Speed, Cost, and Smart Choices
Episode 1 laid out the sources of capital. Here Tony Gray and Matthew Gillman compare them on the two things that decide most choices: how fast the money arrives and what it really costs, including the costs that are not interest.
How fast is friends and family money, and what does it cost?
Matthew Gillman: It is the least institutional and simplest route to capital, and the cost varies widely. Some friends and family will lend below market because they compare it with what their savings earn. Others see the risk and want a much higher return. The biggest benefit is that it often runs on a handshake, even with documents in place, but your cost of funds can vary.
Tony Gray: Cost is more than interest. Some relatives will want a piece of your business, which is an opportunity cost you give up early. Some will ask for equity and interest. And your own money, from a 401(k), savings or selling stocks, stops growing in the market the moment you put it into the business.
What does venture capital really cost?
Matthew Gillman: Start with what you are doing with the money. With no contracts and no revenue, friends and family money can be cheaper than raising equity. Once you have revenue, there is no reason to give up equity. Venture capital is very early-stage money and it will cost you a fair amount of equity. That equity could make your company 5, 10 or 30 times more valuable, but it still costs equity. The question is whether you need to give up equity to reach your goals, or whether you can use debt.
Tony Gray: There is smart money and there is stupid money. Look at the quality of the capital as well as its cost: what advice comes with it. A relative who built a successful business, or a venture firm with industry experts, can guide you. Cost, speed and quality: often you can only pick two.
When do credit cards make sense?
Tony Gray: With good credit you can get one quickly. The catch is the cost of carrying a balance.
Matthew Gillman: Credit cards are great for solving timing: bridging a short gap of a few weeks, or earning points or cash back, with no intent to carry a balance. People get caught carrying a balance at a high interest rate, and that is where it gets very costly. Used within the window and paid in full, a card costs you nothing for roughly a month of leverage.
How long does a bank loan take?
Tony Gray: Expect your bank to ask for business and personal financial statements and other documents for its underwriting. In my experience that can take as much as four to six weeks.
Matthew Gillman: The bank process can be a 90-day process, which is a fairly good average, and SBA is similar depending on how complex the situation is. Not all bank products are equal. A signature line, where the bank relies on your strong personal credit, can carry a fairly low cost of funds and still take two to three months, and it will be capped.
Why can a cheap bank line hold you back?
Matthew Gillman: Ask whether the product is right for you today and in six, nine or twelve months. Like most secured lenders, bank or non-bank, the bank will file a UCC on your business. A $75,000 line at a low rate looks great, but the lien covers your collateral, and for a growing government contractor that includes receivables that might reach $400,000 or $500,000. With an all-asset lien in place, it is hard to get more financing without taking out the bank.
If your company will stay the same size, it is a great product. If you are going to grow quickly, historical financials do not support the future, and you need something that grows with you.
What is a UCC filing?
Matthew Gillman: When you sign a loan and security agreement, or a factoring agreement, you pledge collateral: inventory, accounts receivable, equipment. The lender files on those assets, which means you cannot pledge them to someone else. The first position belongs to your senior lender. The filing is standard across the industry, bank or non-bank, and it covers all of your business assets. It is the same idea as the senior lien a mortgage lender holds on your home.
Will my bank loan cost the prime rate?
Matthew Gillman: No. Prime is the benchmark. SBA loans, for example, are mostly variable and priced at prime plus a spread, so they move when prime moves. The spread depends on the size of the loan and the program: larger SBA loans carry smaller spreads, and smaller loans larger ones. Do not read prime as what you will borrow at. Read it as the benchmark: if it moves up a quarter point, your rate likely does too.
Tony Gray: The smaller or earlier-stage the business, the more risk the bank sees, and it prices that risk into the spread.
How is private credit different on speed and cost?
Matthew Gillman: Private credit is broad: some lenders do $25,000 loans and some do $500 million. In the small to middle market it can move a lot faster, because the people building these products are trying to operate faster than banks can. Many specialize. We focus on government contractors, so we understand their ability to perform the contracts, their financials and how fast they can grow, and we build products to fit. Others specialize in energy or apparel and know exactly how goods are ordered, shipped, checked in and paid for.
What does it mean to not be bankable?
Matthew Gillman: Private credit exists for companies that are not bankable or do not want to be in a bank, and not being bankable is not always negative. Some reasons are: losing money, books out of order, taxes not paid on time. Many are positive. A fast-growing company’s historical financials may not support its future. A company may grow moderately and reinvest every dollar, running at break even on purpose. A bank will say it understands, but the company does not meet its internal ratios. Private credit exists to solve that working capital problem.
Which source of capital is fastest, and which is cheapest?
Tony Gray: Friends and family can be fast, with costs that vary with how much your uncle likes you. Venture capital takes time and costs equity, and private equity works the same way for later-stage companies. Credit cards are quick and cost nothing if you pay the balance each month. Bank loans move slower, about four to six weeks in my experience, at a moderate cost that depends on your stage and your financials.
Private credit is generally faster than the other sources. It costs a bit more than a bank loan and generally less than a credit card. Whichever you choose, consult an expert first.
Read more on this
- Government contractor loans, compared
- The complete guide to government contract financing
- Contract line of credit
This is an edited version of the conversation: spoken repetition is removed and each answer leads with its point. Every figure and example is as said in the episode. For financing specific to your business, talk to us.
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