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Need Money? Renovations

When running a successful business, a shop owner will – at some point – utter the word “renovations”. In his next breath, he’ll shake his head and utter the words “need money”.

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Let’s face it, renovations are an ongoing process for many shops
as additional spraybooths and other equipment are added and new
space becomes necessary due to growth. If these renovations are
minor fixups (e.g. adding a couple of offices), shop owners can
usually pay for the improvements out of cash flow. Not so for
major equipment purchases and renovations. In these cases, most
shop owners need to look to outside sources for financing.

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If you’re one of these shop owners, you can stop shaking your
head and wondering where the money will come from. Six financing
alternatives available to body shop owners for major equipment
acquisitions and capital additions or improvements are equity,
venture capital, conventional bank financing, Small Business Administration
7(A) guaranteed loans, Small Business Administration 504 loans
and leasing.

Equity

The American Heritage Dictionary defines equity as "the residual
value of a business or property beyond any mortgage thereon and
liability therein." On your balance sheet, equity is commonly
referred to as "owner’s capital" or "stockholder’s
equity." As the American Heritage Dictionary indicates, equity
is the value of the portion of your business that you own over
and above what you owe. "Own" is the key word here.

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If you’re looking to expand or renovate your shop, equity is an
alternative source of financing. If you have personal resources
that enable you to inject additional equity to finance the expansion
yourself, then you won’t need outside sources; if you already
have much of your personal net worth tied up in your shop – like
most shop owners do – it’s unlikely that you have large amounts
of personal cash available. In this case, if you’d like to use
equity for a major expansion, you’ll need to consider outside
sources.

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You might go to friends or family for equity capital or to other
sources. Whether the equity investor is someone you know well
or not, what you’re doing in accepting equity capitalization is
giving up a portion of the ownership of your business for access
to capital for expansion. The equity investor then shares in future
profits of the business as the residual value of the shop increases
or decreases.

An equity investor will sometimes want to become directly involved
in the day-to-day operation of the business in which he’s invested.
If you do seek outside equity, be sure to establish upfront whether
or not you or he expects direct involvement. A word of caution:
Even if the equity investor doesn’t become directly active in
your business, you can rest assured that the investor will become
quite interested in the success (or lack thereof) of your shop.
This might not be all bad, though. Oftentimes, the fresh opinions
a co-owner offers can be very helpful, particularly if they’re
from a macromanagement standpoint. Of course, the opposite can
be true if the investor decides to try to micromanage your shop.

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Although you’re giving up a portion of your ownership, don’t give
up controlling ownership – retain at least 51 percent. Also try
to negotiate a buy-back agreement upfront. You can build in certain
stipulations that allow you to buy back the stock from other investors
after a certain period of time or based on certain parameters
(i.e. sales or profitability reaching a certain level).

The key advantage of equity:

  • It provides a source of capital with no specified repayment
    agreement. While the co-owner will share in the successes of your
    body shop relative to the amount of equity invested, he’ll also
    share in a proportionate amount of risk.

The key disadvantage of equity:

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  • You’re giving up a portion of the ownership.

When should you consider equity? Equity typically is used only
for substantial projects. If you’re looking to build a new facility,
double the size of the building in which your shop is located
or add a second location, then equity might be a viable alternative.

Venture Capital

Venture capital is a kissing cousin to equity. In fact, the terms
"capital" and "equity" are somewhat interchangeable
in the business world. Venture capital comes from a venture capitalist,
and a venture capitalist essentially is a professional investor
with funds available to help businesses grow.

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Some specifics on venture

capitalists:

  • They’re looking for high potential rates of return and a method
    of exit.

  • They generally don’t invest in startups, but in new, rapidly
    growing businesses. Some exceptions exist, but most are looking
    for a minimum project size of $1 million.

  • They’re generally interested in businesses that can eventually
    grow to $25 million or more in annual sales.

  • They’re looking for a potential 500 percent to 1,000 percent
    return on investment.

  • They’ll want to own anywhere from 25 percent to 70 percent
    of your business.

  • Venture-capitalists typically use a combination of common-stock
    purchase, debentures and lending to fund a rapidly growing entity.
    At some point, they want their investment to be paid off completely.

The key advantages and disadvantages of venture capital are virtually
the same as those for traditional equity:

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The advantage of venture capital:

  • Funds are made available with flexible repayment terms that
    are typically tied to the future profits of the business.

The disadvantage of venture capital:

  • Some ownership and control are relinquished.

