1. Personal Savings.

The first place to look for business financing is with you. Investors and lenders will not risk their money in your business if you're not willing to risk your own money. Outside investors and lenders will likely require you to invest a reasonable amount before they will supplement it.

Savings include your checking accounts, savings accounts, CDs, mutual funds, stocks, bonds, and other liquid assets that you can use to start a business.

If you've done your homework, you know how much you need. You've saved and planned accordingly. If not, it may be best to delay the new business venture until you accumulate sufficient savings. Cut back on personal expenditures. Pay yourself first by saving a reasonable percentage before all other expenditures. Consider working overtime at your current job or moonlighting at a second job to increase your needed savings.

2. Sale of Personal Assets.

If you don’t have sufficient liquid assets, such as savings and investments, consider selling other assets.

Prepare an inventory of all the assets that you own, estimate their value, and determine which ones are expendable. Possibilities include investment real estate or a home that might be larger or more expensive than you need. Also consider automobiles, boats, partnership interests, corporation interests, and other personal property.

Consider holding a garage sale to accumulate additional cash by selling used books, clothing, or furniture. Perhaps you own some valuable col­lectibles such as antiques, coins, or baseball cards. These could be an additional source of untapped cash.

3. Home Equity Loans.

If you own a home, a great source of funds is a home equity loan. Lenders are more concerned that you have sufficient equity in the property than with how you spend the proceeds. Thus, you won’t need to be as persuasive in convincing them of the viability of the enterprise. Consider obtaining a home equity loan while you are still employed and have a steady income stream that lenders love.

Home-equity loans have three other benefits. First, the interest rates are lower because sufficient equity in local real estate secures the debt. Second, the loans are often for a substantial time period. Loans of ten, fifteen, and thirty years are possible. Third, the tax law favors home-equity loans. Interest on up to $-100,000 of home-equity loans is an itemized deduction, regardless of how you use the proceeds. If you can trace the proceeds into your business, the interest qualifies as business interest, and is 100% deduct­ible on your business schedule or business return. For individuals, this reduces income subject to both income tax and self-employment tax.

4. Personal Borrowing.

Consider several other borrowing alternatives you have. If you own a whole life insurance policy with cash value, you can borrow on the cash value at very favorable rates. Check with your insurance agent for the specifics.

You can also obtain cash advances up to your limits on the credit cards. You can make purchases for business supplies and assets on the credit cards. Credit card interest rates are high. Don’t use this type of borrowing for long-term purposes. However, it is helpful to have access to the credit lines when needed.

If you have a current job with a stable salary, apply for several credit cards. Request increases of your credit lines on a regular basis. You may never need access to such lines, but they’re valuable to have.

Even if you never plan to utilize the cash advance credit on your credit cards, credit cards are an excellent means of simplifying your record-keeping chores.

Carry four credit cards for expenditures. Use one card for business supplies, business equipment, business seminars, and all other business items that are 100% business tax deductible. Use a second credit card for business meals and entertainment that currently have reduced deduction rules. Use a third credit card for automobile expenses that you must later prorate between business and personal use. Use the fourth credit card for purely personal expenditures.

This method minimizes the number of checks you write, and it is an excellent way to keep organized receipts for year-end record keeping and potential audit documentation. It will make your CPA very happy.

5. Love Money.

"Love money" is financing you receive from friends, relatives, and other acquaintances to assist you in starting the business. Think seriously whether you even want to consider such funding. You may be happier strictly sepa­rating business and personal relationships. Such requests can put your friends and relatives in a difficult and uncomfortable position. Many close personal relationships have later soured because of bad business or investment experiences.

If you do proceed, ensure that all parties understand the investment specifics. Clarify whether the investment is equity, debt, gift, or any hybrid. Document the agreement with all details in writing.

Ensure all parties understand the relationship and how you will utilize the funds. Inform them of all the risks involved. Ensure that the fund providers can financially afford such risks.

The parties should also be aware of their potential liability, especially if they are general partners. Consider classifying the investor as a lender. Alternately, consider using a limited partnership or corporation if liability limitation is an issue.

6. Bank Loans.

Banks are conservative and unlikely to loan to start-up businesses absent other factors. They may loan to start-ups with an SBA guaranteed loan. They may also loan if you have an existing relationship with them, have equity in real estate, or have other assets to secure a loan.

