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Sound Advice

Financing Your Way To Success by Corinne Light

One of the most prevalent problems in the production audio business in Canada is a lack of capital to obtain the right equipment to do the larger and more lucrative venues. While the banks seem to take the brunt of the blame for this, they alone cannot be faulted for not understanding how the industry works and who will survive long enough to profitably pay them back. It is up to the individual business person to clearly show why a financing situation is a safe bet and to obtain the funding from the correct sources.

The production industry, whether it is audio, lighting, video or staging, all operate on the same principles. Say you have $1,000,000 in equipment, you earn about $1,000,000 in revenues each year in total for manpower, transportation and equipment rental charges and make about 5-10% in net profits after wages and all expenses are paid. If you wanted to grow by 25% in the next year, you would need more equipment and manpower. Typically, this could mean an additional $250,000 in equipment to achieve this, which can be very difficult to purchase without external financing if you only made 5% or $50,000 profit the year before. Of course, you could always cross-rent your equipment from your competition but somehow this doesn’t make sense to do on a large scale as you are really helping them pay off their equipment and it takes an enormous amount of manpower and cost to do this.

Sometimes it appears as though some businesses have endless amounts of capital available while others, who have been around just as long, can’t seem to borrow even a small amount of funds.

Most companies that get major funding have worked hard to make sure they have presentable financial information on their company that shows clearly that they will and have previously made profit from this kind of investment and have approached the correct funder for the task. This is something that the majority of businesses could do and it is surprising how few actually do it. Because of the enormous inventory requirements needed in the production industry, very few companies can grow to their potential without the aid of external financing, although many try because of their lack of comfort in this area. Care must be taken to obtain financial backing in the correct sequence and to use the correct form of financing for each task.

Many business people first go to the bank to get funding, as they are familiar with them from their daily banking tasks. While this appears to be the logical first choice to most, borrowing from a bank does have its drawbacks and can often limit the overall amount of credit you can obtain. This is caused by the method of securing loans that banks use as in many cases they will attach collateral security to everything you and your company owns to loan an amount of money. These are the dreaded GSAs or General Security Agreements and personal guarantees that allow them to take any or all assets you may have to pay off a loan in case of default. If you have confidence that you can pay back the loan this is not a problem, except that other financiers may not like the idea that if something went wrong, the bank gets theirs and they may get nothing.

Although this looks unfair, it is reasonable to the bank. Banks are in business to loan money and receive money back as payment. They don’t want the item you purchased, they would much rather take easily disposable assets like new inventory, cash, accounts receivable and your house. Product suppliers, while they too would like to be paid in cash, will often give you short-term credit as, being in the same business, your items of inventory have some value to them. However, they have the same problems as retail dealers, they are not banks and usually don’t have the resources to give long-term financing to everyone, even if they wanted to. Supplier credit should be used only to finance short-term inventory turnover and sales not your long-term inventories.

While product suppliers can be more liberal with credit than banks, even 12 month financing on production inventory can be detrimental to some companies; it is difficult to grow when the profit earned on an item is less than the ongoing payments to obtain the item in the first place. Many have built their business on the “leap-frog” method of financing but it is a painful way of doing it and just as many businesses have suffered years of cash flow and personal income pain because of it. Besides, product suppliers love cash and some will give additional discounts to get it quicker.

DInvestors are wonderful if you can find one but are really expensive if you do actually make the profits you promised them. Reasonably, an investor wants to make more than interest on their money for the risk they are taking.

Lease companies are ideal for long term financing but are not easy to obtain funds from unless you want a car, computer or photocopier. In our industry, it can sometimes be hard to obtain funds for inventories. Understandably, lease companies can be nervous about leasing equipment that does not stay in one location. As well, restaurants and bars do not, on average have a reputation of longevity and they are often confused or identified with our industry.

However, properly approached, leasing companies can be an invaluable source of capital, especially for production inventories.

One of the principal differences between leasing companies and banks is that while banks loan money, leasing companies buy the goods for you and charge you a monthly fee to use it. While this sounds like you don’t actually own the item, which you don’t, the leasing company doesn’t really want to own the item either and it is usual to pre-arrange a buyout at the end of the lease term.

In reality, leasing is just another format of lending funds and earning money because of it. A lease is more of a long-term rental contract rather than a loan document and lease companies have less security to collect funds, in case of default, than banks if something goes wrong. The bank usually can take everything, except the leased items, which the lease company owns. Lease companies like the idea that you were approved for bank credit but know that they stand to lose everything, except the item itself, if you owe the bank too much.

By using the bank line of credit for short-term financing of purchases and accounts receivables and leasing for production inventories, a combined larger amount of credit can usually be obtained.

Many make the mistake of focusing in on the cost of leasing versus bank loans. It is easy to forget that you are in business to make money, not to save money. Banks alone are fine as long as they can provide all the funds you require when you need it. While leasing can be a few percent more, this should not affect your profits nearly as much as not having the funds at all. Too many companies use up their available bank credit to buy inventory items then suffer from missed cash payments discounts, paying supplier interest and bad credit ratings, all of which are very costly. If you lease first, the leasing company looks at you in a healthy position. Once the bank comes in, the leasing company probably won’t give you too much more lease equipment because they are aware that the bank is in first position.

Logic dictates that if you can’t make more than 12 or 14 % on your money, you shouldn’t be borrowing it anyway.

Another problem is that, unfortunately, many companies decide to overly depreciate their production equipment inventories to save paying corporate tax. While this is very inviting if you are cash tight it makes you look unprofitable on your statements and nobody wants to lend money to an unprofitable business. Besides, if you intend to sell and replace these items, you are not really deferring much and if you do any major changes, you may inadvertently exceed the corporate tax relief level in a given year and cost yourself excessive tax payments.

In this perspective, when it comes to financing, showing a profit and paying tax is a good thing. It will help get you the financing you require to achieve your potential. Remember that it is difficult to see the difference between a company who is trying to avoid paying tax and one that just can’t make a profit.

In our industry, growing 20% can mean 20% more equipment need to be purchased so proper financing can be critical.

Understanding a bit about financing and working with your company’s financial information to maximize your credit capabilities will help you grow and profit using other people’s money.

Corinne Light is the President of Light Financial Corporation. She can be contacted at c@lightfinancialleasing.com

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