Tuesday, August 12, 2008

Raise Money When You Don't Need It?

I found this article, Raise money when you don't need it by Dileep Rao in Forbes a little naive and misleading.
Rao writes, I recently got a call from an entrepreneur who wanted money that very same week in order to meet payroll. He also said he was willing to pay "any reasonable return" to get it.

This wasn't exactly the sort of plea that inspires confidence. Though I could have commanded a serious rate, the guy didn't get a cent from me.

See, financiers have this strange notion that they should get their money back, along with a reasonable risk-adjusted return. That's why strong businesses have more financing options, enjoy lower interest rates and suffer fewer restrictions, while weaker ones go wanting.

This is completely intuitive, of course, and yet countless entrepreneurs make the same mistake: They go looking for money when they really need it instead of raising it--on far better terms--when they don't.
He writes further, The fact is, undercapitalized small businesses crumble by the scores in any economy. Lines of credit (not committed until you draw down the money) get cut, loans get called in, more assets (like houses) get pledged and toys get sold.

Even if the business hangs on, your hands may be tied. Consider that regular bank-lending rates for small businesses usually range from "prime" (the rate that banks charge on loans to their most credit-worthy commercial customers, now at 5%), to prime plus 200 basis points (usually backed by a personal guarantee).

And, he ends with 4 tips (of which I'm highlighting 2); Rather than wait for disaster to strike, take some precautions. Here are four:
Act now. If you fear rough waters ahead (or at least a measurable, short-term dip), draw down your credit line before your bank cancels it. You may end up paying interest on unused funds, but it's better than not having them when credit gets tight.

Pig out. Raise as much capital as you can as early as you can. Sometimes start-ups have an easier time selling the dream than a few quarters worth of reality. And even if you don't think you can drive a hard bargain, don't sell your company short: The first assessment of what your business is worth will color the valuation in later financing rounds. If you disagree with an investor's valuation, avoid bickering about the specific dollar amount. Instead, address the assumptions that went into the valuation, like projected growth rates and overall industry prospects.
I'm very perturbed because Rao is suggesting that businesses anticipate financing by borrowing when loan funds are freely available. That, with the greatest respect, is a recipe for financial disaster. Don't listen to such advice ... unless you are suicidal.
Frankly, if your business is expanding during a period of scarce lending, just prepare better loan proposals. Most banks respond to cashflow forecasts. If your business cashflow is strong and the business prospects look good, sales orders are consistent, customers are long-term with established patterns of ordering - there's no reason why banks won't lend.
Rao's friend must be a speculative businessman! Otherwise, in the best of times and, in the worst of times, bankers will always line-up to lend to businesses with strong cashflows.
The problem with banks are that they are fair-weather friends. If your business is facing some cashflow problems even with strong-looking order books and customers, the banks may adopt a sceptical view on lending.
This is why, the best thing that businessmen can do is either to manage strong cashflows (by watching the costs and bottom-line) or, spend some time building a long-term relationship with local banks (foreign banks are even more ruthless!).
But, don't just take my word for it. Have a read of Rao's article to make up your own mind here.


Anonymous said...

Indeed a babaric society at the moment but this is our land and we should make it right.

Anonymous said...

I agree with you.
It's just a bad idea to borrow if you don't need it?
Having said that, I worked in a company which just preferred to roll it's credit facilities around...