When one thinks of small-business financing, it's easy to default to term loans and business lines of credit. However, there are plenty of alternative forms of financing out there.
We had the chance to speak with David Nilssen, co-founder and CEO of Guidant Financial, a company that leverages one of those alternative forms of financing. Guidant offers something called "rollover as business startups" (ROBS) financing. It's a fairly complex subject, but essentially, entrepreneurs use their personal retirement funds to fund their small-business ideas. David personally saw how complex ROBS financing can be, so he worked to create Guidant Financial, which helps customers go through the ROBS financing process among many other things.
David gave us detailed insight into his thoughts on the small-business lending market as well as how he thinks borrowers should treat ROBS financing.
This interview has been condensed and edited for clarity. If you're a small-business owner interested in sharing your funding story, tweet us at @ValuePenguin.
David, could you talk a little bit about your background?
My background actually is as an investor and entrepreneur. Back in 2002, I was in the real estate business, developing real estate here in Washington. I was talking to an attorney about how to fund this transaction for one of my bigger projects, and he suggested self-directed IRAs. At the time, I didn't realize that somebody could use their retirement assets to invest in anything other than stocks and funds. I learned a lot about it, and actually helped a couple of investors to invest in that project through their IRAs. At the end of that they got a great return, but we found out this process of investing using IRAs is really complicated.
I saw this as an opportunity for us to take what has traditionally been reserved for higher net worth individuals and make it accessible to Main Street America. When we originally launched the business, it was helping people invest their retirement funds in things outside the stock market, like real estate and small business. But my business partner and I are passionate about entrepreneurship, not necessarily these nonstandard investments. And so, over time, we started to spend more and more of our efforts focusing on finding capital, or helping entrepreneurs find capital, to buy or launch their small businesses. Eventually, it led to us divesting our real estate-related efforts and instead focusing exclusively on credit or capital for entrepreneurs.
Why do you think most people don't know about rollover as business startups (ROBS) financing?
I think there are more and more people that want to go down that path, for a variety of reasons. One of which is that they prefer to invest in themselves rather than taking on debt from a bank and having to worry about servicing those debts on an ongoing basis; that's one camp. I think ROBS also fills a gap in small-business financing. Today, the time and effort it takes for a bank to underwrite capital to a small-business owner is about the same, regardless of the loan amount. So you can imagine these banks: If it takes the same amount of time and energy, but one theoretically has less risk and a higher profit margin for me, I'm going to move upstream into these larger-scale transactions. So inevitably, what's happened is fewer and fewer banks are providing capital to new entrepreneurs or startups where the total acquisition need is under $1 million.
And so ROBS fills this interesting gap, particularly in the $100,000 to $500,000 range. Under $100,000, home equity lines, credit cards and other types of stacking mechanisms are available; but it really fills a sweet spot where there is a gap in credit. So, why don't people know about it? I think, largely, for a couple of reasons. The first is, 401(k)s are relatively new, having only really been around since the 1970's. But the reality is that it takes time to accumulate assets. What you're seeing is a large group of people, baby boomers, who have been saving for a long period of time and now have accumulated enough assets to put it to work.
Secondly, and this could be more of a conspiracy theory, financial advisers who historically have been largely responsible for helping clients manage money get paid for having those assets in their own portfolios. They then invest in things like stocks, funds and other securities-type investments. So when somebody takes their money out and puts it to work in something like buying real estate or investing in the stock market, there isn't much of an incentive to educate the client. For that reason, I think there have been companies like Guidant Financial that have been helpful in bringing that to Main Street America. But we're certainly not getting a tailwind from the industries that have interest in those dollars.
Given the recent rise of online lenders, where does Guidant fit in the market?
Now, you're right: There's the rise of the digital lenders. But those companies almost exclusively are focused on organizations that are already operating who have two years' of tax history or merchant history that they can attach that lending decision to. We have actually moved upstream, and are exclusively focused on the time when an entrepreneur (first) takes ownership of a business, whether they're buying it or whether they're starting it from scratch. So that's how we differ: We're helping people at the time when they're launching or buying a business, and the digital lenders are making decisions almost exclusively around individuals that have been operating for a period of time.
How do you feel about recent discussions on some online lenders misleading borrowers with the true costs of their loans?
I would say that truth in lending hasn't yet hit small-business financing the same way that it has mortgages. However, I do think consumer demand, and some of the attention that's been put on these lenders, has started to shift that. That being said, in our case, the types of financing or capital access that we usually provide to entrepreneurs come with a lower, or zero, cost of capital. Now, when somebody is making an investment from their retirement plan into a small business, there aren't interest payments to service, they're not having to pay back a bank, because they have effectively decided that this is the best investment for their retirement fund, so they're making that investment in their own business. So for that one, it's really easy to compare against, say, a digital lender that may say they're offering something in the teens or low 20s in terms of an interest rate, but the APR is much higher.
