A Real Life Story of Business Finance

 

Many of us assume that in order to start a business, we need to have stockpiled a significant amount of cash.  However, there are many alternatives to having that cash accumulated in your bank account.

 

Recently, I had an opportunity to talk to Dan Erhart, a Mill Creek resident, about his experiences starting up his Telecom sales firm, Visor Communications, LLC that sold voice, data and internet solutions as a 5-Star Authorized Distributor on behalf of SBC.  As a partner in the firm, Dan was instrumental in launching the business and making it a success. 

 

When the partners decided to start Visor they talked to the accounting firm of Dolins, Dolins and Sorinsky of Deerfield, Ill for ideas on how they could finance their business.  Although they didn’t have all the cash-in-hand required by their business plan, their accountants showed them how to move their funds out of their retirement plans and into a customized 401K. 

 

The partners were able to use the money in their 401K to lend back to themselves to reinvest into Visor.  Repayment had to be made according to a regular schedule and interest had to be applied at a standard market rate. 

 

This arrangement allowed them to launch their company but there are certain risks to consider.  For one thing, if the borrowers were unable to meet the repayment schedule, any defaulted amount is treated like an early withdrawal from a tax deferred savings account. Taxes are paid at the standard rate plus a 10% early withdrawal penalty.  Another issue for many retirement planners is the impact that borrowing from a retirement account can have on retirement savings.  Generally retirement funds are invested in equities with an expectation that they will produce a higher rate of return than that associated with the 401K loan that you make to yourself.  Before making that loan to yourself, you should be confident that what you’re using it toward (i.e., financing your own business) will eventually pay back in a way that supercedes the loan you’re making yourself.

 

Dan and his partners also turned to an “angel investor”, a wealthy individual willing to review their business plan and provide them with funds based on the merits of their ideas and his confidence in the partners.  Angel investors are a type of venture capitalists. 

 

Venture capitalists (VC) are firms that work with privately held companies in need of capital.  VC look for opportunities to reward the relatively high risk associated with up-and-coming firm by making substantial profits when these firms crossed a new tier in their development such as the sale of their first batch of stock.  The term “angel investor” was coined to refer to individuals who had a fair amount of wealth often built up through other business activities.  Angel can also refer to the soft-touch they bring to the business unlike the more hands-on, management-by-the-numbers oversight that many VC firms exercise.

 

When considering a venture partner, you are often exchanging a substantial portion of the ownership in your firm for the funds you gain.  Venturevest Capital, a VC firm, advises that “entrepreneurs should be clear as to the intentions of the corporate venture firm in terms of follow on rounds, board seat control, and exit opportunities”.  There is a wealth of information to read and of course, you’ll want to get advice from both your accountant and especially your attorney.

 

Returning to Visor’s funding issues, because of the nature of their business; customers didn’t pay for their orders until the service/equipment was installed and operational.  Visor had roughly 90 to 120-days between inking a contract and receiving payment.  In the meantime, Visor needed to manage its monthly business expenses (e.g health care, rent, professional services) and pay the staff to support their organization.  To facilitate this cash flow process, they decided to use a bank line of credit.

 

Visor shopped the idea around with three different banks comparing fees and terms.  They settled on BankOne.  Dan explained that not only was BankOne competitive, but they very helpful in guiding Visor through the process of completing their SBA paperwork.  The SBA or Small Business Administration is a department of the Federal Government that works with local banks to extend credit to upstart companies.  Although the loan is provided by BankOne, the SBA supplies 85% of the funds.  The bank serves both the client and the government by supplying the other 15%, verifying the creditworthiness of the business and handling the on-going administration and collection on the loan.

 

The business had been operating for about seven months before they approached the bank for a loan.  This provided Visor with financial information to demonstrate why they needed the loans and how they would have the funds to repay the loan according to the agreed upon schedule.  The SBA does, however, have programs that may be useful for brand new startups too.  We’ll go into that in a future newsletter.

 

Eventually, Visor ran into supplier issues with SBC when the telephone company decided to rework their distributor network.  Dan and his partners spent many 12 hours days holed up in a conference room in front of a large whiteboard, going over possible new strategic directions for the company.  In the end, Dan was unconvinced that they could identify a new revenue stream that would support the business and comply with the contractual constraints that SBC had put upon them.  Dan sold his share of the company to one of his partners.

 

Asked about the overall experience, Dan is proud of the company he helped build and philosophical about the challenges they ran into.  “When we started up”, he said, “our attorney gave us this bit of insight.  While running your own business, you’ll experience your highest highs and lowest lows and sometimes, they’ll happen within hours of each other.  That’s what our experience was like with Visor… but I wouldn’t have traded that experience for anything.”

 

Dan Erhart is a Mill Creek resident and former partner in Visor Communications, LLC.  He is currently investigating various options for his next professional challenge.  You can contact him at 630-262-8537.   If you have questions or comments related to this article or you would like to be a guest columnist for “The Small Business Advisor”, please contact Tim Hadfield at 630-208-4828 or thadfield@allantgroup.com.