Getting Credit: Fewer Hurdles But Higher Costs

Though jewelers in search of money now are welcome at many banks, they often must pay more for the credit they receive. Even when bankers say no, there are a number of other places to turn.

Retail jewelers, take heart. The credit crunch of the past five years is easing as more banks dust off their welcome mats to businesses seeking financing. There is a catch, however: loans may cost more.

Is credit really easing? Eighty-five percent of small and medium-sized businesses that applied for financing in 1995 obtained it (up from 74% in 1994), according to National Small Business United, an organization for such businesses.

Similarly, members of the JCK Retail Jewelers Panel say banks have become more accommodating. More than three-quarters say they have good to excellent prospects of borrowing cash to fund a major business expense. The same percentage say they haven’t had any problems getting cash to fund new business ventures.

The situation has improved for several reasons. Bankers credit the establishment of community lending programs for smaller accounts. These programs are mandated in the U.S. Community Reinvestment Act of 1977, which the government has looked at more closely since small businesses complained of tight credit hampering growth during and after the recession of 1990-’91.

Banks also say they’ve rediscovered smaller businesses as potential customers for a full range of add-on financial and business services. In fact, banks now find smaller companies attractive enough to compete with other funding sources for their business.

But make no mistake on two points:

  • Loans to small businesses cost lenders more to make, so they’ll cost you more to obtain.

  • Banks and other lenders demand that their business clients be well-managed and have a clear focus on how they’ll compete in the future.

Here’s a closer look at both points.

Cost of credit: Think laundry detergent. Small boxes cost 20%-40% more per unit weight than big economy-size boxes because packaging, shipping and marketing are virtually the same but the return is much different. Now think loans. Salary, administrative and other costs associated with a $100,000 loan are virtually the same as those for a $10 million loan, but the return is much different. In other words, small loans don’t pay as well as big ones.

Some bankers say they may start to charge more to make more on smaller loans. But along with higher prices, they will offer more services. Their strategy is much like an independent jeweler’s: offer value in the form of services rather than the lowest price.

“We are redefining the relationship between small business and banks,” says Sandy Maltby, executive vice president of KeyCorp. This Cleveland-based bank now operates in 14 states and has grown into the country’s third largest lender to small businesses by offering a full array of financial and business services. “Many of these businesses need so much help beyond lending,” she says. KeyCorp’s services for loan clients include credit card processing, 401K plans, checking, payroll and credit cards for small business executives.

Some services are part of the financing bundle, some aren’t. But even those that cost extra invariably are cheaper through KeyCorp than hiring staff or separate companies to do, says Maltby. She admits that people consider bank charges unfair or unwarranted, but believes they’ll change their minds once they understand what they get for their money.

Personal security required: When you apply for a loan at a bank these days, the cost may involve more than bank fees. Be prepared to secure the loan with personal assets such as your home, bank account or stock portfolio. Banks say they’re adding this requirement because store inventories are difficult to get rid of in bankruptcy liquidations and because gold and diamonds can be spirited away or switched for inferior merchandise too easily if a store goes bust.

“If they’re truly committed to their business,” says one banker, “they’ll be willing to make personal guarantees.”

Not everyone in the jewelry industry agrees. Richard Hahn, president of Juergens & Andersen Co., a 140-year-old wholesaling company in Chicago, began to shop for a new bank when the one he’d used for 18 years began to impose several hundred dollars worth of monthly service charges. “Every bank we went to told us we’d have to put up our personal assets as collateral because inventory was too difficult to get rid of,” he says. Hahn stresses he has faith in his business but says he didn’t want to risk his home. The purpose of a corporation in the first place is to separate business and personal assets, he says. Hahn eventually went back to his old bank and met its requirements.

Business counselors say personal assets are a good source of financing if the small business is successful and its owner has confidence. But they advise owners to avoid pledging personal assets if their business is struggling.

