How to Obtain Financing in Mexico?

When looking for financing or credit, where  should a business go ? The choices range from banks to SOFOMES, fintechs  and crowdfunding. What are the differences between each of these institutions? 

These are questions that many businesses and startups grapple with. In this two-part series, we’ll look at the four steps that must be executed when looking for financing. In Part 1, we’ll outline Steps 1 and 2, which deal with defining what kind of financing you want to raise and what you will use it for.

Step 1: Define 

The first thing you must be clear about, as a businessman or entrepreneur, is for what or how you will be raising the money. That is to say, identify if you want to raise it as capital (partner money) or if you want to raise it through debt.

Capital is the money that goes into the company as part of the equity, which you will have to pay or recover through the returns (profits) that your own company generates. It is money for long-term projects. It shares the risk of the company's success and goes hand in hand with the risk faced by partners, therefore, it is a solid and deep commitment. It can be considered as a business marriage.

Debt is a loan, it is money that you receive from credit, factoring or leasing (the latter in the form of an asset). Whether in kind or cash, you must pay it back, usually in monthly payments, regardless of the company's results.

Nowadays, only 35 percent of the businesses in Mexico have access to formal financial productsMany companies do not take on debt because of the mistaken thinking that debt is bad or because they believe, erroneously, that they do not need it. This is one reason behind the low market penetration of these products.  

There is no company in the world, regardless of its line of business or size, that has grown or succeeded without an intelligent leveraging of its capital, which involves using someone else's money. You need it to grow your business, to expand your facilities, to bolster your equipment and machinery, to create a marketing campaign or to implement any growth strategy for your business, which in almost all cases, requires investment and capital.

Step 2: What For? 

The next step is to define what you are going to use the money for. You may use it to buy stock, to remodel facilities, to carry out marketing campaigns, to ride out a crisis, for acquiring machinery — there are multiple reasons why you need financing. At this point, you must analyze how you are going to get the money and define a source of income to pay the money back. A good credit would be the one that, in the first instance, would be used to generate more income or to increase efficiency (cutting costs); thus, healthy credit, credit that is used to become more productive or to increase your income or profitability, will always be healthy financially speaking.

Any destination for this money must be thoroughly  analyzed. You need to have a clear plan of action on how you will recover it; for example, to get out of a crisis, you must have a clear plan of action to recover and be able to repay the financing as well as a backup plan in case the plan of action does not succeed. You cannot take this type of credit relying on luck only or divine intervention: Therefore, it is important to analyze this type of financing very well  because it can become dangerous without a clear plan of action.

You also need to evaluate if the performance reflected in your business will have an impact in the short term (less than a year) or if you will see it reflected in the long term (more than a year). This will help you choose the term. For example, when your customer takes many days to pay and you need to finance the operation as you are collecting, let's say to pay your payroll or expenses, that would be short-term financing; if you need the financing because you are in an emergency, you need liquidity, you are going through a difficult time, your customers’ payments are late, or you need to ensure the continuity of the business, that is classified as short term.

It's understandable that sometimes you need financing to get out of a slump but always try to link credit to an additional source of income and not to something of urgency.

Knowing whether the term you need is short or long will help you understand which product suits your needs. Short-term products are revolving credit lines or factoring, in which you use the money and when you pay it back you only absorb the interest on the use of the line. You can reuse and repay them repeatedly; it really works like a credit card. There are long-term products too, such as simple credit, mortgage credit and leasing. It is a credit to be paid over a certain period, whether it is one year or five years or more. This term must be aligned with the use you make of your credit. Why do I mention this? Because, before dealing with any financial institution, you must understand the products they offer. Although they are all financial institutions, not all of them offer all products. You would think that the banks, being large multiple banking financial institutions, would offer all the products but they don’t. This is why you need to know who you have to approach.

What products are available to finance my business? 

The Simple Loan or Credit.

The simple loan or credit is when someone lends you X amount and every month you commit to paying the interest plus a part of the total amount they lent you (principal) every month during the  amortization period; this is the most traditional product and all the financial institutions offer it. Some offer it with collateral, without collateral, tooling, etc. There is a whole range of these products.

Use this product for something that is not short term, such as investing in facilities, launching a new product, a long-term marketing strategy, an investment in technology, infrastructure, equipment or machinery. These are things that you can amortize over time.

Revolving Credit

Like the previous vehicle, you will find this product offered by most financial institutions. This type of financing is an open line of credit that you can use every month, like a credit card, and every month you can pay interest and/or principal and you may reborrow the amount paid to the principal.

This type of credit is ideal for working capital or short-term plans. If your client is overdue or not paying you, if you have a project that you should capitalize on, or you need to pay your payroll or incur a sudden expense, the revolving line of credit gives you a lot of flexibility.It is very similar to a credit card.

Leasing

This product is appropriate when a company wants to buy equipment and machinery given that the company does not have to be decapitalized to modernize. You can lease anything, from computers and furniture to company cars and machinery.

Leasing provides a financial benefit but above all a fiscal benefit, since, rather than paying amortizations, you “rent” it and at the end of the contract you don't have to keep the old equipment that loses value over time; that is, you don't have to pay the total capital. In the end, you will have the option to return the asset, if that suits you, instead of paying for it all. Leasing allows you to use the money in a very intelligent way and it is fully tax deductible.

When it comes to equipment or machinery, leasing is the product to use, undoubtedly.

Sale and LeaseBack

This product consists of selling your assets to a finance company, which will then rent them to you through a lease contract, with the same conditions as a regular lease. 

In essence, your assets are used to provide liquidity to your company and you pay a monthly rent. Another advantage is that at the end of the contract you have the possibility to buy your assets at a lower price.

Factoring

Factoring is yet another widely used financial product. When you can't afford financing, your customers pay in 60-, 90- or 120-day terms and you can then go to a financial institution, use your invoices (receivables) as collateral, obtain credit, and the financial institution waits for your customers’ payment term.

The institution will charge you interest for the waiting period; if you get paid in 30days, you will pay 30 days of financing and so on. This product is ideal when in your business cycle you must pay raw materials, labor or suppliers and your client pays you at a certain time Factoring will help you maintain your financial cycle.

Confirming or Supplier Financing

Confirming or supplier financing is a quite new financial product that consists of replacing the financing that you get from suppliers through a financial institution, obtaining cash conditions. This product allows you to obtain the best payment conditions since suppliers will not incur any financial cost.  Paying in 30 days is not the same as buying in cash.

Confirming helps you to adjust your sales cycle so that it does not affect your company's liquidity.

Crowdfunding or Collective Funding

Crowdfunding or collective funding is a good way to finance your business but instead of resorting to a financial institution you ask the community for funding. It is similar to going public on the stock exchange. You use a crowdfunding platform that acts as an Uber for financing: by publishing your needs for funding on its platform, it connects you with people and companies that are willing to lend out money.  The platform is responsible for coordinating and managing the entire process, thus practically eliminating the financial institution as an intermediary, which results in better conditions for the financial parties and a model that provides you a connection to  the community at large.

(In Part 2, we will discuss the next steps, including existing options and where to begin.)