August 2012
Starting a Business with Little to no Funding In an economy where small businesses are struggling to keep their doors open, there are still opportunities available of which most entrepreneurs are unaware. There are two industries where individuals can conduct business--through private and public sectors. Most people are aware of conducting business in the private sector, however many have not realized the potential of conducting business in the public sector. Public sectors are enterprises that are part of the federal, state, or local government. But before we get into those opportunities let’s discuss the cycle of business and what’s essential in running a small business. All businesses can be broken down into front end and back end operations. The front end includes the purchase of products GOODS and the sale of those products. Once the products have been delivered CASH SALES then the back end of business operations begins. That includes Cycle of invoicing your clients, accounts receivable, and converting those Business accounts receivables into cash to start the whole process again. Those RECEIVABLES DELIVERY accounts receivables are considered an asset and can be leveraged for INVOICE cash or credit. While the cycle of business is important, there are four essential elements needed in order to have a successful business. Businesses need to have (1) cash or a line of credit, (2) a product or service, (3) the sale or conversion of those products to cash, and (4) management including fiscal, legal, and accounting. Without all four of these components your business is doomed to fail. Most entrepreneurs who start a business usually have a product or service to offer and a target sales
audience. What a lot of small businesses are struggling with is obtaining loans or lines of credit that will allow them to purchase their wholesale products for resale. So the question remains--what kind of business can entrepreneurs run with little to no funding or overhead expenses? The answer…government contracting! Let’s take state contracting for example. There are approximately 220 state agencies in Texas and over 1,900 co-op members who look to do business with small business vendors. These state agencies range from courts, state schools, prisons, public service agencies, and universities to co-op members such as school districts, hospital districts, council of governments, etc. In 2009, state agencies within Texas spent $13.6 billion in purchases alone with nearly $2 billion allocated to Minority and Historically Underutilized Businesses. These state agencies purchase any and everything and are constantly looking for new vendors to conduct business. Generally speaking, in order to do business with these state agencies your business must be registered with the Centralized Master Bidders List (CMBL). Although it’s not required to be registered with the CMBL to do business with the state, this is often the first and sometimes only source state purchasing CASH
DOES NOT Require Good Credit Create Debt Receive Cash/Credit Fast Fund Start-ups Limited Lending Restricted Lending Requirements Typical Fees for Usage
LOAN
SUPPLIER CREDIT
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PAYMENT GUARANTEE
FACTORING
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√ √ 0% 4-18% 0% 1-5% 1-5% (3-7yrs) (30 days) (30 days) agents look to identify vendors who can accommodate their needs. Once these vendors have been identified, a request for bid proposal is sent out to those vendors for a cost estimate. When the contract is won, the business owner is obligated to provide the products to the state agency. So how do you get the product? There are a number of ways: (1) pay cash out of your pocket, (2) get a loan from the bank, (3) get a line of credit from the supplier, (4) get a payment guarantee from a financial institution, or (5) contract sales through “Factoring Financing.” Most people are unaware of the 3rd, 4th, and 5th strategies, limiting themselves from starting or expanding their business. The better of the latter three strategies is obviously a credit line from your supplier. In most instances the line of credit from the supplier can be based on your personal credit, therefore this may not be an option. When that option is not available, some non-banking financial institutions offer a guarantee to suppliers so that they may extend a line of credit to you. In the event you, the vendor, do not pay for the product within a certain time period, the financial group that was the guarantor is obligated to pay the balance owed. The fifth strategy, factoring, is considered a form of financing, but not a
4000
4000
786
2159
3427 4000
4598 4000
4000
4000
4000
5678
6677
7599
loan. Wikipedia defines factoring as “a financial transaction whereby a business sells its accounts receivables, e.g., invoices to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business.” Let’s say you are a vendor and received a contract to provide toilet paper to the Texas A&M University System (TAMUS) next month. The contract states that you will supply the TAMUS with 400,000 rolls of white 2ply toilet paper for $125,000. You know your supplier will charge you (vendor) $100,000 to get the product to your state agency. A factoring organization could advance your business the $100,000, purchasing your accounts receivable up to the amount advanced ($100,000) plus their fees (hypothetically 4% or $4,000) leaving you the balance. If those fees are 4%, the factoring company will receive $104,000 and your business would net $21,000. Although it’s not entirely rational to compare a bank loan to factoring, the chart above compares the interest of an 8% loan on $100,000 over a period of seven years from a bank to that of a factoring business that would charge a 4% fee on the $100,000 they would have advanced to your business. The interest that is paid to Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Bank Loan Interest ($30,924) the bank is compounded, and your Factoring Fees ($28,000) payments are applied primarily to interest at the beginning of the loan while principal payments are applied near the end of the loan. The biggest difference is that the interest your business has paid on a one 7-year $100,000 loan ($30,924) is comparable to the fees ($28,000) of seven $100,000 transactions in factoring financing. In using factor financing you have borrowed and paid back $700,000 in the seven year period, established good business credit, and, because of the availability of cash, have been able to take advantage of more profit making opportunities, seven times to be exact! That’s a lot of buying power when you compare how much money you can get paying the factoring fees versus how much you can get paying the banking interest. And, after so many business transactions with your supplier, he may feel comfortable with extending your business a line of credit and receiving payment after the delivery of the goods. Now you are in business with no supply costs and no debt! Operating with no debt is ideal for all businesses and is very beneficial when developing or addressing an exit plan if you decide not to operate the business or you’re forced to close the business for any reason.
Factoring isn’t for all businesses, but for those who provide products and can contract from a reliable business such as a government agency, it can provide for much more buying power and greater financial rewards. To sign up as a vendor for the State of Texas and be placed on the Centralized Master Bidders List, visit www.window.state.tx.us/procurement/prog/cmbl/ and click on “apply for CMBL.”
For more information contact: Jimmy Henry Program Coordinator Community and Economic Development jlhenry@pvamu.edu Phone: 936.261.5115 Fax: 936.261.5143
The Cooperative Extension Program serves people of all ages regardless of race, color, national origin, sex, religion, disability, political beliefs, and marital or family status. (Not all classes are protected by legal statutes).