Sound management: Bankers also want proof that a business is well-managed, and it’s not difficult to understand why. “Lets face it, there’s a large percentage of failures among retailers, and the jewelry industry’s record isn’t that inspiring,” says Dale Perelman, president of Jewelers of America and head of the 32-store King Jewelers in western Pennsylvania. Perelman, who also sits on the board of First Federal Savings & Loan in New Castle, Pa., points to the many jewelry operations – large and small – that have been under bankruptcy protection at some time in the past five years.

Even though the credit situation has improved, Perelman says bankers still want to see a proven record of sound management and planning. “It’s the same old story. Those who need credit the most will have the most trouble getting it.”

Bankers agree with Perelman that sound management is critical. They say many retail jewelers, even some larger chains, lack a clear strategy. “Many just want to open more stores in more malls without any idea of what type of customer they’re trying to reach or what the competition is like around them,” says one prominent banker.

Worse, say bankers, many jewelry operations don’t have a handle on their inventory. They don’t know what is selling, what isn’t selling or even where their stock is at any given moment. “How can we determine what a business is worth if we can’t get a fix on its inventory?” asks one banker. “And suppliers will certainly have difficulty retrieving their memo goods if the retailers can’t locate them or can’t distinguish them from their own stock.”

Bankers also complain that too many jewelers take the concept of “family business” too far, often putting relatives into key positions for which they are not trained. “That’s not a way to win a lender’s confidence,” says one banker.

Vote of confidence: Michael Saul, executive vice president of Rhode Island Hospital Trust National Bank, says he’s well aware of the jewelry industry’s problems, but says it’s basically sound and creditworthy.

“The law of the 1990s is better, faster, cheaper, so we’re aware that margins have been declining,” he says. The key, he says, is whether jewelers have factored this into their plans and reduced costs accordingly, and how well they’ve managed credit in the past. “In short, if they have a strong balance sheet, we will bank them. If they are highly leveraged with shrinking margins, we won’t.” And creditworthy operations which need some cleaning up can expect higher interest rates and bank charges.

Ironically, jewelry chains that have gone through Chapter 11 bankruptcy protection may be in the best position now to obtain credit, says Saul. “Chapter 11 has cleaned their slates; they’ve become much more efficient,” he says. In fact, his bank now has sufficient faith in the jewelry industry to pursue medium to larger retail chains.

Interestingly, retailers’ competitive focus on “better-faster-cheaper” has put pressure on their suppliers, says Dion Kenyon, a senior vice president of Fleet Bank in Providence, one of the largest lenders to jewelry manufacturers. “Many of the [large] retailers are very, very efficient now and won’t allow any margin of error for their suppliers. As a result, the ‘better’ part has forced many suppliers to beef up quality control, ‘faster’ has required them to improve their own inventory controls and shipping procedures and ‘cheaper’ has made them cut margins, reduce expenses, run leaner and tighten terms – or at least charge more for memo and long-term payments.”

Alternatives: While the tight credit situation may be easing, pockets of resistance remain. One fifth of the JCK Retail Jewelers Panel have had problems getting adequate financing. About a quarter of the panelists say banks have little or no confidence in retailers.

Charles Peltz of Peltz Jewelers in Marshall, Tex., sought financing for a second store but was turned down even though he had a long history and a spotless record with his bank. The bank finally approved a loan after the Small Business Administration agreed to guarantee it.

If a bank turns down your loan request, don’t despair. Alternate sources have proliferated in recent years (see “When the Bank Says No,” page 91).

The most popular sources of non-bank credit among JCK panel members are friends and family (9% of all panelists and 27% of those using non-bank financing have gone this route) and suppliers (49% of those using non-bank financing for an important business venture).

Legally, family members can lend each other up to $10,000 without paying gift tax if the loan is repaid with interest. As with any loan, however, use caution, says Stephanie McAlaine, assistant director of the Small Business Development Center of the Wharton School of Business at the University of Pennsylvania in Philadelphia. “Many small business people make the mistake of not treating such [family] loans like any other business deal where terms and conditions are agreed upon at the outset,” she says. Without a written agreement specifying terms such as the length of repayment, interest rates and possible equity and default provisions, “there can be significant ill-will and even legal action among family members down the line.”