For the SBA loans we work with, the 7A loan is limited to 2.25 or 2.75 points over the prime rate. So you're seeing that loans today are being granted in that 7.5, 7.75 range. And that's something that lenders can't manipulate, because the SBA actually dictates that. For us, that doesn't end up being much of an issue, primarily because ours are so easy to differentiate. And we don't compete for that same business; as we talked about earlier, the online lenders are going after someone who is different than the customer that we're looking at.
Any chance you can talk about the technology that Guidant uses to differentiate its underwriting process from banks and other lenders?
Sure. Most institutions looking to lend capital will do it under specific terms and to specific borrowers. Large banks, for example, tend to only approve 20 percent of the full loans that come their way. For entrepreneurs, that can really deter their efforts if they realize how difficult it is to access capital. Guidant is not a direct lender, and we don't ever want to be. We want to be objective about the clients we take on, and have lots of options to help them carry that over the finish line, versus being subject to our own specific portfolio guidelines. You'll see that in our success rate. When we take in a full application and start to work with a customer, there's a 94% chance that they're going to get fully funded, versus a 20% chance if they go directly to a big bank.
Now, in terms of how we leverage technology, I would say that Guidant, more than anyone I've seen in our market, is a digitally enabled service provider. We use technology, one: to help us better understand who our core customers are, so we can be helpful to them; and there's a proprietary algorithm that we use to do that. We use technology to better communicate with our customers. We communicate the right educational information to them in time, where we're at in the approval process and more. On the back end, it helps us better manage the relationships with our customers. Technology isn't just enabling one component, but really the entire ecosystem that we provide to entrepreneurs.
How does Guidant manage the fact that business owners are risking significant portions of their retirement savings with ROBS financing?
There's typically two camps: There is the paternalistic side that says we should protect people from themselves, and then the other side says, let people make decisions on what's best for them. I have a perspective that there's something in the middle. I think people should be allowed to make decisions that are best for them, but it's our obligation to make sure that they have good information.
So the way that plays out for Guidant Financial is, we spend time making sure people are moving into these transactions with eyes wide open. Any entrepreneur needs to recognize that there is a risk in owning or starting a business, regardless of how they finance it. And then when they look at financing, they have to decide what they're comfortable with. Some people are more comfortable with going down more traditional bank financing: They would rather use somebody else's money and then just collateralize their home and use their credit, and maybe just supply a small down payment. Others will say: I don't want to do that, because if this goes south, I don't want my home at risk, I don't want my credit fried.
They would rather invest their retirement saving in that business and not have to worry about the interest payments on a monthly basis, or repaying that bank. Instead, they're responsible only to themselves and their own future. Now, let's play to the other side. So, I've talked about the risks, but then there's also the upside. If I leverage a bank loan, I'm going to be paying interest along the way, and paying principal back. That is going to reduce my income over that period of time, which under the SBA is typically 10 years. On the flip side, with ROBS, they've made a pure equity investment in a lot of cases. From that standpoint, they should be generating more free cash flow. That could show up both in terms of increase in success rates—that's what we're seeing, at least historically—and then the second benefit is it could potentially increase their value because they're showing more profit.
Many of your customers are over the age of 50, but how much runway do they really have to start and build a business before they need to retire?
Unfortunately, I don't have great data to answer that question since Guidant has only been around for 15 years. What I can tell you is, the last statistics I saw from Dun & Bradstreet is that only about 40% of businesses are operating after their fifth year. Our clients are outperforming that by over 70%. So we are seeing, statistically, that they're more successful in terms of longevity; but that also doesn't include the fact that they may have sold, or done some other exit strategy.
So I don't have perfect data around that number to be able to support that. But what I do want to go back and comment on is, starting a business at 50 is becoming very common. One: It's not surprising to us that our customers are that way, because as I talked about, it takes time to accumulate enough assets to make an investment in a $500,000 or $250,000 business. So it's typically someone who has spent 10 to 20 years in corporate America and has earned enough to be able to put away enough money to make those longer-term investments. And the second thing is, we're finding that the cost of living continues to increase, and as our expected lifetime continues to increase, people are working longer. So it's not surprising to me that someone would start a business at 50, especially the types of businesses that we serve. Because, again, we're serving brick-and-mortar Main Street American small businesses such as service companies, franchise operations and quick-serve restaurants.