When should you consider venture capital? Because the majority
of body shops are smaller, one-shop operations, venture capital
isn’t a viable source of financing for most owners. For some of
the larger, multishop owners looking to expand by opening new
shops or acquiring existing body shops, however, venture capital
might prove a valuable source of financing.

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Conventional Bank Financing

Conventional bank loans are the most common form of outside financing
for body shops. Unlike venture-capital and equity sources, conventional
bank financing involves no co-ownership, so the bank doesn’t "share"
in your success – the bank is only renting you money. But because
the reward is lower, the risk tolerance of a conventional bank
loan is much lower than that of an equity partner or venture capitalist.

Banks are cash-flow lenders and will focus primarily on the historical
performance of your shop when considering a loan request, which
means the banker will need to be comfortable that you can generate
sufficient profitability to repay the loan being considered. If
you’ve recently had a bad year or two, you might still qualify
for conventional bank financing if you have a good explanation
for the loss (i.e. lost a big account, moved during the year,
etc.) and have taken steps to fix the problem.

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Advantages of conventional bank loans:

  • The biggest advantage is the relatively low cost of the money.
    Bank interest rates typically range from prime to prime plus two
    points (current prime rate is 8.25 percent). Most banks use the
    "The Wall Street Journal" prime, which is published
    daily. Some banks also are willing to provide fixed rates for
    real-estate and equipment loans that might be needed to fund shop
    expansions. In today’s interest-rate environment, you could expect
    to pay anywhere from 8 percent to 12 percent for most conventional
    bank fixed-rate loans.
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  • You maintain control of your business and of the asset being
    purchased.

  • Conventional bank financing is the opportunity to build a
    financial-services relationship. Every other type of financing
    covered herein is more transaction oriented. But with a conventional
    bank loan, you’re building a complete relationship because your
    bank can also provide deposit, cash-management, investment, trust,
    international and even leasing services. Banks also can provide
    other types of financing, including lines of credit, letters of
    credit, vehicle loans, personal loans, etc.

    Disadvantages of conventional bank loans:

    • The biggest disadvantage is the relatively short repayment
      term required. Equipment loans typically are required to be repaid
      in full within five to seven years. Real-estate loans usually
      are limited to no more than 15-year terms.
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  • Banks are inflexible in the repayment terms if you have some
    cash-flow hiccups.

    SBA 7(A) Guaranteed Loans

    The Small Business Administration (SBA) was formed in 1953 to
    help people get into business and stay in business. With the guarantee
    program, a bank actually extends a loan to a small business, with
    the SBA providing a guarantee of repayment for a certain percentage
    of the loan amount (usually 75-80 percent).

    The four key advantages of the SBA:

    • Because the SBA assumes most of the credit risk, commercial
      banks generally are more willing to consider riskier deals that
      normally might not be considered "bankable."
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  • The terms of repayment generally are more favorable than those
    offered with conventional bank financing. For real-estate loans,
    the term can go up to 25 years; this might be just the ticket
    for a body shop owner needing extra capacity, but who can’t work
    a loan payment into existing cash flow on the 15-year payback
    of a conventional commercial real-estate loan. For fixed-asset
    loans (equipment, vehicles, etc.), the term may be as long as
    10 years, depending on the useful life of the asset being purchased;
    and for working capital loans, the borrower may take as long as
    seven years to repay the loan. These terms compare favorably with
    the typical maximum terms for conventional business loans of seven
    years for fixed assets and four years for working capital.
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  • The program is very inclusive. While there are some restrictions
    in terms of how a small business is defined, the SBA estimates
    that more than 90 percent of all businesses in the United States
    qualify for SBA financing.

  • There’s no minimum loan amount, with a maximum guarantee amount
    of $750,000. In other words, a loan could be as high as $1 million
    with a 75 percent SBA guarantee.

    The disadvantages of the SBA:

    • The primary disadvantage is the relatively high cost of financing
      compared to conventional bank loans. The SBA charges a guarantee
      fee for term loans based on a sliding scale of 3 percent on the
      first $250,000, 3.5 percent on the next $250,000 and 3.875 percent
      on the remaining guarantee amount. For example, on a $667,000,
      75 percent guaranteed loan, the guarantee level would be $500,000,
      which would result in a guarantee fee of $16,250 (3 percent x
      $250,000 plus 3.5 percent x $250,000).

