The old adage “it takes money to make money” may prove especially true when you’re looking to expand your business. Understanding what sources you should consider for financing will give you a big heads up on your competition.
By Mark E. Battersby, Contributing Editor.
How many convenience store retailers have failed to grow or expand their businesses because of a fear of “over-extending” themselves? All-too-often this fear exists simply because the convenience store operation’s executives and managers are not aware of the tremendous number of financing options that are available to expanding and growing businesses.
Interest rates remain close to their historical lows, but financing for many c-store businesses continues to be elusive. One problem: lower interest rates have translated into lenders and investors being more selective. How then, can c-store retailers hope to fund the expansion of their operations?
Growth Funding 101
To avoid a cash-flow crisis, a surprising number of c-store operators have been overly cautious. Remember, however, successfully balancing growth with financial risk is one sign of a healthy, growing business. The cash-flow problem normally associated with over-investing in the c-store operation can be avoided by understanding the many financing avenues that can be taken when expanding the business.
Raising expansion funds by borrowing allows the chain operation to benefit from the principal of leverage—a technique of increasing the ratio on investment through the use of borrowed funds. As long as earnings exceed interest payments on borrowed funds, the application of leverage allows the c-store business to increase the rate of return on stockholders investments. But leverage also works in reverse.
Do-It-Yourself Expansion Financing
Today, many businesses have funds available after paying all of the bills, including taxes. One choice is to distribute earnings to shareholders in the form of cash dividends. Seldom, however, are all of the earnings paid out as dividends. At least a portion of earnings is usually kept to finance future growth. Thus, another source for expansion funds is the re-investment of earnings from the business.
Unfortunately, more commonly, retained earnings are largely only wishful thinking. In fact, expanding with internally generated funds can be a very difficult process to plan for and implement. The main consideration, obviously, is whether the business has sufficient internal cash flows to pay for expansion outlays.
Where the business is branching out into uncharted territory or contemplating growth that may or may not create a larger asset base against which to borrow, a c-store operator may find himself in need of subordinated debt or equity financing.
Generally, there are two basic ways to fund expansion: debt financing or equity financing. With debt financing, the capital is received in the form of a loan which must be paid back. With equity financing, capital is received in exchange for part ownership in the overall c-store business.
Equity financing can come from a variety of sources, including the c-store operation itself, the shareholder’s pockets, as well as from private investors. Remember, however, keeping control of the business and its direction is more difficult when outside investors are involved.
Equity financing for growth or expansion is more straightforward than subordinated debt financing as the investor need only be persuaded that the expansion will increase the equity value of the operation above the price the investor is purchasing his equity today.
The ESOP Option is No Fable
Selling stock or an equity interest in the c-store business does not have to involve strangers. Selling company stock to employees through an “Employee Stock Ownership Plan,” or ESOP, is an often-overlooked and usually misunderstood option.
With an ESOP, the incorporated retail business issues new shares of stock and sells them to an ESOP. The ESOP then borrows funds to buy the stock. The business can use the proceeds from the stock sale to its own benefit, such as to fund expansion or store renovations.
The company 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%, depending on the operation’s tax bracket. Remember, however, the tax shield does not help with S corporations since they don’t pay corporate income taxes. Capital gains deferral, however, can make ESOPs attractive to these pass-through business entities.
Borrowing for Expansion
In addition to those loans that a business often receives from its owner, shareholders or even suppliers, a variety of funding is available from a surprising number of sources. A bank is probably the best-known and most obvious funding source for most convenience store companies.
Typically, banks are the place to go for short-term lending, usually secured by tangible assets. In other situations, however, banks often help in either of two basic ways. First, commercial banks can help a business by providing funds to secure new equipment, machinery, vehicles or intangibles, such as software, zoning variances, etc.
The second area where banks can help is with working capital, such as lines of credit designed to help the chain expand its cash flow volume.
Uncle’s Helping Hand
Often thought of as a lender of last resort, the U.S. government can be an excellent source for a wide variety of economical financing. After all, the federal government has a vested interest in encouraging the growth of small businesses. As a result, some loans, particularly those of the Small Business Administration (SBA) have less stringent requirements for owner’s equity and collateral. In addition, many SBA loans are for smaller sums than most banks are willing to lend.
7(a) Loans: The biggest, and most popular SBA loan program, is the 7(a) Loan Guarantee Program for eligible borrowers starting, acquiring and expanding a small business. While borrowers must apply through a participating lending institution, the SBA guarantees up to $750,000 or 75% of the total amount of a loan, whichever is less. For loans of less than $100,000, the guarantee usually tops out at 80% of the total loan.
A 7(a) loan can be used for many business purposes, including real estate, equipment, working capital or inventory. The loans can be paid back over a period as long as 25 years for real estate, and 10 years for equipment and working capital. Interest rates are a maximum of 2.25% over the prime rate when the loan term is less than seven years, and 2.75% if more than seven years.
The 7(a) program also offers several specialized loans, including the Low Documentation Program for fast processing for amounts under $100,000. The “LowDoc” program relies heavily on the operator’s personal credit rating and the c-store chain’s cash flow.
504 Loan Program: At the top end of the SBA loan size spectrum is the 504 Loan Program, which provides long-term, fixed rate loans for financing fixed assets, usually real estate and equipment. 504 loans are usually made through Certified Development Companies (CDCs)—nonprofit intermediaries that work with the SBA, banks and businesses looking for financing.
Those c-store retailers seeking funds of up to $750,000 to buy or renovate a building or buy some major equipment, bring the c-store operation’s business plan and financial statements to a CDC. Typical percentages for this type of package are 50% financed by the bank, 40% by the CDC and 10% by the business or its owner.
In exchange for this below-market, fixed rate financing, the SBA expects the chain to create or retain jobs or to meet certain public policy goals, such as an Enterprise/Empowerment Zone, a minority-owned business, etc.
Among the best sources for assistance—and in many cases funding for expanding businesses—are the many state, regional and local economic development agencies. There are nearly 12,000 economic development groups in the U.S. The purpose of these groups is to provide economic growth and development in the areas they serve. They generally encourage new or expanding businesses to locate in their area—or to remain in the area.
Even those who are aware of public funding often have misconceptions about who will and will not qualify. Many of these programs are looking for businesses with proven track records. The state, regional and local agencies are willing to help them expand their sales, which in turn will help expand the tax base as well as increase employment.
While not always a source of expansion financing, a state’s office or agency of economic development can be a guide to regional and local funding.
Fear of Funding
How many c-store retailers have failed to grow or expand their businesses because of a fear of over-extending themselves? All-too-often this fear exists simply because the company’s executives, managers and operators are not aware of the tremendous number of financing options available to their expanding and growing business.
Looking to the same sources that helped start the business, or tapping savings, profits, friends and family, banks, venture capitalists or the stock market are all options. Whatever is done, it will be a lot easier to fund a growing business—and grow a business that is well-financed.
Obviously, financing the growth of a c-store business is a complex affair. Funding to help grow and expand the operation is, however, widely available to those retailers willing to do their homework. Comparison shopping for lenders, rates and terms is also strongly recommended.