The travails of corporate giants such as AIG and GM make lots of headlines, but most troubled firms fly under the radar. Clients who own small businesses are likely to face problems in this uncertain economy, and financial planners can help address at least some of their issues. Business owners who once thought they had their capitalization and cash-flow needs under control may now be facing yawning gaps. Company valuations have fallen, which can wreak havoc with succession and estate plans. Advisers may be able to help clients gain access to capital, as well as funding for business continuity and succession plans. Moreover, they can perform more orthodox tasks, such as helping clients review their retirement and estate plans. Here are some ways to help.

LOAN ARRANGERS

For many small companies, capital traditionally comes from a bank, in the form of a loan or line of credit. Even during the current credit crunch, that may still be the case. “There are thousands of banks in the United States,” says Bob Seiwert, a senior vice president with the American Bankers Association (ABA). “Many are willing and able to lend money to small businesses.”

That doesn’t mean, though, that any business owner can drive down to the local bank and get a pocketful of cash. “In most cases, a bank will want to see three years’ financial statements before lending to a small company,” says Seiwert, who heads the ABA’s Center for Commercial Lending in Business Banking in Washington. Companies that have been creditworthy in the past and can show adequate cash flow still have a good chance of getting a loan or line of credit.

Loans may now come with more stringent terms. “The current economic climate has affected banks’ lending capability, while the credit risk of applicants has increased,” Seiwert explains. “A loan that might have been unsecured a couple of years ago may have to be secured now. Lenders often look for a secondary source of repayment besides the company’s operations, such as collateral or a personal guarantee.”

Especially in these times, business owners need to develop a full-service relationship with their banker, Seiwert says. “Communication is the key. Bankers don’t like surprises. Tell them the bad news as well as the good news. If receivables are slowing up, for example, a banker might suggest ways to deal with the problem, such as offering a discount for prompt payment.”

Many companies, of course, work with a line of credit from their bank. “In this environment, business owners should ask their banker if their line will be cut back or eliminated,” Seiwert continues. “If that’s the case, the owner can start looking for a replacement.” A financial planner might add value by networking and providing leads to banks that are still lending to small businesses.

Planners can also help by emphasizing the need for personal financial discipline. “If a personal guarantee is required, the banker will check the applicant’s credit score for signs of personal credit problems,” Seiwert says. “It pays for a business owner to keep his or her credit score as high as possible by making payments on time and by regularly checking credit reports and cleaning up any errors.”

CALLING ALL ANGELS

While it’s generally believed that established small companies might be able to get bank financing, that’s not always the case. Young companies and start-ups, in particular, may have a difficult time borrowing money in today’s economy. Typically, seed money for small companies comes from the founder, family and friends. Venture capital and angel financing may be available, too, for business owners willing to give up some equity in their enterprise.

“Angels are still investing,” says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. “Our latest database, which covers 2008, indicates that over 55,000 ventures received angel funding last year, for a total of more than $19 billion.”

The number of deals in 2008 was down only 3% from 2007, but the amount of dollars invested was off by 26%. According to Sohl, the data also indicates that whereas angels have not significantly decreased their investment activity, they are committing less dollars per deal, as a result of lower valuations and a more cautious approach to investing. Only 10% of companies presenting to angel groups received funding in 2008, down sharply from 23% in 2005.

Although the pattern is not perfect, angels (wealthy individuals) generally provide funds to embryonic companies with perceived growth potential; venture capital (from investor groups) might become available if a promising company needs more money than angels can provide.

Either way, these investors will want some form of equity in the business as well as an exit strategy that’s aimed at producing profits in the foreseeable future. Therefore, neither angel financing nor venture capital is appropriate for clients whose goal is to build a business, run it for many years and pass it on to younger generations.

RELYING ON RECEIVABLES

There are other sources of capital for business owners, including asset-based financial services. “When credit is tight, people come to us,” says Andrej Suskavcevic, CEO of the Commercial Finance Association (CFA) in New York. “Our members have been very busy lately, doing a brisk business.”

Some of those members are factors-companies that buy accounts receivable at a discount. Other CFA members provide loans secured by assets such as receivables and inventories. Both of these groups offer fast cash flow for small companies, and both seem to be in demand now.

The CFA’s latest report, through the first quarter of 2009, indicates that asset-based financial services are expanding. In its year-end 2008 report, the CFA found that factoring volume reached a record $136 billion in 2008, an increase of nearly 50% since 2001. Outstanding asset-based loans increased 8.3% last year, to a record $590 billion.

Most companies with receivables or inventory can obtain cash via asset-based financial services, but the price may be steep. Asset-based lenders generally charge at annualized rates of 12% to 18%, depending on the quality of the collateral, reports Tom Matthesen, CEO of President Financial Corp. in Atlanta, and factors may charge even more.

The factoring process makes it difficult to put a hard number on the cost. In a typical arrangement, a factor advances 80% to 85% of the invoiced amount: If a company submits $100,000 of invoices, it will get back $80,000 to $85,000 in cash. Once the factor collects on the invoices, it sends the balance to the company, minus a fee that might range from 1% to 5%.

