FINANCING YOUR BUSINESS
How are most small businesses financed?
Researchers estimate that 95 percent of new businesses are financed with personal funds and loans. Personal investment may come from savings, investments from family and friends, and/or credit cards and loans.
. While this is not always possible, outside investors and lenders like to know that the entrepreneur has some personal investment in the enterprise beyond their labor.
Family and Friends
. This is a potential source of start-up capital with little or no paperwork or legal issues. However, money issues can be a major source of conflict in relationships, so give serious thought to your ability and timetable for repayment of these types of funds.
While it is never recommended to carry large credit card debt, there are many anecdotal examples of entrepreneurs who used credit cards to successfully start their enterprise. This may be a viable option if the interest rates are reasonable and a reasonable pay-off schedule is likely.
According to the Small Business Administration, commercial banks are the largest suppliers of debt capital to small firms. See below for more information on commercial loans.
What is the bottom line when it comes to my business finances?
As always, the bottom line is whether the business will turn a profit. Will the income from the business exceed the expenses and allow the entrepreneur to meet his or her basic and long-term needs? This is hard to predict, particularly for new entrepreneurs. The business plan is the instrument that allows you to make this prediction in an objective manner.
How do I fund my new business enterprise?
Lack of capital is among the leading causes of small business failure. It is essential to have a business plan that details start-up and ongoing capital needs and their sources. Outside financing usually comes in these forms:
• 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 what the loan is being used for.
• Commercial bank loans may offer a variety of loans and terms for small business.
• Real estate financing is typically financed over a fairly long term, 10 to 30 years. Expect a down payment of about 20%.
• Accounts receivable financing is money loaned against accounts receivable pledged as collateral.
• Equity financing is money put into a business by the owner, private investors, and/or venture capitalists. Equity gives an investor ownership and possibly some control of the business.
Are there grants available to start my new business?
While new entrepreneurs sometimes expect “free money” in terms of grants or other sources, the reality is that grants (outside funds that do not require repayment or an ownership stake) are almost never available to for-profit enterprises.
Equity financing is more often available for technology or innovation-driven enterprises with prospects for greatly increased earnings in the long term, based on rapid growth or a technological or other type of innovation. However, there are some investors with other, more specialized interests, so this may be worth exploring if you are willing to provide outside investors with a financial ownership stake in the business. Selling shares or stock in a business is another possible option. An attorney and investment banker should be consulted for more information.
Smaller start-ups or home-based enterprises sometimes have difficulty securing funding through traditional lending institutions or programs. However, there may be loan programs or organizations in your area that provide loans for microenterprise or specific types of business owners or business activities for which you may qualify. These include federal and state loans, community micro-lending programs, minority lending programs, and agriculture-related loans. Sometimes these sources may not always be widely known.
What is venture capital and can I use it for my business?
Venture capitalists, angel investors, and others are equity investors looking to invest money in exchange for an ownership stake in your business. These investors usually look only for businesses where a high rate of return can be expected in a short period of time. This is more common in high-tech/biomedical type enterprises. One rule of thumb suggested that venture capital should be sought only if you expect profits well in excess of a million dollars within the first five years. For more information on venture capital, see www.capital-connection.com.
How do I increase my chances at getting a bank loan?
The kind of financing most entrepreneurs seek through commercial lenders is debt financing. Most banks provide debt financing for existing and start-up businesses. Banks vary substantially in their lending practices. While one bank may decline your loan application, another may be willing to take a higher risk or be interested in lending to small businesses. It is advisable to understand a bank’s lending guidelines before applying for a loan. The general guidelines that would enable a lending officer to at least make an informed decision regarding your loan proposal are as follows: consideration of the business idea, usually explained in a business plan, collateral down payment (or equity in an ongoing business), credit history and personal financial net worth, management ability, ability to repay the debt, and conditions of the economy and/or market area.
Commercial lenders do vary widely in their offerings and requirements and often their personal relationships with local or regional lenders still have real significance. Communication with lending officers should be viewed as a relationship that may require time, multiple contacts, and a long-term focus. A business plan is essential to commercial lenders, even those with whom you might have a strong relationship. A solid business plan and a thorough preparation to ensure that the lender’s requirements are met are the essential ingredients to commercial loan application.
How can I strengthen the financial health of my business?
The most essential item is the development and maintenance of a sound financial plan with associated systems for tracking financial status. See the financial plan section for more details. Within the framework of a financial plan, there are five areas that contribute to the financial health of your enterprise:
• Effective management of financial resources
• Effective financial systems/tracking
• Conservation of existing capital
• Increased profit
• Access to outside capital
Which numbers should I use to assess the ongoing financial health of my business?
One of the most significant tools for growing your business is the development of a clear set of performance indicators that represent criteria that you will monitor and use to assess your business. In general, make a list of factors most critical to your business performance and then select a group of key indicators to track on a regular basis. For example, you might focus on sales growth, cash management, profit measures, customer feedback, and/or employee feedback.
In addition, here are some numbers that you may want to monitor weekly:
• Current cash position (how much cash was received, when, and from whom)
• Cash disbursements (such as payroll, purchasing, rent, etc.)
• New sales
• Accounts receivable (beginning balances, outstanding credit, and cash receivables)
• Accounts-payable payments
• Order backlog
• Productivity (sales per employee, etc.)
• Inventory (with accounting or physical tests for accuracy)
• Accounts-receivable average days outstanding
• Accounts-payable obligations (with aging breakdown)
There is also easily adaptable and user-friendly software available for small businesses. Among the most common are QuickBooks (www.quickbooks.com) and Sage50, formerly Peachtree (http://na.sage.com/sage-50-accounting-us/).