Thursday, October 31, 2019

Use "OPM", Other Peoples Money

Developing a network of financial backers that have liquidity is critical in the growth of any business.  Whether you are planning to have investors or not, cash flow is crucial to every business.  Formal (investors) or informal (Uncle Joe) sources of cash will allow you to take advantage of opportunities at the speed of business.

In the Private Equity world, we call it the “Capital Stack”.  What are the sources of your funding and will they be available when you need them?  If you are building a retail facility, do you have enough money to complete the build-out of the store?  Maybe the landlord is contributing, some will come from your savings, and you have a loan for some.  If there are construction overruns (inevitably there will be), where does that money come from?  Another scenario could be that one of your competitors is going out of business and is offering to sell you their inventory (that you know you can sell quickly) at 90% off the wholesale price.  Do you have the cash to put that profit in your pocket?

The best time to establish these sources is before you need them!  Waiting until you need them will almost assuredly cause you to miss the opportunity.  Your soon-to-be former competitor will be in a hurry to purge his inventory and will be offering it to everyone just to get quick cash.  In the case of the build-out, lenders will quickly identify that you didn’t plan well enough, a red flag for them, and most likely not approve the additional capital.

It’s important to note that there are many sources for these funds and that they all have different associated costs.  The sources can include Traditional Banks, Credit Cards, Private Lenders, Suppliers, Angel/Private Equity/Venture Capital Investors, and Friends and Family.  The least expensive will require the most time (with the possible exception of “Uncle Joe”), while the quicker, higher risk lenders will want to get paid for assuming that risk.  None of them are bad if used correctly.  Don’t use a high-interest rate loan for long term debt.  You can use it to take advantage of an opportunity and then refinance with a lower-rate loan.

Banks and other traditional resources are fine for long term debt, (although this should be kept to a minimum), but it is the "friends and family" of the business that will create the ability to take advantage of short-term opportunities. 

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