It appears, upon first glance, that there is a plethora of sources of finance for the riskier and different 3rd sector. But recently, upon closer inspection, it appears we may have some that are just playing a part in a fancy dress party.
We recently guided a client through one of these funds geared towards social enterprise or any enterprise who could not get funding from a traditional bank. Now we all know what the traditional banks want: personal guarantees backed up with nice net worth statements, contracts signed with money pending, track record, and so on. We also know that for many applying from within the 3rd sector a high net worth and personal guarantee are not going to be as easy, contracts might be on the horizon–but it’s cash now that is needed, and the track record only comes with time. This gap is supposedly bridged by the quango like lending and investing institutions. Well, maybe.
Turns out that the special moniker for these institutions may be in name only. Ok. To be fair, I am speaking specifically about one organisation (who shall remain nameless, this is not about who dunnit). However, this organisation is substantial and its in their charter, like many others, that they are supposed to be a last resort. Instead, they require all the items that a traditional bank requires and then tells the client that the loan (yes, loan–not investment) cannot be used to pay the members of the applicant’s company any salary. I get the no salary bit, IF it were an investment as noted below as a funding faux pas and the members of our client company had not already invested a considerable amount of their own capital into the venture, but as a loan covenant when the loan is backed by net worth statements and personal guarantees? (our client agreed to a personal guarantee and had a net worth to validate it and a respectable client list to date)
"3. Paying yourself too much (and/or accruing unpaid
salaries). One of the worse signals an entrepreneur can send an
investor is that they’re living off the investments of others.
When investors see an entrepreneur who has made a limited
investment in their business, yet they’re paying themselves
$200,000 a year–not on sales revenue, but investor
capital–we’re strongly inclined to pass on the deal. Some
entrepreneurs try to get around this by accruing a differential
between what they feel is an "affordable" salary and the
salary they feel they’re truly worth. The difference is
expressed as a debt to the business. Investors generally find this
offensive and won’t invest under those conditions. "(Entrepreneur Magazine 16 Jan 2006)
Our client is on the path to finding another source of cash through what appears to be a more logically defined and operated quango lending institution. They don’t need all the money for paying themselves, but you may be wondering why they are choosing to borrow to pay themselves? Well, they have been funding the business thus far and now have the confidence to seek outside funding to carry them through to the next round of contracts. Leverage 101. I think the lesson here is to borrow the money up front for the rent, furniture, etc….as these will be acceptable uses of money for the majority of lenders. Otherwise, like our client, you may find yourself looking for cash in the future with limited institutions to provide it.
Still, this experience left us and our client perplexed. I would be interested if any readers have encountered similar roadblocks or if you are in the financial sector….can you explain this situation (tell me what I don’t get). How can you be described as a lender of last resort if your qualifications are the same as a bank? (Even higher if you have a good relationship with your bank and they don’t require a personal guarantee.)
Further reading |
Salary Caps as covenants
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