Financing your business takes both time and a tactical approach. Let’s take a look at some of the basic and acceptable forms of financing your business.
Start with the Economy and Bank Regulation
We’ve had an extended period of record low interest rates in the US (and in Europe) with no indication that rates will return to anything like what they were in the inflation-coming-down 1980s (let alone in the inflation-increasing 1970s).
However, while the economy has had these record low rates, the government’s bank regulatory environment has been anything but benign – especially in terms of lending to small and medium-sized businesses and startups. And, typical of this, there have been almost no new small community banks started in the US over the last several years; and, these are the banks that have traditionally provided loan and credit services to smaller and mid-size businesses.
The Fintech Revolution
As is often said, “nature abhors a vacuum” and well-meaning (judge for yourself) banking regulation has created an enormous lending vacuum. On one hand, savers get almost nothing for depositing their funds; and, on the other hand, banks either are prevented from doing so based on regulations, or disposed not to lend because they can’t achieve a reasonable “risk-adjusted” rate (both their adjusted rate and the regulators).
As a result, all of these new peer-to-peer (P2P) financing platforms such as Lending Tree have been created. Some of these platforms are more consumer-focused and others more business-focused. They can be a very good source of reasonably priced funding if the amounts aren’t too large.
Looking Forward – Tax Changes
Another aspect of medium-term business planning has to include income tax considerations. We all know that at a corporate level, the US Federal Tax rate is non-competitive with the rates in other nations and absolutely needs to come down.
The dilemma is that all of the US tax laws are out-of-date, too complex and viciously intertwined between individual and corporate rates. And, the dilemma of what to do is that a great many US businesses do not operate as corporations. Instead, they operate based on the individual tax returns of their owner (or owners plural at partnerships and limited liability companies).
An example of this avoidance of the corporate tax rates are a number of pipeline companies in the US such as Kinder Morgan Inc., which switched from a corporate structure to that of a master limited partnership. This change of business structure across many businesses has cost the US treasury hundreds of millions (if not billions) of dollars, which instead were able to go into the company’s shareholders pockets as dividends and be taxed only once (no corporate taxes due).
The takeaway here is that it is unlikely the US corporate tax code will be able to be changed without changes to the personal tax structure. We know it is very important and has to come; and, when it does, any business designed around tax breaks may be in for a rude awakening. In almost every tax plan being looked at, there will be “lower rates” and “fewer deductions”.
Why Financing Is Important
Since this is meant to be short and introductory, with some generally applicable principles, it may be worth considering again where we are in the equity (stock market) cycle and what history warns us about.
If anyone regularly listens to Bloomberg (or equivalent) business news shows, one knows that the stock market is at a lofty price-earnings ratio and that profits as a percent of corporate earnings are at record highs. Opinions are divided on whether the stock market is over-valued and whether the share of corporate earnings going to profits versus labor will be changing.
As such, each business will have different circumstances and opportunities to meet its financing needs. While EBITDA (earnings before interest, taxes and depreciation) is a well-known metric, in today’s uncertain interest rate and tax rate environment, it may be worth balancing out risks – i.e. what will happen to the business if interest rates rise; or, if additional equity financing becomes difficult; if funds from cash flow are threatened by competitors or a business disruptor, etc.