    The maximum rates that can be charged are, again, based on the
    "Wall Street Journal" published prime rate, which currently
    is 8 3/4 percent, plus 2.25 percent for loans of less than seven
    years and prime plus 2.75 percent for loans of seven years or
    more. Many banks also will provide fixed-rate SBA guaranteed loans.
    While the fees and rates charged are somewhat higher than those
    charged for conventional commercial loans, it should be noted
    that they’re much lower than those charged by venture capitalists.

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    • Another disadvantage is the amount of paperwork involved in
      an SBA loan. The SBA has instituted a Low Documentation program
      for loans of $100,000 or less that involves significantly lower
      paperwork requirements. However, for loans in excess of $100,000,
      the documentation requirements are higher than for a conventional
      bank loan. Still, the amount of paperwork is roughly equivalent
      to that which is required for a residential mortgage and is not
      as excessive as it once was.

    SBA 504 Loans

    The SBA’s 504 Certified Development Company (CDC) Program is designed
    to provide growing businesses with longer-term financing for major
    capital expansions and can be used for real-estate additions and
    equipment acquisitions. The SBA describes a CDC as "a nonprofit
    corporation set up to contribute to the economic development of
    its community or region." There are more than 290 CDCs nationwide,
    and your area should be covered by one of them.

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    Some of the basic parameters of the SBA 504 program are:

    • The typical 504 transaction involves a 10 percent downpayment
      from the business owner, a 50 percent loan from a conventional
      bank and a 40 percent SBA guaranteed debenture arranged by the
      CDC. For instance, on a $500,000 capital expansion, the owner
      would put in $50,000, the bank would loan $250,000 and the CDC
      would help arrange a $200,000 SBA guaranteed debenture bond.

    • The maximum SBA debenture, in most cases, is $750,000. This
      means that a 504-related project could be as large as $1,875,000
      or even larger if the bank is willing to provide a larger portion
      of the financing.
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  • Specific uses for a 504 loan include purchasing land and improvements,
    including existing buildings, grading, street improvements, utilities,
    parking lots and landscaping; construction of new facilities or
    modernizing, renovating or converting existing facilities; and
    purchasing long-term machinery and equipment.

  • 504 loans cannot be used for working capital, inventory or
    for consolidation and refinancing of debt.

  • Interest rates on 504 loans are tied to a spread above current
    market rates for five-year and 10-year U.S. Treasury Notes. They’re
    generally favorable compared to the rates charged for conventional
    bank financing.

  • The collateral requirements usually are tied directly to the
    asset(s) being financed. Personal guarantees from the owners also
    are required.

  • For every $35,000 loaned by the CDC, the business must create
    at least one new job. In the previous example involving a $500,000
    project and a $200,000 SBA guaranteed debenture from a CDC, the
    body shop owner would have to create at least six new jobs ($200,000/$35,000).

    The key advantages of 504 financing packages:

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    • The downpayment requirement usually is only 10 percent.
    • The overall cost of the money borrowed is relatively low with
      the favorable rates provided by the CDC on the SBA guaranteed
      debenture.

    • The loan maturity for an equipment loan can be as long as
      10 years with a 20-year maximum for real-estate loans. These maximum
      terms are longer than those included in most conventional bank
      loans, which provide cash-flow enhancement.

    The key disadvantages of 504 financing:

    • The paperwork and documentation requirements are extensive,
      and as a result, the 504 route is not recommended for capital
      expansions of less than about $400,000.
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  • The time frame involved in obtaining approval for an SBA 504
    loan can be several months.

  • The fees on an SBA 504 loan are high compared to conventional
    bank financing. SBA 504 fees typically total approximately 3 percent
    on the debenture portion and 1 to 2 percent on the bank loan.

    To find out which banks in your area are active SBA lenders, contact
    your local SBA office. The number should be available in your
    local telephone book, or call information of the largest city
    near your shop. You can also find out more about the SBA at their
    World Wide Web site: www.sbaonline.sba.gov

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    Leasing

    A growing trend in body shops is to lease significant equipment
    purchases, such as spraybooths and computer systems. You’ve probably
    been offered leasing options from your equipment suppliers, and
    banks also offer lease programs. With a lease, the leasing company
    actually purchases and technically owns the equipment. You pay
    a monthly payment based on a present value, lease rate and residual
    value, and at the end of the lease, you typically are given the
    opportunity to buy the equipment at the specified residual value.

    The advantages of leasing:

    • Lower downpayment requirements. Most lease contracts require
      little or no downpayment.

