A Professional Service Firm Finds Capital
Few things can put the brakes on entrepreneurs' dreams faster than a shortage of capital.

Lee Reicher, co-owner of an Internet marketing agency, confesses that he and his partners experienced serious obstacles when seeking cash from commercial banks to finance their business. "Our advisors reinforced the need to have access to capital to fuel our growth. There were two primary sources of capital at the time, venture capital and commercial bank financing. The venture capitalists wanted too much ownership for meaningful amounts of capital. Our lack of hard assets and position as a start-up made us an unusual prospect for banks," reflects Mr. Reicher.

For many professional service firms - lawyers, accountants, advertising agencies, information technology consultants, architects, construction managers, financial planners, insurance brokers, management consultants, staffing agencies, and real estate appraisers - obtaining financing from a commercial bank requires active preparation and tenacity to overcome several areas of risk from the bank's perspective:

• Hard Assets
  A manufacturer, retailer, or wholesaler typically owns assets - equipment, trucks, or property - that generally hold value in a fairly predictable fashion and can be sold relatively easily. A professional service firm's main asset is the skill or knowledge of its staff - commonly referred to as intellectual capital - which is extremely difficult to value, let alone pledge as collateral.
  
  
• Revenues
  A professional service firm typically provides a menu of services or solutions for its clients. The sometimes fleeting nature of employees and the marketability of the firm's expertise contribute to uncertainty regarding future revenues.
  
  
• Financial Management
  Managing the basic financial tasks of a business, such as payroll, taxes, budgets, account collections, cash flow projections, and bank reconciliations are typically not strengths identified with new entrepreneurs. But banks are looking for assurances that there will be strong financial management and integrity in the financial reporting.

Mr. Reicher and his partners understood the concerns. The partners took the following steps to properly manage their business financially and to communicate a level of confidence needed to secure needed financing.

Identify a Chief Financial Advisor
The partners needed to find someone who could bring financial expertise to the organization, but they were not in a position to make a high level CFO hire. As a result, the management team decided to engage a financial consulting firm to hire a financial advisor on a contractual or interim basis. Here are the requirements that the co-owners were looking for in their part-time, chief financial advisor:

• A senior level financial executive with in-depth experience in the information technology and media industries.
• A contractual arrangement which would allow the chief financial advisor to work only several days per week on-site, to conserve cash.
• A mentor who would take an active involvement in the business and future banking relationships.

The candidate would also assume the following responsibilities:

• Avoid the top-line emphasis of competitors, and instead create financial reporting that could be used to set goals, benchmarks, and evaluate performance.
• Help to build financial models to assist the co-owners with decision-making about items such as staffing, pricing, overhead, margins, and collections.
• Help to implement a new accounting system that would accurately capture employees' billable hours and track project management activities.

The financial advisor they found was invaluable in communicating the financial needs of the business to both the partners and to financial institutions. The advisor helped the owners make the connection between business success and strong financial management.

Establishing Favorable Payment Terms with Clients
With the partners not pursuing venture financing, they looked to their relationship with clients as potential sources of financing. The partners shared their vision for the business with clients who had prior experience with them. These clients recognized the value that the partners were creating in their new company and had faith in their ability to produce results. As a result, the partners were able to negotiate favorable payment terms with some clients, in the form of cash prepayments, which minimized the company's need for start-up capital. These favorable terms were shared with the bank, highlighting the strength of client relationships and cash management capabilities.

Mr. Reicher emphasizes that while favorable payment terms or cash prepayments can be good, they must be carefully managed so that cash is not absorbed too aggressively into the general business before the work is completed. He figured that if his company managed its cash poorly, it could soon resemble a pyramid scheme with more prepayments required to complete old contracts. Again, the involvement of the company's financial advisor was important.

Understanding the Financial Implication of Business Success
While the partners believed strongly in their ability to attract and retain profitable clients, they also understood that more companies fail due to 'indigestion' rather than 'starvation.' In other words, companies fail because they don't foresee the financing requirements of business growth. Mr. Reicher and his partners worked closely with their financial advisor to plan out the growth of the business, month-by-month, and outline the cash needs to sustain that growth. This financial understanding eliminated painful surprises that would otherwise require quick access to additional capital to make payroll or pay suppliers.

Mr. Reicher and his partners took active steps and exhibited great foresight to improve their firm's cash flow and financial management. By shoring up their firm's working capital requirements with favorable payment terms from clients, they were able to fund the short-term financing needs. By engaging a chief financial advisor, they were able to build a stronger management team.

The partners recently obtained back-up lines of credit, overnight investment sweeps for idle cash balances, and long-term financing for the construction of new office space. Mr. Reicher and his partners now spend time on their real talent - impressing current clients and winning new accounts.

Updated: January 1, 2013

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.