Tax incentive alone isn't
good reason to buy equipment
by Beth Ewen DEAR INFORMER: I’ve been putting off some capital equipment purchases. How do I evaluate when to make those purchases or when to put them off some more?
DEAR WAITING: President Bush’s tax cut in May included some nice incentives for small-business owners who need to buy equipment. That’s why I’m writing this column from my new deluxe hot-tub for the Upsize executive suite. (Oops, just a minute, I need to take a call from our accountants.)
But before you buy that new computer system or jumbo packaging machine, evaluate the fundamentals.
So says Susan Johnson, vice president with Fidelity Bank in Edina, who like most bankers treats the question of buying capital equipment in a no-nonsense way:
Determine how much additional revenue a new purchase would bring in, or how much expenses it would cut. Find out how much the debt would cost you.
Then make sure you have enough coming in on a monthly basis to cover the loan payment, and the bigger the cushion the better. (At least 1.5 times the payment, Johnson says.)
As for the new tax incentive itself, Johnson advises business owners to treat it and things like it as “icing on the cake. You still have to have that fundamental there. You still have to have the cash to repay the loan.
“The way that a capital equipment loan gets repaid is with profits, because it’s long-term debt, vs. a line of credit that gets paid with collection of accounts receivable,” Johnson says. “ I want to make sure that I can count on some type of revenue and profit stream coming from a group of accounts that will help me make that loan payment.”
(As for our accountants, they say I have to send back the hot tub.)
Susan Johnson, Fidelity Bank: 952.830.7243; firstname.lastname@example.org
DEAR INFORMER: I have two existing businesses, one profitable and about eight years old, one not yet profitable and much younger. To finance a third company, should I go to a bank for a loan or to an equity investor?
DEAR SERIAL: Congratulations on your multiple business ventures. Because of your track record building at least one successful company, you’re going to have more options than those building their first.
A bank loan is certainly a possibility, and the cost of that capital in the current low-interest environment will be much lower than with an equity investor, says Rick Brimacomb, a partner with venture capital firm Sherpa Partners in Edina.
Of course a bank will want collateral, either personal assets or assets of the first business.
“The person trying to raise this money has to decide, do I want to risk the first business to launch the third business? Maybe that’s a very good choice, I don’t know, but that’s probably the equation,” Brimacomb says. With interest rates low and the interest for company No. 3 tax-deductible, “the cost of that capital is going to be close to zero.”
Do the math first before going this route, as of course any banker will do: “You wouldn’t want the debt service to be equal to operating income of the first company,” Brimacomb says. “If the first company’s operating income is many times what the debt service is, then it’s not much of a risk. If the operating income is only 1.5 times your debt service, let’s say you hit a bump in the road,” and suddenly the first company is in jeopardy.
By contrast, launching the third company via an investor in this market and in this funding environment, the cost of capital will be high. “Someone would expect a 30 percent rate of return, so they’re going to want a healthy chunk of the company,” Brimacomb says.
Also, our serial entrepreneur indicates that there aren’t outside investors in the first two companies. “This person is probably used to doing it his or her own way,” he says. With outside investors, “there definitely is going to be a tradeoff from a control standpoint.”
Upsize Informer notes that company No. 2 isn’t profitable yet, so should this person wait to launch No. 3? Probably not, Brimacomb says, given this owner’s apparent skill at starting businesses. A better measurement than profitability is stability, he says. Is the second company stable? Is it growing along with the business plan? If it is, launch away.
Rick Brimacomb, Sherpa Partners: 952.942.1070; Rick@sherpapartners.com
DEAR INFORMER: I took my business idea to someone knowledgeable for an informational interview. Now they’re using it! How can I regroup?
DEAR BURNED: First, the good news, from Jim Patterson, partner and intellectual property attorney at Patterson, Thuente, Skaar & Christensen in Minneapolis: In the United States only the first and original inventor can get a patent. “If all of the truth comes out, that our party was in fact the first and the original, the second party can’t patent it. Notice the qualification: there’s truth and you can prove the truth,” Patterson says.
The bad news, of course, is proving the truth can be difficult and costly. So let’s focus on the “shouldas” first. “In order to protect yourself before you talk to the person, you could first of all file a patent application,” Patterson says. A provisional patent costs only $80 to file.
“Secondly, you can have a nondisclosure agreement with the person you’re going to talk to,” Patterson says. That can be a simple letter, which says you’re going to disclose your ideas and the other person cannot use them.
“Most people have no trouble signing that,” Patterson says. And it doesn’t have to be a patentable idea to go this route: it could be trade secrets, know-how, etc. Bonus: You look more sophisticated if you do this, Patterson says.
The third way is to disclose your ideas to somebody in your own company, to your attorney, or the like, “so you can establish your date, and then it becomes not just your word against their word.”
“Most people get burned once, and then they use the agreements,” Patterson says.
Backing up for our questione: Gather any documentation to show that the idea was in place before disclosure, and determine who within the company or circle of confidences can verify it.
If you’ve got the evidence and can prove it, then see if you can file a patent application.
“The second way to go is to say, maybe we didn’t have anything in writing, but this was done in confidence,” Patterson says. “This guy had every reason to know this was proprietary to me and he stole it from me.” That’s a hard case to make, he adds, but it can be done.
Finally, it’s worth a try to call the person up and explain that the idea was stolen. Many people want to do the right thing, and will try to make it right. “The law defines what the minimum acceptable behavior is, when you think about it, and most people want to do more than the minimal acceptable behavior,” he says.
Jim Patterson, Patterson, Thuente, Skaar & Christensen: 612.349.5740; email@example.com; www.ptslaw.com