My column in today’s Tennessean looks at the changing nature of the banker/entrepreneurship relationship:

A lot has changed in banking during this economic crisis. But what can entrepreneurs expect from bankers once credit starts to flow again?

We should expect the rules to be more restrictive on bankers’ ability to lend to small businesses since they will be under tighter scrutiny from federal regulators.

Banks lending to small business will go back to a more traditional and conservative approach based on cash flow, personal guarantees and collateral.

Traditionally, bankers operate with a business model that tries to minimize risk. They are responsible for protecting customers’ deposits held in their banks.

On the other hand, entrepreneurs seek out opportunities that can result in high returns, but their ideas often carry significant risk.

Entrepreneurs need to understand which factors bankers will use to determine what is a “bankable business” based on the traditional business model of a typical bank.

Businesses must be able to qualify for bank credit on their own standing.

This has very little to do with the things that get entrepreneurs excited, such as opportunity, upside potential and vision.

To a banker, a bankable business is one that will pay back its loans with very little chance of anything going wrong. So, rather than getting excited about untapped markets or product innovations, bankers look to three main factors. They are:

Is there adequate cash flow?

Bankers define “adequate cash flow” not as being just enough excess cash each month to cover monthly loan payments, but significantly more than enough excess cash flow.

Also, bankers want to see this cash flow already occurring, not projected in the future within a business plan. That’s why bankers usually are not the best sources of funding when you open a business.

Get a track record and some cash flow, and you will find that bankers are much more receptive.

Can an owner pay back the loan?

Forget about the corporate veil of protection from creditors when it comes to bank loans.

A bank will require personal guarantees, which means that if the business cannot pay the loan, you will be expected to pay it personally.

I am in California with 23 of our students who are competing in the International Delta Epsilon Chi business event.  There are 1,250 students here competing this year.  Postings may be a bit spotty, as our schedules are quite full.

I did want to share the news that we have a new edition of our textbook Entrepreneurial Financial Management coming out in the next week or so through M.E. Sharpe.

We have add some new chapters and updated the rest.

 

 

If you want to buy a copy from the publisher click here.

If you are an instructor and want a review copy click here.

I will be adding a permanent link at the blog in the next couple of days.

Today’s post can be found at our sister blog Strictly Business.  Please click here to read this post.

Venture capital investment retrenched to the lowest level since 1997 during the first quarter of 2009.  VCs invested just .0 billion in 549 deals in the first quarter of 2009, according to the MoneyTree Report from PricewaterhouseCoopers and the National Venture Capital Association.

Quarterly investment activity was down 47 percent in dollars and 37 percent in deals from the fourth quarter of 2008 when $5.7 billion was invested in 866 deals. The quarter, which saw double digit declines in every major industry sector, marks the lowest venture investment level since 1997.

Don’t look to VC backed deals to be the engine that leads us out this recession.  The biggest drop in deal flow was for venture receiving first-time financing.

Tim Jackson, Canadian entrepreneur and venture capitalist, offer his thoughts on our economic future in an interview by Gordon Pitts at ReportonBusiness.com.  Here is a sample of what he had to say:

So if you are laid off from your job and have a business idea, what do you do?

You beg, borrow, steal and you get it going – and you find a customer.

I know that sounds overly simplistic and there are certain companies where you need a venture-backed business because it will take three or four years to develop the technology. But traditionally, businesses have been started by designing something or creating a service or a product.

Then you went and sold it, and you used the revenue from the first customer to get your second customer and improve the product slightly. The revenue from the second customer was used to improve it again and you get the third customer.

We saw 300 companies last year [and funded two] and the vast majority should never have been looking for venture capital. Our advice is just go and start the company. Go and sell this. If you have something people will buy, they will partner with you and you can build a business.

Great advice not only for the accidental entrepreneur, but anyone starting a business.  Your goal is never to raise money — it is to build a business.  If you are successful at that and eventually need funding, it will follow.

My column in today’s Tennessean looks at the challenges of taking financing from family:

In good economic times, 85 percent to 90 percent of capital for small businesses comes from friends, family and the entrepreneur’s own funds.

But during times of tight credit or recession, family members may be one of the few sources of funding for most startup entrepreneurs.

When taking funding for a business from family members, it’s critical that everyone involved fully understands what they are getting into.

Family members provide funding for many reasons. Some are motivated by altruism — they just want to help the entrepreneur get started and be successful. Others can be driven by greed — they see the investment as a way to ride on the entrepreneur’s coattails to fortune and fame.

But no matter what the reason for a willingness to provide financial assistance, defined boundaries and clear expectations must be clearly established.

Here are some rules of the startup road:

• Never take money for a business from a family member as a “gift.” It should be treated either as a formal loan or investment.