Establish a solid banking relationship before you really need it. Build a long-term, trusting, open relationship with a banker. Obtain small loans and pay them off early to establish a solid track record.

It's much easier to obtain loans, just as it's much easier to acquire credit cards, while you have a secure, salaried, full-time job. If you are still in that position, take action before you enter into the insecure entrepreneurial world.

Establish a good credit record. Pay your bills on time and don't over-extend yourself. Obtain a small loan or buy some items on credit to help establish your credit. Periodically obtain a copy of your credit report, and check it for accuracy.

Your business loan package should contain:

• An updated business plan
• Personal financial statements of the owners
• Resumes of the key management people
• Tax returns of the business or owners for the past two years
• Cover letter clarifying:
• Amount requested
• Purpose of loan
• Term of loan
• Source of repayment
• Collateral
• Alternate repayment methods

7. Finance Companies.

Finance companies often make loans that banks reject. Finance companies will take a greater risk, but they also charge a higher interest rate to compensate. A finance company should not be your first choice, but if a bank turns you down, it may be a necessary alternative. Talk with several finance companies, just as you talk with several banks so you can compare services.

8. Small Business Administration (SBA) Guaranteed Loans.

SBA direct loans are extinct, but SBA guaranteed loans are still available. Commercial banks and other lending agencies process the SBA guaranteed loans. The SBA covers a substantial portion of their risk. The bank is more likely to make the loan because its chance for loss is less.

There are many misconceptions about SBA guaranteed loans. SBA does not give away anything, and they are not in the business of losing money. Its guarantee puts the government at risk if you don't repay the loan. SBA verifies that your credit is good and that you have sufficient collateral.

Loan amounts generally range from $50,000 to $750,000. Smaller loan amounts may be available through other government or private programs.

Rates on SBA guaranteed loans are negotiable, but generally range from 2% to 3% above the prime rate. In addition, the borrower pays the SBA a loan guarantee fee ranging from 3% to 3.875% of the principal. There are no loan prepayment penalties.

It's not easy to qualify for the guarantee. The interest rate isn't a bargain, but there are benefits. The big plus is actually obtaining the loan in the first place. You also have the chance to stretch payments over a longer period than the two to three years conventional lenders generally allow.

The average term of an SBA loan is nine years, which allows lower monthly payments. Fifteen-year terms are common. For certain real estate transactions, you can extend payments up to twenty-five years. SBA guarantees loans to start-ups and ongoing businesses. Start-up businesses account for approxi­mately one-third of the loans.

A bank does not need to reject your loan application before you apply. However, a lender has to specify that you could not obtain a loan at a reasonable term without the guarantee. SBA also expects a new business to contribute approximately 30% of the capital needed. There are industry size limits on obtain­ing the loan. Most businesses with fewer than five hundred employees qualify.

The process itself is straightforward. You submit a loan application to a bank or other lender. After reviewing the application, the lender sends it to an SBA loan officer at their closest district office. If it's approved, you receive the proceeds shortly. You repay the lender according to the negotiated terms. “Preferred Lender Status” and “Certified Lender Status” financial institutions process the paperwork even faster since SBA delegates more of the decision making to them.

9. SBA 504 Program.

The SBA 504 program is a loan program de­signed to enhance community economic development through job creation and retention. The program assists small business with capital investments that include machinery, equipment, and real estate. It provides fixed asset financing for up to twenty years. Three investors come together in the financial package. There is at least 10% owner equity, up to 40% SBA guaranteed debt, and 50% third-party private sector financing. Any real estate must generally be more than 50% owner-occu­pied. The SBA 504 program can make loans up to $1 million.

10. Other Government Financial Programs.

Other government financing options are available. Check with federal, state, and local agencies. Financing programs, terms, and requirements change regularly. Contact the government agencies for details. Many have specific lending programs to encourage certain businesses, or to encourage busi­nesses in certain areas. Some have grants available, and some even make equity investments in a company.

Two of the most appropriate state agencies to contact are your state Department of Commerce and your state Department of Economic Development. Check with your state, county, and city for additional agencies and departments available to assist small businesses.

One federal program that entrepreneurs should be aware of is Small Business Innovation Research (SBIR). It started in 1982 and has served as a highly competitive program spurring technological innovation among qualified small businesses. The goal of the program is to meet the needs of eleven federal government agencies.

