Getting the Funding You Need
Where do you go to find financing for the operations and expansion of a small business?The answer depends on several things:
How much money do you need?What personal financial resources are you willing to invest in the business?How long have you been in business, and what is your track record?
How much are you willing to give up, either in cost of credit or ownership of the company, to get the money you need?
START CLOSE TO HOME
Most small business owners suggest that you search "close to home" for funds during the early stages of your company. The vast majority of Inc. 500 companies used personal savings or obtained consumer loans from banks, mortgage companies, or friends and relatives to fund the start-up of their companies. Only 19 percent relied on bank loans and only 2 percent received money from venture capital firms.
Once you establish a profitable track record, you will find that it's easier to get financing and that you will have a greater variety of funding sources to choose from.
DEBT VS. EQUITY FUNDING
There are two basic types of funding for a small business - debt and equity. You will want to decide which type best suits your needs.
Debt Funding is simply borrowing the money that you need to finance operations and growth. Like automobile loans or mortgages, you enter into a legal obligation to repay the amount of money borrowed. Debt funding, or credit, is available from banks, non-bank institutions, such as asset-based lenders and brokerages, and friends and relatives.
Equity Funding requires that you sell a partial interest or ownership in your company. In return for their money, equity investors ask for a share of your profit. Sources for equity funding include private investors, venture capital firms, and friends and relatives.
Most small businesses prefer debt funding for financing. The cost is usually far less, since the owner does not give up ownership or control in how the business is managed. In addition, the cost of credit is generally far less than the return that an equity investor will require. On the other hand, debt finding will be difficult to get if the owner, or another key officer, has had previous credit problems, or if the business is a high-risk venture. Also, like an automobile loan or a mortgage, debt funding usually requires that the small business owner provide collateral that can be used as a guarantee for repayment of the loan. In addition, if the business fails, the borrower is still legally obligated to repay the loan.
TYPES OF DEBT FUNDING
There are three categories of debt funding that you should be familiar with: personal loans, operations related financing, and business loans.
Personal Loans; A personal bank loan is one that you obtain from a bank and pay back in monthly installments. A personal bank loan can either be secured (collateral is required as a guarantee that you will repay the loan) or unsecured (no collateral is required).
Loans From Life Insurance; You may be able to borrow against the cash surrender value of your life insurance policy. In many cases, an insurance company will let customers borrow up to 95 percent of the paid-in value of a whole-life policy.
Credit Cards; Although it is more costly form of credit, your credit card can provide ready access to cash. You should only sue this source if you have a credit limit high enough to cover your needs, and if you can pay off the card quickly.
Second Mortgages (Home Equity Credit); If you have enough equity in your home, you may qualify for a home equity loan or line of credit. Including the first mortgage, you can generally borrow up to 80 percent of the appraised value of your home. This type of borrowing may offer tax advantages; however, if you fail to repay the loan, you are in danger of losing your home.
Friends and Relatives; Friends and relatives will be eager to help you succeed and may offer financial support. If you use this option, make sure to treat the transaction in a professional manner; that is pay a fair rate of interest, sign a legal promissory note, and repay the money as agreed.
This category of financing is dependent upon the day-to-day operations of your business. Some of these options are available to start-up businesses.
Supplier Credit. The suppliers with whom you do business can be a source of funds if they extend favorable credit terms to you, such as "net 30". The availability of this form of credit will vary, depending on the industries you and your vendor are in.
Customer Credit; By getting your customers to make a deposit or pay in advance for products or services, you can create a form of credit. You may want to offer a discount as an incentive for your customers to prepay.
Leasing; Leasing is a rental arrangement that gives you the use of an asset - such as a car or a piece of machinery - that someone else owns. Although the total cost of leasing will be more than purchasing the item outright, this is a way to reduce the amount of up-front money you'll need to get your business off the ground.
Accounts-Receivable Financing; If you have receivables - accounts that have been invoiced but not yet paid - you may be able to use these as collateral for a small business loan. Lenders that offer accounts-receivable financing will generally offer between 50 and 80 percent of the total invoice amounts outstanding, depending on the type of receivables and the ease of collection.
Factoring; Instead of borrowing against your receivables, factoring allows you to sell them to a financing source, called a factor. You will be paid a percentage of the total value of these accounts, depending on the type of receivables and the ease of collection. Once you've sold the receivables, the factor will collect the accounts and absorb any losses.
Asset-Based Financing; You may be able to borrow money on the assets your business owns, including inventory and other fixed assets such as plant and equipment. Asset-based financing can be structured as a one-time extension of credit or as a revolving line of credit requiring a periodic review of the assets pledged as collateral.BUSINESS LOANS
This category of credit is the most traditional and widely used among businesses. Listed below are the most common forms of business loans used by small businesses.
Term Loan; These are simply installment loans that are paid back at regular intervals over a specified length of time. These loans are granted for a specific purpose, such as for working capital or an upgrade in equipment. The term of the loan will depend on the use of the funds, but it can range from short term (less than one year) to long term (more than five years).
Demand Notes; A demand note is a single-payment loan that is intended for very specific short-term needs. Although the contract will usually call for payment in full within 90 to 180 days, the lender can call for (or demand) repayment of the note at any time. You may be asked to make periodic interest payment during the life of the note.
Line of Credit; A line of credit, like a credit card, establishes a credit limit and specific terms for repaying money that is borrowed. Lines of credit are easy to access and offer flexibility in managing the cash flow needs of a small business. Many small business owners establish a line of credit as a precaution, before thy have a real need for the money.
Government-Assisted Loans; There are several loan programs in which the government either directly lends to small business owners or provides a guarantee of repayment for other small business lenders. Government-assisted small business loans are offered by federal agencies such as the Small Business Administration (SBA), as well as by state and local agencies. Government-assisted loans, like bank loans, usually require that the small business owner have enough of his or her own money invested in the business in order to share the risk with lender.
WHERE THE SBDC COMES IN
One of the most valuable services the SBDC offers is to assist would-be small business owners and existing business owners in preparing loan proposals, pro-formas, and income and cash flow statements. The pro-forma statements tell a potential lender that the business has the capacity to pay back the loan. You only have one chance to create a good impression. Why not call today for an appointment with one of our professional staff or attend our course "Starting Your Own Business" and let the BV-SBDC help you in acquiring the funds you need to ensure the success of your business?