Present the interested family member with a formal business plan, which should be discussed in full detail.

• Any loan from a family member should have a formal loan agreement that defines interest rate and payment terms. To help the entrepreneur, payments can be delayed, but interest should accrue during this time and eventually must be repaid.

The Internal Revenue Service publishes the current minimum interest rates at its Web site, www.irs.gov/ (just enter “interest rate” into their search feature).

• Do not structure any loan without interest. There can be tax consequences for all involved if such a loan is not set up with acceptable interest charges.

• If the money comes in as an investment, the family member is now the entrepreneur’s partner. This means they have certain rights that any shareholder has in a privately held business, which can include approving certain major decisions, such as the sale of the business.

Send reports

All investors should be provided with complete financial data at least once a year.

If the business makes a profit, they probably will owe taxes on this profit. All of this must be made clear before any investment funds are accepted.

Whether the money is treated as a loan or an investment, the entrepreneur should regularly communicate good and bad news. Provide regular quarterly or even monthly summaries that include any significant accomplishments, challenges and major events.

All of these steps will help keep issues that are business related as strictly business, and issues that are family as family matters. After all, Thanksgiving comes every year. Don’t let a business deal spoil the family dinner.

The Money Tree report on VC activity in 2008 shows how the recession has hit funding for high growth deals.  From that report:

The decline in investments over the prior year is spread across industries and stages of development, with some notable exceptions. Dollars invested in the Clean Technology sector grew more than 50 percent in 2008. Companies in the Seed Stage of development also received more money in 2008, reaching the highest level seen since 2000.

The increase is seed funding is probably attributable to some long term hedging on deals.  With lower returns in funds it is likely that there will be more risk-taking on early stage ventures to gain higher returns in the out years of these funds.

The increase in “clean” technology is undoubtedly anticipatory economic rent seeking behavior.  Investors are betting that the new administration is going to make good on its promise for massive government spending on “green” energy — and they are getting in line at the public trough.

Brad Feld, an early stage investor and an entrepreneur, offers great advice on things NOT to do when trying to make that perfect pitch in an article at US News.  Here is just one of his eight no-no’s when looking for money:

Listing 27 advisors but only one co-founder: Advisory boards, especially at the very early stages of a company, are generally useless. A few key advisors who have deep domain knowledge or experience in your industry are great, but a long list of lightly engaged people who have well-known names but aren’t helping you diminishes your credibility.

So read Feld’s advice, brush up on your pitch, and join us for the first phase of FastPitch Nashville called Pitch Camp:

The details:

When: Friday, February 6, 2009, 1-5pm
Who: Anybody that has, or wants to dream up, an idea
Where: Gordon Inman Center, Belmont University
Cost: $35 per person

My column for the Tennessean this week is the third in a series on managing cash flow:

My previous two columns have examined why the phrase “cash is king” is so true and what steps entrepreneurs can take to improve their cash flow.

So what is the purpose of building up cash reserves? Think of your cash reserves as four pools of funding with four distinct purposes.

The first pool of cash is to plan for those large expenses that are not part of regular monthly expenses, but are critical nonetheless. Examples are quarterly tax payments, annual equipment replacement purchases, or large seasonal marketing campaigns.

Create a calendar of these payments and put cash aside to build up enough to cover them.

The second pool of cash is used to better manage the natural “lumpiness” of cash flow. The reality is that the rate that cash flows into a business is never smooth and predictable. Some businesses have to pay for products to be made or for services to be provided well before they actually get paid. Other businesses may have seasonal sales swings, such as many retail businesses that have most of their sales in November and December.

This second pool of cash should be used to create your own internal line of credit to help navigate the natural “lumpiness” of cash flow.

Be ready for the unexpected

Think of the third pool of cash as your emergency fund. This pool should be large enough to cover at least a month of day-to-day expenses. This will help cushion you from events such as an unexpected loss of a major customer or a major disruption of your business.

I remember one year in our health-care company when we lost about two weeks of sales in the aftermath of a hurricane in September, followed by the loss of about 10 days of sales due to a major ice storm in January. Cash reserves are what got us through those tough times.

The final pool of cash is for an “opportunity war chest.”

Recessions create many opportunities for financially strong companies. There may be opportunities to acquire a competitor’s business that’s been weakened by the economy or to expand and fill the void left by a competitor’s failure.

It may actually prove to be a good time to expand the business — real estate prices, the cost to rent space, equipment expenses and labor costs will all be lower.

Develop an annual plan to forecast all of the needs for a cash reserve.

Create a separate bank account to keep these funds segregated from the cash needed for day-to-day operations.

And make regular and frequent transfers into this account whenever possible to ensure that the funds will be available when you need them.