Supplier financing, meanwhile, can range from direct loans to indirect loans such as memo, extended payment terms, inventory adjustments and swapping old inventory for new.

Supplier financing became so critical in the early 1990s that Gordon Bros. of Boston, a jewelry inventory liquidator and one of the largest jewelry suppliers in the country, decided to open its own retailer finance division called GBFC Inc. Today, GBFC has $160 million of loans to retailers of all types, says President Ward Mooney. The minimum is a $1.5 million yearly credit line for retailers with $6 million to $8 million annual volume. “We don’t have a limit at the upper end,” he says. Clients include jewelry, apparel and hardware stores, among others.

Though GBFC favors retailers with “excellent, consistent margins,” it also works with companies that need financing to restructure themselves out of problems or to make an acquisition or expansion. “It comes down to trust and a strong, viable business plan,” Mooney says.

Bankers’ concerns: Such alternative sources may grow more important as time goes on for two major reasons:

  • Local banks may not be local for long because of a new round of mergers that started this year and the fact that big banks like big loans. (Bankers generally deem any business with less than $10 million in yearly sales small, though that’s not small by jewelry industry standards.)

  • Big banks are growing leery of retailing because it’s cyclical (creating cash flow concerns), less profitable (as price competition drives down margins) and less predictable (customers are more fickle, and the formula that brings them in today may be obsolete tomorrow).

In addition, bankers and even many retail analysts feel that retailing has become too competitive and overstored. The situation is compounded by the growing success of category killer stores, TV shopping and computer shopping in the past few years.

“Many banks don’t understand retailing, how the market works and how to use inventory as collateral,” says Mooney. He concedes retailing can be difficult to understand these days and says this has opened the door to companies such as GBFC that understand the jewelry industry.

Advice from the experts: Before you even approach a bank or alternative lending source, you should clear up any management weaknesses. Here are four major tips from bankers:

  1. Reduce your dependence on memo. “Memo sounds like a great deal in the short run,” says Ellen Heath, who heads the Precious Metals division of Rhode Island Hospital Trust Bank. But retailers end up paying more, often a lot more, and manufacturers find their inventory is much less financeable if it’s out on memo. There are three reasons:

    • Returns. Banks say it’s difficult to determine financing levels for suppliers if they don’t know whether January’s returns will be $5 million or $50 million.

    • Inventory control. Many retailers don’t keep proper track of memo goods, so their suppliers may not get everything back if there’s a problem. “Smart retailers often find they can get 15% or more in discounts from the memo price by buying at regular terms and paying on time,” says Heath.

    • Turn. Memo goods often turn more slowly because retailers may be less careful selecting pieces they don’t have to pay for up front. (Only 11.6% of JCK panelists have scaled down their memo programs in the past three years. Thirty-eight percent have increased them and the rest have made no change.)

  2. Communicate. If there’s a potential or existing problem, bankers want to know. In the vast majority of cases, they will help clients work through it. “Bankers are like everybody else,” says Heath. “We hate surprises. Every banker knows there will be bumps in the road.”

  3. Redirect cash resources into inventory that’s turning quickly at sufficient profit margins. Sell off slow movers at a big discount to raise cash if necessary.

  4. Use financing for things that help your business to grow, such as expanded inventory and store additions. Banks are less inclined to finance catch-ups or “problem repairs.” Here a solid business plan is essential, says Richard Robbins of Arthur Andersen’s Enterprise Group, which worked with National Small Business United in the study mentioned at the beginning of this story. “Use your best estimates for growth and obtain the financing up front,” he says. “Many companies underestimate the capital required to finance increased sales, profits or employment they project in the accompanying expansion, and they may face a shortage of cash.” Then it may be more difficult or more expensive to get additional financing.

WHEN THE BANK SAYS NO

OK, the bank has turned you down and you don’t have enough cash on hand for that important business venture.

What do you do?

If you’re like many jewelers, you turn to suppliers, family or friends. A recent nationwide JCK poll found that half of jewelers who obtained financing in recent years got it from suppliers while one in four got it from family or friends. But after these sources, most jewelers seem to run out of ideas. “You tell me where to go because I’d really like to know,” says one jeweler. “If we knew the alternatives, we would pursue them,” adds another.

