to apply their skills; states gain revenues.

The Patriot Express program guarantees up to $500,000 in business loans for a new or expanding business. The program offers benefits to National Guard, active duty military ready for retirement, reservists, veterans and spouses and children of deceased military veterans. For more information go to the SBA Patriot Express Program

Discussions on the mortgage crisis, grime economic news and the continuous mention of the “r” word (recession) by the media may leave entrepreneurs believing financing for businesses has dried up.

Not so says the New York Times Business Section. A recent investment conference in Southern California attended by 1,000 investors demonstrates that investment money is readily available, especially for clean energy, environmental, communications, water treatment and biomedical companies. Of the 330 companies represented, 50 came from China.

Plenty of Venture Capital

Less competition encourages investors who seek small, dynamically growing companies hidden from the broader investment market. James W. Montgomery, Chairman of Montgomery & Company, saw the same enthusiasm at a technology conference held by his firm in Santa Monica, CA. Montgomery said “There is plenty of capital around because venture capital hasn’t been in the bubble mode in recent years like real estate and debt markets.” Montgomery also mentions that companies providing entertainment and services for cell phones do well right now because the communications industry is hot.

Venture Capitalists are not throwing money around by any means. Many still remember the years of the Dot Com Boom and the resulting bust that left venture capitalists holding the bag. But companies with reasonable valuations with the potential for a nice return in two to three years find small amounts of capital for investment. Internet start-ups usually fall within this category because they don’t require expensive plants and equipment.

Green is the “In” Color

“Green” companies such as those that convert contaminated water into drinkable water, solar energy companies also attract investment funding. Investors aren’t just oriented on California, even Chinese companies in the technology field find US capital. Those getting the nod from investors include everything from steel finishing products for appliances to lithium-ion batteries.

Investors also look to acquire operating companies with great earning potential. Large companies expend millions researching companies to acquire and operate. With the down turn in private equity funds who often bid prices up on their reign of buying everything in sight, other investors believe prices have become more reasonable.

In our previous posts (part II and part II) we discussed  some sources for business acquisition financing. This is the final segment of this subject.

Seller

If you purchase an existing business, the seller often offers financing for a portion of the purchase price. Expect better negotiation power with seller financing during a down-turn in the commercial real estate market.

In some cases seller financing is unavailable. When the business seller does offer financing, this solves not only solves the financing problem; but validates that the seller believes the business offers sufficient cash flow for supporting the new owner and his/her ability to replay the business acquisition loan. The seller stays invested for the duration of the loan, ensuring the buyer a willing assistant for business success. A seller jumping in the business boat with the buyer, now that’s great advertisement!

With seller financing, a buyer stills needs a plan for a down payment of approximately 25% to 50% of the purchase price. As with financial institution financing, expect market driven interest rates with seller financing, though with more flexibility.

Seller financing exacts a price. Just like a finance company or bank, the seller wants information about the buyer before making a financing commitment. The seller expects background information, including work experience, education and a sense of the business savvy of the buyer.

Prepare for selling your qualifications if you want seller financing. Just as you need a sales pitch about purchasing the business, the seller needs the confidence that you possess the business savvy for repaying the loan and not ruining the business. Assuming you want to purchase the business and expect seller financing, offer the seller your financial statement, list of references, a copy of your clean credit bureau report and any background information he might need. This demonstrates good faith, professionalism and an understanding that business is business.

Be forewarned that most financing from a seller comes in the form of a balloon note. A balloon note allows the seller’s removal from the business within a reasonable time and yet gives the buyer a reasonable time for repayment through business profits. If full repayment still isn’t possible, the buyer gains valuable time building a track record for financial institutions demonstrating the business is a reasonable risk. Sellers usually amortize notes with regular monthly payments kept low and a very large balloon payment at the end of the specified note term. Depending on the movement of interest rates, buyers may refinance the balloon note early once they’ve established a good credit and find a financial institution with more favorable rates and a longer term. Balloon notes offer both buyers and sellers a win-win situation.

401(K) and IRA Accounts

Recent rules developed by several large national CPA and attorney firms, and receiving approval of the IRS allow purchasing a business with 401(K) and IRA accounts without tax penalty to the account owner.

Funding a business acquisition with 401(K) and IRA accounts do involve legal and accounting fees. Best sources for information of these fees come directly from your lawyer, accountant or a reputable business broker; but expect the fees to be less than tax penalties for early withdrawal of these funds. My business brokerage firm, VRBusinessLakes, continually develops relationships with both attorney and CPA firms who specialize in these types of financing transactions. Let us know if we can make a referral.

A Trifecta!

The five new business financing sources listed are not mutually exclusive. Buyers can use one or a combination of these sources for a business acquisition. I recently handled a transaction in which three of the five sources were used to buy the business.

It’s called creative financing!

Yesterday we discussed Family Members  as a possible source for acquiring a business acquistion loan. Today we discuss two additional sources.

Banks

Thinking about a business loan? A bank automatically comes to mind as a good source. Unfortunately, most banks resist making business acquisition loans. Strange but true; especially because after starting a business, the banks actually seek your business! So why do banks avoid making business acquisition loans?

Banks may advertise business loans, but they usually mean for existing businesses. Unless you have a strong business plan, an even stronger former relationship with the bank and good collateral, count on hearing many reasons for declining your loan application to purchase a business. Your best banking source comes from those banks participating in the SBA loan program if they qualify you for an SBA guaranteed loan (see SBA as another source below).

Just because a bank turns down a business acquisition loan application, it doesn’t mean that you and your business plan aren’t viable. Banks practice risk aversion and turn down many new business purchase requests. When you finally secure a business acquisition loan, choke back the giggle when the same bank who denied your loan comes calling for your business. Consider handing them an application and telling them you will get back to them after they furnish documentation and you take it before the bank committee.

SBA (Small Business Administration)

The SBA offers business acquisition loans through approved lenders. Usually the SBA only guarantees loans made by financial institutions rather than directly making loans. This SBA guarantee program is called the SBA7(a) program.

Your local SBA office furnishes a list of approved lenders. The list includes both banks and other types of financial institutions such as GE Small Business Lending, AT&T Finance, CIT Group and others. In some cases the financial institutions provide for a starting working capital along with the actual price for acquiring the business. Expect a required down payment of approximately 15% to 25% of the loan amount; and plan on additional up-front fees for an appraisal and other costs. SBA approved lenders should be offering market competitive interest rates.

The downside of an SBA guaranteed loan includes piles of documentation and lots of detail along with a generous helping of patience. You benefit by providing all the required documentation in a quick and efficient manner. The sooner the completed package arrives at the SBA underwriter’s desk, the sooner you can expect an answer and start your new business. While waiting raises the frustration level, successfully obtaining a loan makes the outcome with the SBA a positive experience.

In Part III we discuss two more possible business aquisition loan sources.