The SBIR program consists of three phases:

• Phase I: This phase evaluates the value and technical feasi­bility of a project. An award up to $50,000 for six months of research is available.
• Phase II: This phase encompasses expansion and further develop­ment based upon the results obtained in Phase I. Research and development programs usually have a two-year maximum period. Awards of up to $500,000 are possible.
• Phase III: This is the commercialization stage of a project. SBIR funding stops at this point. You must obtain private non-SBIR financing.

The eleven federal agencies are responsible for selecting topics, issuing solicitations, evaluating proposals, and bestowing awards for the program. The SBA publishes a quarterly listing of pre-solicitation announcements that contain the basic information concerning SBIR solicitations. For more information and to be added to the mailing list, write to:

US Small Business Administration

OIR & T, Room 500

1441 L Street, NW

Washington, DC 20416

11. Business Partners.

Think about going into business with a partner. Besides the additional service, advice, and expertise, a business partner can also contribute financially. If you don't have the funds to go it alone, consider combining resources with other likeminded entrepreneurs. It could increase your chance for success.

However, business partnerships have certain disadvantages. Disputes can arise as to how to run the business, and as to who is responsible for what. Make sure you know prospective business partners well before entering into an agreement. Make sure that you have a complete written agreement defining the duties, obligations, and rights of each party.

Find partners with complementary talents, rather than clones of yourself. This increases your chance for success in the business. For example, if you have great financial skills, adding two partners with great financial skills is not optimizing your chance for business success. It would be much more effective to add partners with marketing or operations skills to comple­ment your financial skills.

Seriously consider using the limited partnership or the corporate form of ownership instead of the general partnership. General partners all have say in the management of the business, but they also all have unlimited liability. A limited partnership or a corporation may be more appropriate, even though they are more complex and will probably cost more to form.

12. Angels.

Thousands of individual investors contribute seed capital to startups when more established sources turn deaf ears. These independent investors are "angels." Because they are unaffiliated with any formal venture capital network, angels are especially hard to identify. It’s wise to attend local business meetings and talk with profes­sional contacts. Angels discover most of the companies they invest in through word of mouth. Ask your attorney, accountant, financial planner, and banker, for possible con­tacts.

Angels appear in a variety of forms and have a variety of strategies. Some look for a sure thing. Some want a large share in the equity of the business. Some want to make substantial capital gains quickly. Some want to tell you how to run your business, while others just want to be part of something new and exciting. Some have ceilings on how much they are willing to invest, while others won't invest below a certain amount.

Be prepared and do your homework. Impress the potential investor with your knowledge and experience in the busi­ness, and with the potential of the business. Have a formal, written agreement with investors that clearly explains the relationship.

13. Small Business Investment Companies (SBICs).

SBICs make venture and risk investments by supplying equity capital and extending unsecured loans to small enterprises that meet their criteria. They help with straight loans and equity investments, providing management assistance to the companies they finance. Most SBICs concentrate more on later-stage and leveraged buyout deals, where more companies can afford to mix debt with equity. However, they do provide start-up dollars for new companies as well. Each SBIC seems to have its own specialty.

To obtain a directory of the approximately 200 SBICs across the country licensed by the SBA to invest in small business, write to:

National Association of Small Business Investment Companies (NASBIC)

1156 15th Street NW, Suite 1101

Washington, DC 20005

14. Venture Capital.

The principal source of financing for high growth potential companies comes from the venture capital industry. SBICs usually take a debt or a small equity position. However, venture capitalists usually take only an equity interest, planning for long-term appreciation. By numbers, the SBICs are dominant. By dollars, venture capitalists have provided about 90% of venture capital equity investments.

Venture capitalists normally provide capital in return for convertible preferred stock. They're willing to ride out their investment for three to seven years. They don’t require any cash return until the company shares become liquid. This usually occurs through an initial public offering or a merger with, or acquisition by, a public corporation.

An entrepreneur seeking this form of capital must provide a comprehensive business plan that describes the entrepreneur's dream. The plan should have a strong, concise executive summary that commands attention. The business plan should include the management team's qualifications. It should include a statement of the capital required and the projected investor payback within five years.

Venture capital is not a realistic financing alternative for most start-up businesses. Typically, venture capitalists will look at only ten out of one hundred business plans submitted. They will fund only one or two of these ten plans. You need to have a great idea and a great management team to be a candidate.

