It’s All About the Collateral

I’m often asked if a business plan is solid enough to take to the bank for financing. I disappoint a lot of folks when I tell them that, while a solid business plan is important, getting loans is all about the collateral.

Banks are not in the business of understanding your business. They don’t know how to evaluate a broadband business plan. It’s important to understand that in a given week a bank might be offered your broadband business plan, a plan to roll-out a dozen yogurt stores, a plan to combine several farms, and a plan to start a new brewery. They can’t begin to be able to understand the nuances of the many business plans they see.

It’s very easy to become too invested in your business plan. I often hear people describing their business plan as ‘can’t fail’. I can usually demonstrate that this is not so by changing a few of their key assumptions. It’s the rare broadband business plan that can’t be worsened by lowering the customer penetration rate, slowing down the speed of sales, or increasing the interest rate on debt.

Banks understand this. Every bank has a portfolio of failed projects where the bank lost a lot of their loan investment even though a project looked solid. Banks are skeptics by nature because they deal all day with prospective borrowers who are convinced that they are bringing a no-fail project. If a loan is large enough, a bank might hire an expert like me to check the assumptions in a business plan to help to identify the most sensitive variables. However, even with expert advice, a bank is still going to assume that a business can fail.

That’s why I say that the most important thing is collateral. Collateral represents the ability of the bank to recover some of their funds should a project fail. The stronger the collateral, the easier it is for banks to make the loan.

There are various types of collateral. The best collateral is a payment guarantee that kicks in even should a project be a total bust. This is the reason why municipal bonds that are backed by tax revenues can get lower interest rates. If a city builds a fiber network, a golf course, or an arena and the expected revenues don’t materialize, a tax-backed loan requires the city to raise taxes to make the bond payments.

Many new ISPs become familiar with the idea of collateral when banks ask them for a personal guarantee, meaning a borrower must pledge their home and savings as back-up for a project. That guarantee is rarely as powerful as tax-collateral, but it improves a borrower’s chance of getting the loan.

Established ISPs also face loan guarantees. If a telco wants to undertake a large new fiber project, they generally end up pledging their entire existing company to get the new loan. Communities often wonder why existing ISPs don’t expand faster, and more often than not it’s because they’ve already used up all of their collateral on existing loans. Just like with households, every business has a natural lending cap, at which no bank will loan them more.

Banks do consider other issues other than collateral. For example, a bank might consider track record when lending to an ISP that has been successful many times in the past – and that track record might lower the needed collateral. Banks love grants, but love owner equity even more since it means the owner has skin in the game.

Occasionally I see a new fiber venture that gets funded when it probably shouldn’t. There are local banks that lend to a local fiber project because they think their community needs fiber to thrive and survive. A bank in that situation is putting themselves on the line since they see their survival tied to the survival of the community.

The bottom line is that a project without collateral is not easily bankable. Unsophisticated borrowers think the numbers in their business plan tell a bank all they need to know. The truth is that the business plan is several items down the checklist for a bank, with collateral at the top of the list.

The Evolution of the Fiber Business Plan

Fiber CableThe other day it struck me how much the telecom consulting business has changed over the last decade. A decade ago a huge amount of the focus of an FTTP feasibility study was about integration. And today all of the emphasis is about finding the money to pay for fiber.

Integration is the effort required to make the equipment from different vendors work together. In the early days of the FTTP industry this was a very big deal because there were different issues with every brand of electronics in the industry. There was nothing at all automatic about getting a cable TV headend or telephone voice switch working on a given fiber network.

A lot of the work involved in choosing a brand of electronics was deciding which brand had the least number of bad things that wouldn’t work on an FTTP network. There was a time when very basic things like supporting a fax line or provisioning a T1 on FTTP was an issue. There were tons of problems getting some telephone features to work. And no matter what the vendors told you, when it came time to get a new network up and running all sorts of new surprises would pop out after each new software release from the many vendors. It got so bad that we were recommending not updating software at one point.