In fact, there are many alternatives, say financial experts and jewelers interviewed by JCK. “There are fewer innovative financing programs for small businesses than for large ones,” says Dr. Josh Lerner of the Harvard School of Business, a specialist in venture capital and private equity. “But there are still many sources for small-business owners energetic enough to go out, look for, persist and find them.”

Even jewelers with good relations and a regular line of credit with their bank may want to develop these alternatives to reduce dependence on banks or as a hedge against future problems. Here’s a brief look at some options:

  • Barter finance. Exchanging services or goods for business products, equipment or services is one way to hold down spending. Contact the International Reciprocal Trade Association, 6305 Hawaii Ct., Alexandria, Va. 22312; (703) 916-9020 .

  • Be your own banker. Open an account from which you can borrow for your business. Randy Wimmer, a jeweler in Fargo, N.D., has a $5,000-$20,000 bank account from which he makes loans to the 76-year-old family business. “If I’ve got $20,000 in a bank certificate of deposit on which I earn 4% interest, and at the same time I borrow $20,000 from the bank and pay 8% interest,” he says, “I might as well loan it myself at close to the bank rate.”

This is one reaction to the “new way” of doing business with banks, he says. “We’re a solid business and always repay our loans on time, yet banks require more guarantees and more paperwork than ever, making it tougher on jewelers,” he says. Wimmer still works with his bank for major projects, “but we now try to minimize it.”

  • Borrow & save. In a crunch, you can borrow from savings, stocks, bonds and/or mutual funds; refinance a mortgage; borrow against insurance policies; or invest in short-term high-interest investments. And there’s the Ben Franklin approach: a penny saved is a penny earned. “Small businesspeople forget that reducing expenditures and carefully reviewing where they can save is another source of cash,” says Stephanie McAlaine, assistant director of the Small Business Development Center of the Wharton School of Business at the University of Pennsylvania.

  • Commercial finance companies. It’s often easier to obtain a loan from a commercial finance company than a bank and at comparable rates. CFCs lend against the value of assets such as accounts receivable, equipment, inventory and real estate, and are interested in companies with annual sales of $250,000+. They also are involved in leasing. Contact the Commercial Finance Association, 225 W. 34 St., Suite 1815, New York, N.Y. 10122; (212) 594-3490, fax (212) 564-6053

  • Consumer finance companies. These companies provide loans for many needs, including small-business financing. Some also give unsecured “signature loans,” though only to customers with superior credit ratings.

  • Factoring. This is popular in some retail trades, especially the garment trade, though few jewelers use it. In factoring, a lender buys a business’s accounts receivable for a percentage (or factor) of their value, contingent on their aging or the industry standard of aging. The essential criterion is creditworthiness of the retailers’ customers, not the retailer itself. “This can sometimes be an expensive source of financing and should be used sparingly,” says Wharton’s McAlaine. “You might turn over $100,000 in receivables and get just $55,000 outright for them, while the lender is betting he’ll get back $75,000.”

  • Going public. Forty-two states now allow companies to issue stock at the state level through a Small Corporate Offering Registration. To qualify, a company must have less than $25 million in annual sales, register in the state in which it wants to offer stock, set a per-share price of at least $5 and raise no more than $1 million a year. The company can make multiple offerings, and there is no limit on the number of states in which it registers. Contact the National Association of Securities Administrators Association, One Massachusetts Ave. N.W., Suite 310, Washington D.C., 20001; (202) 737-0900, fax (202) 783-3571

  • Gold loans. Hospital Trust Bank of Providence, R.I., offer precious metals financing to some retailers. While programs are tailored individually, the client typically sells the gold content of his or her inventory to the bank and then leases it back at a fee comparable to interest rates on a cash loan. The loan is denominated in gold ounces instead of dollars. Once the client sells the product, he or she can repay the bank in equivalent precious metal or the dollar equivalent calculated at the gold price on the day of the payback. Clients use gold in their care any way they wish. Ellen Heath at Hospital Trust says this method of financing can be as much as 4% cheaper than traditional loans and that a number of larger retailers have taken an interest.

