Whether you’re starting a business or expanding one, sufficient ready capital is essential.
While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second.
Whether you’re starting a business or expanding one, sufficient ready capital is essential. But it is not enough to simply have sufficient financing; knowledge and planning are required to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the amount required, or underestimating the cost of borrowing money.
The 8 C’s of Lending
- Credit – It must be good.
- Collateral – Something of value to secure the loan.
- Cash Flow – Ability of the business to repay the loan from operations.
- Capacity – Your personal ability to repay the loan.
- Capital – Your cash investment or down payment.
- Character – You!
- Conditions – Anything that can affect your business (industry, economy, etc.).
- Commitments – Your will to succeed.
You will need good credit.
If there are any problems on the report that can be remedied before meeting with a banker, do so. A lender may be able to make exceptions if you can document that a negative report was due to circumstances beyond your control. Include a detailed written explanation with supporting information in your financing proposal. However, if the report shows that you are irresponsible and you have not demonstrated a willingness to repay obligations, the lender will be unable to make a loan.
There is no such thing as 100% financing.
You are going to have to put some money into the business and the more the better.
A bank will require you to personally guarantee the loan even if you are incorporated.
There is no way to avoid putting personal collateral at risk. If necessary this collateral could include your house.
Some businesses are easier to finance than others.
Since over 60% of all small business start-ups fail within 5 years, lenders know that the odds are against a new business being around long enough to repay a loan. An existing business is easier to finance if profits are sufficient to repay the loan. Also, many sellers are willing to hold some of the financing. Franchises are generally easier to finance than independent start-up businesses.
The process is not quick.
If you must have the money to open by a certain date, make your loan application as far in advance as possible.
THERE IS NO SUCH THING AS A GRANT OR FREE MONEY.
We have never heard about anyone – anywhere – who got free money from the government to open any type of for-profit business. Grant money is typically available only to NON-PROFIT ORGANIZATIONS.
The Small Business Administration does not lend money.
The SBA does have a guaranty program that is designed to provide more security to lenders so that they will lend money to small ventures which would be too risky for a regular bank loan. SBA guaranteed loans are made and processed by a bank, with the SBA guaranteeing up to 90 percent of the loan. Interest rates and repayment terms are negotiated between you and the lending institution. SBA does limit the interest rate the lender can charge and there is a small guaranty fee.
Types of Financing
Debt financing does not give the lender ownership control, but the principal must be repaid with interest. Length of the loan, interest rates, security and other terms depend on for what the loan is being used.
Commercial Bank Loans
- A. Short-term: Loans for short periods (30 – 180 days) usually made to cover temporary or seasonal needs for inventory or personnel. These are common for established businesses, but may be hard for a new business to obtain.
- B. Medium to long-term: These loans may be repaid over a broad range of time, from 1 to 5 to even 20 years, depending on how the funds are used. The source of repayment is the cash flow of the business. Typical uses are for equipment, fixed assets, etc. Most loans to start a small business will be of this type.
- C. Real estate financing: Real estate is typically financed over a fairly long term, 10 to 30 years. Expect a down payment of about 20%.
- D. Accounts receivable financing: Money loaned against accounts receivable pledged as collateral.
Equity is money put into a business by the owner, private investors, and/or venture capitalists. Equity gives an investor some percentage of ownership and possibly some control of the business.
- A. Your own savings: It is nearly impossible to start a business without using some of your personal funds. It is hard to convince someone to take a risk in your idea if you do not.
- B. Friends, relatives, business associates, etc.: Most small businesses get started with this kind of help. They may provide some of the cash or may back a loan from a financial institution.
- C. Venture capitalists: Groups invest in a new firm (usually high tech or innovative concepts) looking for an very high return on investment. Minimum investments are from several hundred thousand dollars to millions of dollars.
- A. Customers: Your own customers can be a source of temporary financing if they provide the raw materials or if they pay a cash deposit. This is not feasible in most businesses.
- B. Trade Credit: Once you have obtained a good reputation with your suppliers you may be able to have credit for a range of time from 30 to 90 days. You may be able to order, receive and sell the goods before the bill is due.
- C. Profit: Hopefully you will earn enough profit to be able to invest in and expand your business.
Leasing is simply another form of financing. Leasing reduces the cash needed up front, but like a loan you are obligated to the payment for a certain period of time. Some lease contracts give you ownership of the leased item at the end of the term for a specified amount.
Types of Federal Government Financing
- Basic 7 (a) Loan Guaranty: This is the SBA’s most flexible business loan program. The 7 (a) serves as the SBA’s primary business loan program to help qualified small businesses obtain financing. Loan proceeds can be used for most business purposes including working capital, machinery, equipment, furniture and fixtures. The typical borrower is an existing business.
- Microloan 7(m) Loan Program: This program provides short term loans for up to $35,000.00 to small businesses and not-for-profit child care centers for working capital or the purchase of inventory, supplies, furniture, fixtures, equipment or machinery. Small businesses must apply directly to one of the SBA’s local intermediary lenders: REDC, New Visions or New Ventures.
- SBA Express, Patriot Express, Community Express: Participating banks use their documents and procedures to approve and service loans. This loan program makes it easier and faster for selected lenders to provide small business loans up to $50,000 or less.
- 504 Loan Program: Provides long term fixed rate financing to small business to acquire real estate, machinery or equipment for expansion or modernization. Restricted to for-profit businesses.
For more information on these programs, see SBA Loan Programs.