If all invoices are paid and the fee is 3%, for example, the company is effectively paying a 3% fee for getting money in advance of its normal collection pace. Although the annualized rate might be steep, the CFA numbers indicate that many companies rely on factoring for a steady stream of cash.

Suskavcevic justifies his organization members’ fees by saying that they must cover their own high costs. “They have to do more initial due diligence and more ongoing monitoring, compared with what banks do when they make loans,” he says.

Asset-based lenders are going “back to basics” now, Suskavcevic notes, placing more scrutiny on their loans. “Besides collateral, they’re looking for a smart business plan and a borrower who is not over-leveraged.”

Therefore, planners can not only help clients understand asset-based financial services and their costs, but they can also suggest ways to bring down those expenses. “Financial planners might advise business owners to be as transparent as possible,” Suskavcevic says. “They should get their books in order. If they’re going to use inventory as collateral, have that inventory audited by a field examiner.” The less risk to a factor or lender, the lower the cost to the business owner.

SUCCESSFUL SUCCESSIONS

By using one or more of the above financing tactics, business owners may keep their companies afloat until the proverbial rising tide once again lifts their boats. For clients who team up with angels or venture capitalists, the next phase of the cycle may provide an opportunity to go public or be acquired, at a substantial profit.

Many clients who own small companies will have different goals, though. If they want to run the business for many years and then retire, perhaps passing it down to descendants or in-laws, those business owners will need a succession plan.

“Now that the economy has gone through a difficult time, succession planning seems to be higher on the list of business owners’ concerns,” says John Schwan, a New York Life agent in Aberdeen, S.D. “Existing clients are asking if their plans still apply, given what’s happened. New people we see are much more interested when we say, ‘Let’s develop a succession plan.’”

Economic weakness has affected small business succession plans in several ways, but two are most apparent. Business owners whose personal retirement funds have been depleted may have to keep working longer than anticipated to rebuild their investment portfolios. In addition, business values may be depressed now, requiring a hard look at succession agreements already in place.

“We estimate that about 35% of businesses with 100 employees or less actually have done something about a business continuity plan,” says Jane Ann Schiltz, vice president of business markets at Northwestern Mutual in Milwaukee. “In a typical arrangement, a value will be set in the agreement, and the parties will reset that value periodically.” If a company’s value is based largely on revenues or net operating income, the current valuation may be much lower than it was a couple of years ago.

“Family businesses are taking advantage of the lower valuations by gifting” shares of the company, Schwan says. If a formerly $5 million company is now valued at $4 million, for example, senior family members can give 20% or 30% of the company’s shares to younger successors and incur a smaller gift-tax liability. Valuation discounts may drive down the gift-tax impact even further if the transfers are made via a family limited partnership or a limited liability company that holds the transferred shares.

Schwan says that family businesses are also using intentionally defective grantor trusts and grantor-retained annuity trusts (GRATs) to transfer shares to successors. The former can freeze the value of those shares while GRATs, which can be structured for zero gift tax, work extremely well in a low-interest-rate environment. Ultimately, the purpose of all these methods is to reduce estate tax on the intergenerational transfer of the company.

PURCHASING POWER

The issues are different with a nonfamily business. “The relationship is more adversarial,” Schiltz says. Generally, the successor wants to buy low while the current owner wants to sell high. If a formal buy-sell agreement is in place, with a method of adjusting the purchase price, disputes may be reduced.

The catch? “Not every attorney who drafts a buy-sell agreement worries about funding,” Schiltz says. That is, if a successor is going to buy a small business from a retiring owner or that owner’s estate, where will the required $2 million, $5 million or $10 million come from?

Life insurance is commonly used to provide cash to buy shares from a deceased owner’s estate. “Permanent insurance usually works best,” Schiltz says, because the buyout might not occur for many years. “If term insurance is used, I hope it’s convertible term,” which can become longer-lasting coverage, she adds.

Of equal or greater concern to Schiltz is that most buy-sell arrangements won’t provide funding in case the current owner is permanently disabled and unable to work. “The buy-sell might include disability as a trigger event, but how do the people know if the owner is disabled enough to trigger the buyout?” she asks. “An attempt to define disability in the buy-sell can be worse than no definition at all.”

Schiltz suggests using disability insurance to resolve those questions. “Let the insurance company define disability and determine whether total disability has occurred,” she says. “That’s what insurance companies do.” Disability buyout insurance, for example, will pay benefits to the named successors, who in turn can use the money for a full or partial buyout of the disabled owner.

Disability buyout insurance may have a one- or even a two-year waiting period, Schiltz points out, because it could take that long to see if the owner is permanently disabled. Thus, “key person” disability insurance, with a shorter waiting period, may also be desirable, to supply the funds needed to hire a replacement in the interim. Financial planners who are familiar with business succession and insurance can go over such proposals to evaluate whether the cost of coverage is reasonable, considering the protection it provides to the business owner as well as to the company that the successor will inherit.