  • Incubators. Business incubators are venture capital investors, economic development professionals or business service agencies designed to help small young firms survive and grow. They provide access to financing, support services and hands-on management help. Some of the nation’s 500 business incubators accept a mix of industries, others focus on niches. Contact the National Business Incubation Association, 20 E. Circle Dr., Suite 190, Athens, Ohio 45701; (614) 593-4331, fax (614) 593-1996

  • Investment bankers. These specialize in raising debt or equity capital for clients thorough the private-placement sale of securities.

  • Leasing. This allows a business to acquire equipment (from finance companies, equipment suppliers or leasing agencies) without large purchases up front. Money freed up from purchases can go elsewhere in the company.

  • Networking. Many groups offer advice on getting financing from other groups, and many of them are government-backed. Women’s Business Ownership programs (including “Access to Capital” seminars), Service Corps of Retired Executives, Small Business Institutes and Small Business Development Centers handle thousands of cases each year. To find them, check the U.S. Government section of your telephone book or call (800) 8-ASK-SBA. Help also is available from local Chambers of Commerce, university business schools and local or regional economic development centers.

  • Partnerships. In a limited partnership, one or more people contribute capital to a business without incurring management liabilities or responsibilities. Partnership losses can be tax-deductible. Or consider a joint venture; it might be more practical to buy into or form a partnership with another business instead of starting from scratch.

  • Private investors. These are individuals who want to invest in a profitable business with a good return. Such business angels can be found and evaluated with the help of your accountant, attorney, banker or business colleagues.

  • Selling off inventory. Special sales of slow-moving, dated or old merchandise can provide quick cash, especially if tied to a gimmick or seasonal theme.

  • State & local help: Most states and municipalities have programs that provide or encourage investment in small businesses, says Dr. Josh Lerner of the Harvard School of Business. “This is often described as ‘cheap’ financing because interest and demands on equity holdings are low,” he says. “However, the cost in energy to get this financing – including paperwork and other demands – and to make it work is high.” For information, ask your municipal government office or your state representative about financial assistance for small businesses.
    More general information on what states and municipalities offer is available from these groups:
    – Academy for States & Local Governments, 444 N. Capitol St. N.W., Washington D.C. 20001; (202) 638-1445.
    – Council of State Community Development Agencies, 444 N. Capitol St. N.W., Suite 224, Washington D.C. 20001; (202) 393-6435
    – Council of State Governments, P.O. Box 11910, Lexington, Ky. 40578-1910; (606) 244-8000
    – National Association of Counties, 440 First St. N.W., Eighth Fl., Washington D.C. 20001; (202) 393-6226
    – National Association of Towns & Townships, 1522 K St. N.W., Washington D.C. 20005; (202) 737-2000
    – National League of Cities, 1301 Pennsylvania Ave. N.W., Suite 550, Washington D.C. 20004; (202) 626-3000

  • Uncle Sam. The federal government offers several programs for small entrepreneurs. The best known is the Small Business Administration. Here’s a look at some SBA programs: – The Basic 7(a) General Loan guarantees up to 90% of a commercial loan up to $750,000. Interest rates usually aren’t more than 2.5% over the prime rate.
    – The Low Documentation 7(a) Loan is $100,000 or less. The program features a one-page application and relies on the applicant’s character and credit history.
    – The GreenLine 7 (a) Loan is designed for short-term cyclical working capital needs of small businesses. It’s made against a certified level of inventory and accounts receivable.
    To be eligible for any of these loans, a retailer’s annual revenue can’t exceed $5 million to $21 million (depending on the industry). Jewelers who have obtained SBA loans say the requirements can be strenuous; they also note that all work is through a commercial lender, not SBA.
    SBA also administers Small Business Investment Co., which comprises 300 programs combining private capital with SBA-guaranteed funds. Other SBA programs provide financing to disabled and Vietnam veterans (up to $150,000), women business owners (up to $250,000), minority businesspeople in inner cities and businesses that need to rebuild after disasters. Contact SBA at (800) 8-ASK-SBA, fax (202) 205-7064.
    Ask your U.S. congressperson for referrals to federal agencies that offer other programs.