    • More flexibility on monthly payment requirements. Lessors
      are generally more flexible than banks in terms of payment requirements.

    • Keeps bank lines open. Most banks maintain a credit limit
      for each borrower. A lease from another financing source or even
      another department of the bank will allow you to preserve your
      borrowing power.
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  • More favorable financial position. Because leased assets and
    the corresponding liabilities generally are accounted for on an
    "off-balance-sheet" basis, the lease doesn’t count against
    your overall debt position.

  • May offer tax advantages. Depending on your overall profitability
    picture, the legal structure of your company and the state in
    which you operate, leasing may be advantageous from a tax standpoint.
    Consult your accountant during your lease/buy decision process
    to see which method will save you the most tax dollars.

  • Protection against obsolescence. When you lease equipment,
    the lessor is responsible for its disposal at the end of the lease.
    Oftentimes, you may choose to purchase the equipment when the
    lease expires, but if you’d rather pursue more state-of-the-art
    equipment at that point, you’re free to do so without the hassle
    of having to dispose of the used piece of equipment.

    The disadvantages of leasing:

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    • The biggest disadvantage of leasing is the rate of interest
      charged on the lease – the discrepancy between lease rates and
      borrowing rates can be substantial. A bank typically will charge
      a lower rate for a loan than will a leasing company for a lease
      because the bank assumes a lower level of risk by requiring a
      20 to 30 percent downpayment. It’s not unusual for lease rates
      to be three to five percentage points higher than borrowing rates.
      For example, if you purchase a piece of equipment and take out
      a $50,000, five-year loan with a 9 percent rate, your total interest
      outlay during that five-year period will be $12,275.07. In comparison,
      the total interest outlay on a $50,000, five-year lease at 12
      percent would be $16,733.34. You’d pay $4,458.27 more in interest
      costs during that five-year term.
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  • The other major disadvantage of leasing is control of the
    asset. As the owner of the asset, you have more control in a purchase
    than in a lease. This provides more flexibility if you decide
    to sell the asset before the finance term expires.

    Decisions, Decisions

    Because expansion and renovation are a necessary part of any successful
    business, knowing your finance options is also a necessary part
    of any successful business. You may not have a lot of cash burning
    a hole in your pocket, but as long as you know where to go to
    get money, you’ll never be without it.

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    J. Tol Broome Jr. is a contributing editor to BodyShop Business.

    What You Need to Obtain Financing

    When you pursue capital financing, you’ll be asked to submit certain
    information with your request, such as:

    • A brief narrative history of your company with some explanation
      of your plans for the new equipment and/or real-estate acquisitions.
      If you’re just starting out or seeking equity or venture-capital
      financing, preparation of a full-blown business plan is strongly
      recommended.

    • A résumé on you and other key people involved
      in your body shop. It’s important to establish management credibility
      and capability early in the process.
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  • At least three years of historical financial statements or
    tax returns on your business and a current balance sheet on its
    owners. If your venture is less than three years old, provide
    whatever financial information you have.

  • Financial projections for at least one year into the future.
    A simple pro forma reflecting your expectations for revenues,
    expenses and net profit during the next couple of years will do
    because the bank and/or lease company will be looking at potential
    cash-flow generation as the primary source of repayment.

  • Information on the capital expansion. You’ll need to provide
    information detailing total cost, warranties, service arrangements,
    useful life and general capabilities of any equipment you’re acquiring.
    For real-estate projects, you need cost breakdowns, contracts
    for land purchases and appraisals on existing real estate.

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    Obtaining Outside Financing

    To better your chances of raising capital:

    • Keep your personal credit clean – Many a viable business-loan
      application has been turned down because the owner didn’t pay
      his personal bills on time.

    • Pay trade creditors on time – Most equity partners
      and lenders will check trade-credit references. You don’t want
      any negative feedback throwing a cloud over your request.

    • Know how much you need to borrow and why – This may
      sound obvious, but it’s not unusual for a small-business owner
      to go to a lender with no idea how much he wants to borrow.
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  • Use contacts to find the right financial partner
    Asking your CPA, attorney or business associate to introduce you
    to a potential financial partner will add credibility to your
    request.

  • Know your financial information – Many small-business
    owners are much more focused on the day-to-day operation of the
    business than on the numbers. But when a body shop owner sits
    down to meet with an equity partner or lender, he needs to understand
    the financial performance of his business.

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