Interest rates have begun creeping up from their historical lows but financing for many snow removal and ice management businesses continues to be elusive. One problem: lower interest rates have translated into lenders and investors being more selective. However, if a bank won’t lend the snow removal business money, the good news is that there are now lots of other options.
Any quest for funding must begin with an understanding of the various types of financing, where that funding may be found and at what cost? What type of funding can best help your operation’s growth plans become a reality?
As a result of tax savings generated by last December’s Tax Cuts and Jobs Act, many businesses have funds available for growth and expansion. Unfortunately, growing any snow removal operation with internally generated funds can be a very difficult process.
For many snow removal and ice management businesses, borrowing can mean a loan from the operation’s owner. Our tax laws contain a number of obstacles that must be overcome in order to avoid the penalties and higher tax bills that result when IRS auditors restructure loans that don’t meet their criteria.
Whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated business, our tax laws require a fair-market interest be included. If not, the IRS will step in and adjust the below-market interest rate transaction in order to properly reflect “imputed” interest. How large the tax impact depends on the effect of added interest income to the lender and the bite of an offsetting interest expense deduction felt by the borrower.
One of the best sources of assistance — and, in many cases, funding for growing the snow removal operation — are the many state, regional and local economic development agencies. There are nearly 12,000 economic development groups in the U.S. whose purpose is to provide economic growth and development in the areas they serve. They generally encourage new or expanding businesses to locate in their area — or to remain in the area.
Even those who are aware of public funding often have misconceptions about who will and will not qualify. Many of these programs are looking for businesses with proven track records. The state, regional and local agencies are frequently willing to help a business providing needed services or willing to hire more workers.
An important form of alternative financing is so-called “asset-based” lending. In general, commercial finance companies are often willing to lend funds to businesses that cannot for various reasons secure credit from a bank. The credit is secured by the assets of the snow removal business, such as receivables, equipment and, in some cases, real estate.
Asset-based loans are generally offered on a revolving line of credit basis or on a term basis. The revolving credit allows the business to draw on a line of credit as needed over a fixed time period. Admittedly, asset-based lenders usually advance capital more quickly and more readily than banks. However, all-too-often, they charge more for the higher risks involved.
CROWDFUNDING AND STOCK SALES
The Securities and Exchange Commission recently approved new rules that will allow snow removal and ice management businesses — even start-ups — to more easily raise money from investors using newer technologies such as online “crowdfunding” sites. Crowdfunding allows those seeking money to post details of their project online and, hopefully, money will come flowing in. Today, by advertising on websites, called “funding portals,” those needing funds can reach out directly to potential lenders and investors.
Although large-scale crowdfunding was not previously permitted under federal securities regulations, today investors can receive equity (i.e. a “share” of ownership in the business), or bonds (i.e. providing a small loan to the business) depending on what the snow removal contractor chooses to offer.
Still on the subject of stock sales as a source of growth funds, an extra incentive is now available to individuals who invest in small businesses. Investors in qualified Small Business Stock can exclude 50 percent of the gain that results when the stock is eventually sold.
THE ESOP OPTION
An employee stock ownership plan (ESOP) can be a tax effective way to transfer ownership of a small incorporated snow removal business to its employees while raising the funds needed for the operation’s growth. With an ESOP, the business issues new shares of stock and sells them to the ESOP. The ESOP then borrows funds to buy the stock. The snow removal and ice management business can use the proceeds from the stock sale to its own benefit — growth or expansion.
The business repays the loan by making tax-deductible contributions to the ESOP. The interest and principal on ESOP loans are tax-deductible which can reduce the number of pre-tax dollars needed to repay the principal by as much as 34 percent, depending on the operation’s tax bracket. Remember, however, the tax shield does not help with S corporations because they don’t pay corporate income taxes. Capital gains deferral, however, can make ESOPs attractive to these pass-through business entities.
Obviously, financing the growth of the snow removal and ice management business is a complex affair. Funding to help grow and expand the operation is, however, widely available to those contractors and business owners willing to do their homework. Comparison shopping for lenders, rates and terms is strongly recommended.