  • Venture capitalists. These individuals or companies invest in companies with healthy growth and profit potential. “The size of the company at the time the deal is made is less important than its environment for potential growth,” says Harvard’s Lerner. Most venture capitalists look for start-up operations, says Lerner, but some are interested in existing retailers. Because they invest substantial amounts and seek a high return, venture capitalists get involved in a company, often joining its board. In addition, venture capital firms tend to focus on companies on the East Coast and in California, which have the infrastructure to support entrepreneurial processes, says Lerner.
    To find venture capital firms, consult Pratt’s Guide to Venture Capital (published by Venture Economics, Boston). Accountants, lawyers and other companies also may be able to introduce you to venture capitalists.

FINANCING SOURCES

Banks and jewelers’ own cash remain major sources of financing. But when banks say no and their own reserves are low, jewelers turn to those closest to them: suppliers, relatives and friends.

If you successfully financed an important business venture in the past three years, what was the funding source?

Bank loan 43%Cash on hand 38%Friends or family 9%A supplier 3%Going public 1%Other 6%

If relations with your bank aren’t as productive as you would like, what other financing have you pursued?Suppliers 49%Friends or family 27%Gold leasing 4%Venture capitalist 2%Going public 2%Other 16%Source: JCK Retail Jewelers Panel

CASH POOR

While most jewelers have no problem getting money they need for regular business operations, according to members of the JCK Retail Jewelers Panel, one in five has neither the cash nor financing for major business expenses.

How do you rate your current availability of cash (or financing sources convertible to cash) to pay for a major business expense?

Excellent 28%Very good 31%Good 17%Fair 10%Poor 12%No answer 2%

How do you rate your prospects of being able to borrow cash to pay for a major business expense?

Excellent 31%Very good 26%Good 19%Fair 13%Poor 6%No answer 5%

In the past three years, has lack of cash on hand or inability to borrow forced you to cancel or postpone a worthwhile business venture?

Yes 20%No 77%No answer 3%Source: JCK Retail Jewelers Panel

JBT & JEWELERS

One in three jewelers polled says his or her Jewelers Board of Trade rating changed in the past couple of years. Most of those with reduced ratings believe the change had little impact on their business operations.

Has the perceived financial strength or weakness of your business caused any change in your JBT credit rating?

Yes 27%No 66%No answer 7%

If your JBT credit rating was lowered, what impact do you think it had on your business?

A lot 15%A little 46%None at all 26%No answer 13%Source: JCK Retail Jewelers Panel

BANKER’S CONFIDENCE

How much confidence do you think your banker has in jewelry retailers and retailers in general?

Very much 18%Some 39%Somewhat lacking 20%Almost none 5%No answer 18%Source: JCK Retail Jewelers Panel

TYPES OF FINANCING USED BY RETAILERS, BASED ON SIZE OF BUSINESS

Figures represent the percentage of respondents using the following types of financing to meet their capital needs in the most recent 12 months.

# of employees ———————-> up to 19 20-199 200-499 all respondents
Commercial Bank Loan 36% 68% 70% 40%
Earning of the Business 24% 39% 44% 25%
Credit Cards 27% 12% 5% 24%
Private Loans 18% 9% 7% 17%
Personal Bank Loans 17% 6% 3% 15%
Vendor Credit 14% 15% 13% 14%
Leasing 10% 22% 25% 12%
SBA- Guaranteed Loan 3% 6% 3% 3%
Private Placement of Stock 3% 3% 5% 3%
Selling/Pledging Accounts Receivable 1% 6% 11% 2%
Venture Capital 2% 2% 2% 2%
Public Issuance of Stock 1% 1% 1% 1%
Other 4% 2% 6% 4%
Used No Financing 30% 18% 15% 29%

Source: National Small Business United