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December 18, 2018

The Challenge of Capital: Situational Awareness

By Josh Fiorini

In the first part of this two-part article, I discussed the basics of debt and equity financing. For a small to medium-sized business, these will be the tools available to capitalize your operation. Now let’s take a look at some common financing situations and how to address them from a capital standpoint.

Seasonal or Event-Driven Inventory

Many businesses have seasonal tendencies, including the shooting sports industry. On the retail side, these cycles are driven by weather, hunting seasons, tax returns and the traditional holiday rushes, and firearms retailers may wish to stock up and spend more than normal on inventory they are confident they can cycle in these higher-velocity seasons.

The simplest way to finance these needs is internally, as most of these seasonal changes will be recurring and predictable. Of course, having a strategic plan in place to address these needs could include reserving cash from operations ahead of time to support purchasing more inventory for those anticipated up-cycles. But if additional capital is necessary, this type of situation is a perfect candidate for debt financing.

Many businesses with seasonal tendencies operate perpetually with a revolving line of credit (or “LOC”). This type of lending arrangement operates similar to a credit card, except that it is sourced directly with a commercial bank and can be secured or collateralized with assets from your business (potentially including your inventory). Such secured LOCs often carry much higher borrowing capability than unsecured credit card accounts. A revolving line can be drawn as you need it, carries small minimum payments (for when you are trying to utilize it), and can be paid back in variable payments at your discretion.

A revolving LOC is generally the perfect tool to manage inventory ups and downs. Other options include more formal fixed-loan arrangements and even a receivables line if you operate with customer credit. Remember, though, that these lending facilities take time to set up, so if you think you may need one in six to eight weeks, the time to move on it is now.

Non-Construction Product or Services Expansion

You may reach a stage in your business where you want to fundamentally expand your product or service offerings. Perhaps you are a retail store that has had a hunting focus and now wishes to expand into law enforcement products. Or maybe you need to add a custom shop or gunsmithing enterprise to your repertoire. These are “hybrid” situations in which either debt or equity financing could make sense.

If the expansion you are looking to do involves simply adding new inventory (targeted at a different market), then refer to the above section: Inventory additions are inventory additions regardless what drives them. At the same time, though, if you are potentially adding staff or equipment and expanding into a line of products/services in which there is uncertainty, then finding an equity partner may be the way to go, as the timeline of the return and the extent of the expenses required are unknown.

Keep in mind that a combination of approaches is possible. For example, equipment can be leased by the business, while funding to cover anticipated temporary operational losses from new personnel and overhead can be sourced from an equity investor. In these cases, it is best to either risk capital you already own or tie the capital sources to the projects and things being financed to whatever extent possible in order to insulate your existing business lines from risk as much as you can.

New Construction and Renovation Projects

Perhaps you’ve reached a stage where opening a new location or adding a range facility to your existing FFL retail store makes sense. Or maybe you simply want to give your enterprise a facelift and retool to better compete with your competition.

If you lease your facilities and are potentially adding value within a property that belongs to someone else, your borrowing options will be limited when it comes to traditional real estate collateralized financing. If, on the other hand, you own your facility (or at least have significant equity in it), the first place to look to finance expenses for significant store physical changes like those I just mentioned is to a mortgage or equity line of credit using your existing facility as collateral. At times it may be possible to even have the potential market value of the new facilities being constructed to be considered collateral.

It is important to remember that the return on these kinds of investments is anything but certain. Your customers may not appreciate or notice your renovations, and a new range may take time to catch on and become known in the community. Where does that leave you with a choice of financing? If you choose debt financing, you need to make sure you can afford the payments based on your existing income. If the expenses for the project fall outside what your current business income can support but you feel strongly about the expected returns from the improved or added facilities, an equity partner would be worth exploring.

New Advertising Initiatives and Marketing Pushes

Not all business improvements are physical or inventory-based in nature. Your business may have reached a stage, for example, where you want to expand your online presence or create one. Or maybe you’ve decided to rebrand or make a new marketing push with the brand you’ve had all along.

Any of these kinds of improvement initiatives carry costs, be they in pay-per-click fees, graphic design, marketing materials or TV and radio ad time. Marketing dollars well spent represent the possibility for a fantastic return, though there is also a large degree of uncertainty here, certainly in the timeline and possibly in the effectiveness. The nature of this uncertainty but its potentially high return should be ringing bells in your head by now that sound like “equity.” A rebranding or brand turnaround effort is the perfect situation in which to look for an equity partner.

What if your rebranding or marketing needs a freshening up but not a total facelift? If your needs in this department are not that sweeping or severe, the next best option here is to increase the amount you reserve from operational cash flow to fund your new marketing initiatives, and in so doing fund this over time organically, from your own efforts and internal capital. Debt can of course be used here as well, as it can for any situation so long as you have credit, collateral and cash flow, but the uncertainty of the returns involved means this should be your last option in these circumstances.

In any of these situations, proper planning prevents poor performance. Strategic planning for your business, which we will discuss in future articles along with how and where to look for equity capital, is of the utmost importance. Plan your moves carefully and calculate your risks and opportunities well. The future profits of your business are its most valuable financial asset: You don’t want to trade those lightly, but be aware that if you don’t have the financing to achieve them, they are worth far less.

About the Author
Josh Fiorini is the former CEO of PTR Industries, Inc. He spent the first decade of his career in finance, holding positions as an equity analyst and portfolio manager before starting his own hedge fund. This experience, along with a deep background in manufacturing, banking and private equity, has made him a sought after contributor on numerous boards and discussion groups on political and economic issues for media outlets, corporations and community organizations. Fiorini currently invests his time and resources with non-profit initiatives and acts as a contributor and management consultant to various firms in the firearms industry as the founding and Managing Partner in the firm Narrow Gate Management.

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Tags: capital markets debt financing equipment lease equity capital equity financing event-driven inventory Gunsmithing Investment law enforcement marketing rebranding return on investment revolving line of credit seasonal inventory

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