Sometimes the integration issues were significant. I had one client who was the first one to try an IPTV cable headend on their FTTP network and they had a huge number of headaches. The integration caused them a delay with their launch and their problems with cable delivery were so bad that they got a bad name in their market that took years to overcome.

But today there is almost no worry about making things work on an FTTP network. Most products are now delivered as native Ethernet and all of the work of decoding the signals is done by smart devices like set-top boxes or modems rather than in the fiber electronics. I can’t recall having used the word integration for many years, which is refreshing compared to a time when we had to practically scare clients to make them understand that they were going to see surprises and have delays every time they launched a new product on their network.

Today we are able to make a pretty reliable estimate of the cost of the electronics and know that when it comes time to get into the business that whatever major brand of electronics is chosen will work well.

Today our emphasis has instead turned towards figuring out how to pay for building a fiber network. This has never been easy, but it seems like all of the old avenues of financing – be that bank loans or municipal bonds – are harder to close these days than in the past. In the last fifteen years banks have tightened up significantly compared to the times before the housing meltdown of a few years ago. And municipal bonds for fiber are a harder sell due to a few failures of municipal revenue bonds for fiber as well as a tougher bond market in general.

I find that I spend far more time these says working on financing and as a firm we spend far less time working on engineering issues. I now warn clients that funding will be the big hurdle where in the past it was the worry of successfully getting all the products to work right. I now put a whole lot of emphasis up front with a new client on finding a business plan that they can take to the bank. I know that bankers are going to scrutinize every assumption and that there has to be a lot of safety margin in any business plan so that it will remain solvent even if it does worse than hoped for.

Opportunity Abounds

English: colorful fiber light

English: colorful fiber light (Photo credit: Wikipedia)

I am often asked about ideas for building a fiber network that can make money. Right now in this country there is a huge opportunity that almost nobody is taking advantage of. There have been tens of thousands of miles of middle mile fiber built in the last five years using federal stimulus grants. Additionally there are other networks around the country that have been built by state or other kinds of grants. And there has also been fiber built to thousands of rural cell phone towers.

These networks are largely rural and in most cases the networks have only been used to connect small rural towns and to serve anchor institutions, or built to go only to cell towers. If you look at these networks closely you will see miles and miles of fiber that goes from county seat to small town to county seat with a few spurs serving schools, health facilities, junior colleges, city halls and cell towers. But for the most part the fiber has not been used to serve anything else.

The whole stimulus grant was cooked up quickly and was not a well-planned affair. They tried to make awards in every state and we ended up with a true hodge-podge of networks being built. In some cases it looks to me like networks to nowhere were built, but a large percentage of the stimulus grants went through rural areas where there are nice pockets of customers.

For years I have advocated a business plan that builds fiber in short spurs in situations where there is guaranteed success. For example, one might build to one large business whose revenue will pay for the fiber route. Or these days that is most likely going to be a cell tower. And so building to that single guaranteed customer can be a successful business plan.

However, any carrier who stops with that one customer is missing the real profit opportunity in such a build. The best business plan I can find today is to build to an anchor tenant and then doing everything possible to sign every customer that is passed to get to that new tenant customer. In economic terms you can think of the cost of the fiber build as a sunk cost. Generally in any business when you make a sunk-cost investment the goal is then to maximize the revenue that can be generated by the sunk cost.

And so, if the anchor tenant you have found can justify the fiber build and pay for the sunk-cost investment, then adding additional customers to that same fiber investment becomes a no-brainer in economic terms. The extra customers can be added for the cost of a drop and fiber terminal device, and in terms of return, adding a home or small business might have a higher margin than the original anchor tenant.

They key to making this business plan work is to keep it simple. You don’t need to be in the triple play business to add residential customers. Offering a very high-speed data connection for a bargain price is good enough to get a good long-term customer with very little effort required by the carrier. If you happen to already be in the triple play business and have all of the back-office support for such customers then you can consider this as an option, but offering only data is a profitable business.

