Overcoming the High Cost of Financing
Money to expand a business can be tough to come by.
By Mark E. Battersby
Today’s high interest rates have put that all-so-necessary funding out of reach for many in the shooting sports industry. This situation is compounded by the reluctance of many traditional lenders to provide that all-important working capital required by every business.
Actions of the Federal Reserve have contributed to an increase in inflation and raised interest rates with no indication of substantial relief in sight. Combine those higher interest rates with leasing and purchase prices essentially doubling in the last few years and funding the shooting sports business today is extremely difficult.
First Stop
With the well-documented reluctance of banks to provide the funds needed by those in the shooting sports industry, it may seem strange to suggest that every search for affordable funding should begin with the operation’s bank. Although numerous factors will impact the type of lender eventually chosen, the best option is usually to start with the bank currently used for the operation’s banking.
Even without a personal relationship with the banker, an existing bank often has a broader perspective of the operation’s debt, spending, and cash flow. While perhaps only a number in the bank’s system, the operation is already in the system. That puts the shooting sports retailer or manufacturer one step ahead, even with a reluctant bank.
Obviously, if a relationship with the operation’s current bank isn’t sufficient to overcome the bank’s reluctance to provide the needed funds—or render advice—a new bank might be necessary. Since banks are often the source for the most economical financing, a community bank might be the answer. Establishing relationships with community banks is often easy, with them considering the operation as a whole alongside the operation’s cash flow, credit, and collateral factors.
Although numerous factors will impact the type of lender eventually chosen, the best option is usually to start with the bank currently used for the operation’s banking.
Needs Versus Cost
In general, all banks are interested in businesses that have collateral and strong credit. Often, while not interested in providing long-term funding, banking services such as cash management, payroll services, merchant services, and lines of credit may be available.
Every business should already have a line of credit to help tide them over the short term. A line-of-credit provides access to funds up to a pre-set limit, and the equipment retailer or manufacturer pays interest only on the funds withdrawn. Fees for having the funds readily available are usually competitive. However, as finding capital becomes more difficult, it’s more important than ever to determine why the shooting sports retailer or manufacturer needs capital, how fast it is needed, and most importantly what it can afford to pay for that capital.
"When traditional sources, even with guarantees, fail to provide affordable needed financing it might be time to explore a relatively new option: online funding."
The SBA
Although banks, especially community banks, typically have low interest rates and offer competitive terms, financing continues to be hard to obtain. Thus, an incentive such as a guarantee by the Small Business Administration (SBA) might help obtain that needed funding.
The SBA offers lenders a federal loan guarantee. This makes it less risky for banks to lend and often means more favorable interest rates and terms for the borrower. Repayment periods for SBA loans are based on what the funds will be used for. They range from seven years for working capital to 10 years for equipment purchases and 25 years for real estate purchases. There are a number of SBA loan guarantee programs available. SBA 7(a) loans, the most popular program, provide funds for many purposes and are available in amounts up to $5 million. SBA 504 loans offer long-term, fixed-rate financing to purchase or repair real estate, equipment, machinery, or other assets. SBA Micro Loans are the smallest loan program offered and provide $50,000 or less to help businesses expand.
When traditional sources, even with guarantees, fail to provide affordable needed financing it might be time to explore a relatively new option: online funding.
The SBA offers lenders a federal loan guarantee, making it less risky for banks to lend. The result is often more favorable interest rates.
Going Online
With the reluctance of traditional banks to lend, online lenders are enjoying a surge of popularity. Best of all, specialty financing, such as gun and ammunition inventory loans, is available. Online banking eliminates the cost of brick-and-mortar branches, thereby generating cost savings to be passed on to borrowers.
Fintech, or financial technology, consists of two areas: interacting with a bank minus the human element and independent lenders working outside the traditional banks. Applying for an online business loans can be accomplished entirely online.
The ESOP Option
An effective strategy for minimizing the cost of the funds needed by the business involves selling the business. An employee stock ownership plan (ESOP) is a tax-effective way to transfer ownership of a small incorporated shooting sports equipment business to its employees while raising the funds needed for the operation’s growth. With an ESOP, the business issues new shares of stock and sells them to the ESOP. The ESOP then borrows funds to buy the stock. The retailer or manufacturer can use the proceeds from the stock sale for its own benefit—growth or expansion.
The business repays the loan by making tax-deductible contributions to the ESOP. The interest and principal on ESOP loans are tax deductible, which can reduce the number of pre-tax dollars needed to repay the principal by as much as 34 percent, depending on the operation’s tax bracket.
Unfortunately, the tax shield does not help with S corporations, as they don’t pay corporate income taxes. Capital gains deferral, however, can make ESOPs attractive to these pass-through business entities.
Bootstrapping and Self-Funding
Obviously, it is wise for every business owner to have at least some personal funds at risk to show lenders or potential investors that the owner is committed to the success of the business. Unfortunately, our tax laws make self-funding a touchy and complex situation.
The most basic, affordable funding strategy, called bootstrapping, means using personal or family funds to finance the business. Offsetting the convenience of bootstrapping is the necessity for the owner or shareholders to give up equity in the shooting sports business.
What’s more, whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated business, our tax laws require a fair-market rate of interest be included. If not, the IRS will step in and make adjustments to the below-market (interest) rate transaction in order to properly reflect “imputed” interest.
A borrower should match the term of a loan to the life of the financed item. If the financing is for equipment, the loan shouldn’t be longer than the expected life of that equipment.
Borrowers Beware
Dealing with an economical, but unfamiliar lender isn’t always trouble free. A loan agreement might, for instance, contain a provision requiring the loan to be repaid if the buyer misses several payments or fails to maintain certain debt service coverage. Every borrower should have a clear picture of when the forbearance will end and what the lender intends to do at the end of that period.
What’s more, every borrower should generally match the term of a loan to the life of the item to be financed. If the financing is for equipment, the loan shouldn’t be longer than the expected life of that equipment. On a similar note, a fixed-interest rate stays the same throughout the term of the loan while business loan rates can fluctuate, making them more expensive.
Avoid At All Cost
In the search for capital, the easiest options may be the most expensive.
- Credit card debt. Business credit cards often offer more flexible repayment terms, but typically have higher interest rates than traditional financing. Designed to appeal to businesses whose cash flow might be irregular, the higher cost of business card debt results because the debt is usually unsecured, making it riskier for lenders.
- E-mail solicitations. Answering those “We Lend Money to Businesses” ads means leaving the banking sector with its various protections and borrowing from a private lender. These options should be avoided.
The Added Cost of Taxes
After funds have been obtained at a favorable cost, it doesn’t mean that the interest is automatically tax deductible. There is something called the “tracing rule” where interest is traced to its use to determine whether or not it is deductible. Suppose, for example, a business borrows money, but only a portion is used to purchase needed equipment. The balance of the borrowed funds goes to a key employee or even the owner to purchase a personal vehicle. Obviously, the interest on the borrowed funds used for equipment, supplies, or other business expenses are deductible. The interest on the portion of those borrowed funds distributed as a loan or bonus is not tax deductible.
Every business in the shooting sports or outdoor trade seeking to borrow money faces challenges. For example, where is funding available? What interest rate? What is the total cost including fees? Is the funding good for an extended period of time or can payment be demanded early? Guidance from a professional adviser may be necessary.