The principal reference source in the industry is Pratt's Guide to Venture Capital Sources, published by Venture Economics, Inc., of Wellesley Hills, Massachusetts. It is available at most libraries. It lists the names and locations of active capi­tal venture firms and contains some helpful articles. There are also venture capital clubs across the country. A directory of approximately 115 venture capital clubs is available from:

International Venture Capital Institute, Inc.

PO Box 1333

Stamford, CT 06904

15. Leasing.

Leasing, rather than buying, is one of the most popular ways to defer expenditures. Instead of requiring a large outlay of cash to purchase an asset, a lease spreads payments out over time, typically three to five years. You can budget for lease payments, thereby simplifying cash flow planning.

Leasing may be more expensive than buying or borrowing in the long run, but leasing preserves precious working capital. It also preserves borrowing power by allowing companies to acquire assets without depleting existing credit sources. You report it on financial statements as a footnote entry, thereby providing off-balance-sheet financing that improves key operating ratios. Be sure to calculate the “finance charge” of leasing. It often equates to a 15-20% effective interest rate.

The credit criteria of lease financing companies may be less stringent than those of bank credit compa­nies. Leases are available even in times of tight money, when cash loans may be hard to obtain. Leasing also receives favor­able tax treatment and provides the technological advantages of quicker access to produc­tive assets and less risk of obsolescence. This is especially important for rapidly changing technology such as data processing and telecommunications. Many leases provide options to purchase and permit exchanges for more advanced equipment as it becomes available.

16. Customer Financing.

Why don’t you have your customers finance your business? There are a variety of ways to do this.

Large, well-known companies will often finance companies that make products it can sell or that will complete a product line. DuPont Company, for example, has funded dozens of young companies with products in advanced materials, electronic imaging, medical imaging, and biotechnology.

There are several other ways to utilize customer financing. You can license your products or ideas for a fee. You can form joint ventures with custom­ers. You can franchise your business. Franchising allows you to sell the rights to produce or market your product or service to other interested parties. You can sell additional items like newsletters, seminars, or consulting services.

Give your customers an incentive for paying fast and paying in advance, even if you have to offer additional products or discounts. You want to obtain the money due you as soon as possible. The customer also benefits by obtaining additional products or services or a discount. Make it clearly in the customer's best interest to pay as soon as possible and to pay as much up front as possible.

17. Supplier Financing.

Some of the same ideas discussed above for customer financ­ing also apply to supplier financing. However, also consider that you are a customer of the supplier. The supplier wants to sell you supplies, inventory, or equip­ment, so let them be your financing source. Do not pay cash. Negotiate for excellent payment terms, stretching out payments for as long as possible for as low an amount as possible. Request that additional products or services be included with the transaction. Remember, it doesn't hurt to ask. You won’t get these benefits unless you do ask.

Consider bartering your goods and services. Ask the supplier if they need what you sell. Many industries use barter extensively. It can be a win-win situation for you and your supplier.

18. Factoring Accounts Receivable.

If you don’t obtain all your money up front at the time of the sale, you have accounts receivable.

One way to obtain cash for those receivables is to "sell" them to a factor. The factor pays you cash up to a percentage of the receiv­ables value. Customers make their payments to the factor. The factor keeps the full amount, making a profit on the discount. You benefit by obtaining cash early.

Discounts vary. They depend upon the risk assumed by the factor and the age of the receivables. Generally, expect a 5% to 20% dis­count on the face value of your receivables.

19. Initial Public Offering (IPO).

If you have a great idea with a lot of potential, you may obtain financing through an initial public stock offering. However, this is more likely to occur later in your business, after you have established substantial growth and success.

An IPO is an issuance of stock to large numbers of unknown investors. IPOs are expensive and time-consuming. However, they can generate substantial funds for the business. The process can make the founder of the company very wealthy.

Keep it in mind as a future financing opportunity. For most entrepreneurs, it's not an option at the start-up phase.

20. Bootstrap.

Bootstrapping may be the best method of all for financing your new business. Bootstrapping involves starting small and conservatively. After becoming successful, you continually plow back the profits into the business, rather than distributing them to the owners.

You may have several great ideas. You may want to go after several different markets and do everything at once. However, a more logical approach suggests starting with one product in one market, making that successful, and then gradually increasing the markets or increasing the products. Take minimum amounts of money out of the business for your own use, and plow the rest back into the business to expand. It will grow expo­nentially and will likely be the best investment you can make.

 

Excerpted from Business Start-Up Guide © 2002, Tycoon Publishing