And so the business plan is to look around you and see where there are facilities built but underutilized. The key to making this work is to get cheap transport to reach the new pocket of customers. By law the stimulus grants need to give cheap access to somebody willing to build the last mile. But commercial network owners are going to make you a good offer also for transport if you can bring them a new revenue opportunity in a place they didn’t expect it. So the key is to first work with the network providers and then look at specific opportunities.

And you possibly don’t even need much, if any staff to do this. There is already somebody maintaining the backbone fibers and they will probably be willing to support your fiber spurs. And it’s quite easy today to completely outsource the whole ISP function. The only thing that is really needed is the cash needed to build fiber spurs and connect customers. The more you have the better you can do, but you could build a respectable little business with only a few hundred thousand dollars.

If you are in a rural area there are probably dozens, and maybe hundreds of these opportunities around you if you look for them with the right eye. As the header of this blog says, opportunities abound.

Finding the Right Partner

Yesterday I talked about public / private partnerships since that seems to be one of the more common partnerships in telecom these days. Today I am going to talk about how you find a partner that you can co-exist with to make a viable long-term venture.

It’s not as easy as it sounds. I had a partner once who said that finding a good business partner was as hard as finding a good marriage partner, and I think he was probably right. I have seen hundreds of telecom partnerships and a lot of them become totally fractious and contentious over time due to the partners growing apart over time in terms of goals, personalities or vision.

But I have been a part of some very good partnerships and I have seen other good ones, and having also seen unsuccessful partnerships I can talk about what seems to work and not work. Here are some things to consider when forming a partnership:

  • Power and ownership share needs to be equitable based upon up front contributions and ongoing contributions. I have seen partnerships who decide up front to split things 50/50 but then resentment grows over time if one of the partners is doing most of the work to make the business successful. It’s okay for the partnership to be disparate and have one partner contribute more than the other, but this ought to then be recognized in terms of ownership and profit distribution.
  • You must share the same goals. This is one of the biggest problems that I see in public / private partnerships in that a commercial company and a municipality have very fundamentally different ideas of the way that things can work. As an example, a municipal venture is considered successful when it is cash flow positive, but a commercial venture needs to make more than that to meet return expectations. If both partners don’t have the same goals, then one partner is going to be disappointed with any outcome.
  • Make sure everybody understands their roles. In a business not everybody can be the boss. Partners need to decide up front will be responsible for what and then insist that partners fulfill their obligations.
  • You must be able to communicate with your partner. Partners must be able to tell each other the whole unvarnished truth. It takes both partners to make a business work, and failure to communicate is always going to lead to trouble down the line.
  • You must be able to resolve differences. In a more traditional business the owners or the Board is ultimately in charge and they can resolve disputes by fiat. But if a two-partner firm can’t resolve an issue the business can become paralyzed. Being able to iron out differences is probably the single most important requirement for a good partnership.
  • You must trust each other. This goes back the statement that a business partner needs to be like your wife or husband in some aspect. Generally all of the partners in the firm can spend the firm’s money, can commit resources, can make decision. If you don’t trust your partner fully – trust them to be honest, to not cheat you, to do what they say they will do, to tell you the truth – then the business is eventually going to get in trouble. Partners shouldn’t be spending their time watching each other, but in furthering the goals of the business.
  • Finally, partners have to be flexible. In telecom a business rarely goes the same as the original business plan and so the partners must be flexible to change as the world changes around them. I have seen too many partnerships that end up quibbling over goals, processes or procedures that were spelled out in the original partnership agreement rather than making the needed changes to make the actual business a success.

I would hope that this list makes it obvious that you have to spend a lot of time up front talking through these issues before leaping into a partnership. For example, you should talk up front how you will go about resolving your first impasse when it pops up. Far too often I see businesses partnering with somebody because they have the same general goal, but if they can’t meet the kinds of goals I have discussed above they are going to have to have a very hard time sustaining a business.