Source:  Wall Street Journal

 The biggest mistakes small businesses make when it comes to debt

By SIMONA COVEL

Around the country, small businesses are struggling to keep their head above water in a sea of debt.

A recent survey from the National Federation of Independent Business showed the worst earnings trends for small businesses in the survey’s 35-year history. With banks too jittery to lend, credit-card companies reducing limits and investors hard to find, many small businesses find themselves struggling to stay on top of their collections and pay their own bills.

The Wall Street Journal spoke with Charles Doyle, managing director at Business Capital, a San Francisco company that helps small and midsize companies restructure their debts.

We asked him about the common mistakes small businesses make with regard to debt and what they can do to avoid having to call someone like him. Mr. Doyle says business at his company is up as much as 90% in recent months.

Here are edited excerpts from that conversation:

Alternative Sources

THE WALL STREET JOURNAL: What are the options today for smaller companies that need to borrow money?

MR. DOYLE: Factoring is really becoming in vogue. That’s when you sell your invoices outstanding to a third-party firm known as a factor in exchange for cash in the amount of the invoices minus the factor’s fees. Then, money that comes from your customers is paid directly to the factor. Typically, factors will charge a daily or bi-weekly interest rate, like 2% every 10 days. Some factors will charge other fees, too, so you could be paying as much as 30% yearly.

Then there are asset-based loans from lending companies that are lines of credit based on a company’s accounts receivable. For instance, if you shipped $1 million in goods this month, you might be able to get a loan for 80% of that amount, or $800,000. You pay interest on the number of days the money is lent out to you. The lender also may increase the loan amount based on how much your inventory, assets or real estate is worth.

Julian Puckett

BORROWER, BEWARE Charles Doyle of Business Capital

Some third-party financing companies will also allow you to refinance equipment or provide financing based on inventory or equipment. But you’ve got to have equipment that has a reasonable liquidation value. They will come in and repossess the equipment and auction it off if they have to. It’s going to be expensive money, but there are people out there who will lend. You can bank on paying upward of 15% interest.

WSJ: What are some tips for finding a factor or asset-based lender?

MR. DOYLE: Sometimes people start to panic, and they’ll go on the Internet and get involved with a factor they don’t know. References should be available, and check the Better Business Bureau. Some of these companies you see on the Internet have a rap sheet a mile long. If it seems too good to be true, it probably is.

Do your homework to make sure you know what you’re going to be paying. If you’re only making a 10% margin on your products and the money is costing you 30%, every time you ship a product you’re losing. Some of our clients build that cost of financing into the cost of the product.

WSJ: When you’re tight for cash, how should you set your priorities in terms of deciding where your money goes?

MR. DOYLE: Don’t get in a situation where you’re not paying payroll taxes or sales tax. Once you start paying penalties to the IRS — that’s expensive money.

Then, if you have a situation where you do have a bank that’s lending to you at a good rate, make sure they’re getting paid at the beginning of the month. They’re looking for any reason to pull credit lines, so make sure you pay them before you pay the guy you get printing services from, for example. Then pay your critical vendors, and explain to them where you are financially.

WSJ: What mistakes do business owners often make when they face this situation?

MR. DOYLE: Collecting accounts receivable has been a big problem for a lot of clients and then they have trouble paying vendors. Partner with vendors and keep communication open. What’s tough to do is to prioritize your creditors. Many times, businesses will pay the vendor who’s the squeaky wheel — the one who’s bugging them the most — to the detriment of key vendors or suppliers whom they have a relationship with. It should be the other way around. Keeping an eye on those relationships is critical [so they’ll work with you].

If it’s not too late, companies should put together an emergency plan for financing — before it’s needed. How we’re going to deal with creditors, with financing, what options do I have if my credit line gets pulled. It’s time to educate yourself on what kinds of credit are going to be available to you, so you’re not operating at a critical time with no plan in place.

Raising Money

WSJ: What does a restructuring company like Business Capital do?

MR. DOYLE: We’re hired to raise money for the company and to pay the creditors. Some companies think it’s like a debt-consolidation loan. They say, ‘So can you pay off all of my creditors and I’ll just have one loan with you?’ That’s not how it works. There are definitely very hard conversations. You’re going to have to take a pay cut, let employees go. Restructuring is not a painless process. We can get you a million-dollar credit line, but if the company has a million dollars in debt, a lender will want a plan of how all of these creditors are going to get paid.

Sometimes we find there’s no way to help a company. If they’re in a situation where they’ve waited too long — they’re not shipping product or providing services and there are no receivables to manage — you’re looking at a wind-down.

WSJ: What’s the typical scenario for a small company that decides to file for bankruptcy protection?

MR. DOYLE: Chapter 11 bankruptcy protection is very expensive. It’s tough, especially these days where there’s no bankruptcy financing available. There are lawyers and auditors and accountants, and liquidation companies and valuation companies. All of these people are getting paid in Chapter 11. That can consume all of a company’s cash. It’s still the case where the majority of Chapter 11 filers end up in Chapter 7 liquidation.

-Ms. Covel is a staff reporter of The Wall Street Journal in South Brunswick, N.J.