Business Owner's Manual

Overview of Options

There are many options that you may need to consider, some of them possibly beyond the scope of the traditional bank loan, in obtaining sources for financing your small business. Some of these options are described in this section.

Family and Friends

After self-financing, this is the most common source of capital for starting up a business. Family and friends are also often relied on for funds for expansion.

Advantages:

Usually, money is more easily available and repayment terms are more lenient than if you were borrowing from banks.

In most cases, you can maintain control of business decisions.

Disadvantages:

Family members may ask for their money back at an inopportune time, and problems in the business could cause problems with those closest to you.

Family and friends may not force you to do the planning required for successful start-up or expansion.

Tips:

Because unforeseen situations arise — divorces, death, family disagreements — it is best to handle this type of transaction formally, as you would with an outsider. Discuss all the details of the transaction and put the agreement in writing. Be sure to include the following:

Whether the money given is a loan or an equity investment. A loan is a debt which must be repaid. An equity investment gives the investor an ownership interest in the business.

If a loan is agreed upon, disclose the terms, including repayment schedule and interest rate. It is best to pay interest, even to family.

If an investment is agreed on, spell out the share of ownership, the role of the investor in the business, and how the investor is to be compensated, e.g., salary, dividends, etc.

Seller Financing

If you are buying an existing business, the seller may allow you to pay over time, thus eliminating your need to come up with the entire cost of the business up front. If the business owner is anxious to sell, you may wind up with favorable terms. Also, the prior owner should have a vested interest in your success, and may continue to make himself/herself available as a consultant.

Advantages and Disadvantages:

Easier access to financing, and usually better terms than banks or finance companies.

Prior owner has a vested interest in your success and can add value as an advisor.

But even with careful checking, you may not have a full picture of what you are buying.

Tips:

Don't let anyone rush you into a decision. There is always another opportunity. Do your homework, utilizing advisors (an attorney and accountant), especially if you are not familiar with the business. Beware of "all cash" deals.

Always establish a new business entity. If you assume an existing corporation, you also assume its liabilities. See Structuring a business for ways to set up a new entity.

Any purchase agreement should be reviewed by your attorney before you sign. The agreement should spell out the terms of sale (purchase price, cash down, repayment schedule, interest rate, etc.) and define what constitutes default.

Community-based Lenders

Most banks will not consider loan requests of less than $10,000 or $15,000 because the return does not justify the processing costs. Many banks are also reluctant to loan to start-ups and, in addition, apply lending criteria that screen out those with a less-than-perfect credit history. There are, however, community-based organizations that are more flexible in their lending criteria and make loans in the range of $500 to $50,000, and occasionally higher. These are often called "micro-loans."

Some community-based micro-lenders also provide technical assistance to support business growth. You can search the Services Directory to find community-based lenders and other sources of financing in the New York City area.

Advantages and Disadvantages:

Requests from very small firms and start-ups will often be considered.

Community-based lenders often make loans that conventional lenders may view as too risky by using different standards to assess risk. Also, they may accept collateral such as office equipment that conventional lenders would be unwilling to consider.

Tips:

Some programs provide only very small loans — under $2,500 — and rates that vary. Check out these issues before investing too much time in applying for a program that won't meet your business needs.

Many lending programs are limited to businesses that are located in specific neighborhoods. Other programs are targeted to women, or minority, owned firms. Again, it's important to determine at the outset whether your business meets the required criteria. By using the Services Directory, you can identify those programs that fit your criteria.

Banks & Other Conventional Lenders

Banks, finance companies, and other institutions offer a variety of products, including revolving lines of credit (using a check-writing method to access funds) and term loans. The increasing availability of small business loan funds is due, in part, to programs like the Small Business Administration's (SBA) Guaranteed Loan Program, which reduces the risk to the lender by guaranteeing some — or all — of a loan for a fee. You can check the SBA Web site for more information on its programs, but you apply at a bank, not with the SBA.

Advantages and Disadvantages:

The cost of the loan varies — it may be less or more from a community-based lender. Typically, the amount of the loan can range from $25,000 (occasionally lower) to more than $750,000. Lines of credit can be obtained for smaller amounts.

Most conventional lenders are fairly conservative in financing business start-ups.

Conventional lenders will most likely require a meaningful equity investment and personal guarantees from the principals and, possibly, additional collateral. These lenders will also require detailed financial documents.

Some banks may have special programs for minority-owned or women-owned businesses and/or businesses in low — moderate — income communities. These programs have somewhat more flexible lending criteria than are ordinarily applied (for example, less equity may be required, depending on individual circumstances).

Tips:

Personal credit history will be reviewed closely by conventional lenders, particularly for start-ups. If you have serious problems in your credit history — tax liens, etc. — be sure to have them cleared up before you apply for financing for your business.

Don't be shy about getting help. There are numerous programs which can assist you with writing a business plan, "packaging" your loan request, and guiding you to an appropriate lender.

Give some thought to which lender to approach first. You're better off going to one that participates in SBA programs, and/or to an institution where you or someone on your team (an investor, board member or advisor) has a relationship, a personal contact, or an account.

Make sure you're prepared with the necessary documents and back-up materials before you approach an institution. See getting ready for a discussion of what documents you'll need.

Particularly if you're a start-up, prepare to be rejected. Your business plan and projections may require revision and you may want to get help with this. Also, you may have to go to several institutions until you find the right one.

Venture Capital

Venture capitalists risk money on new and expanding firms that have fast growth potential and will yield a high rate of return, approximately 40 percent within five years (less for a high tech business). Most venture funds specialize in certain industries — often high tech businesses — and look to make minimum investments of $500,000 to $1 million. However, some private investors and programs will consider smaller investments. This financing may take the form of debt (loans), but the venture firm is more likely to demand equity (an ownership interest) in the business.

Advantages and Disadvantages:

Venture capital is a source of capital for higher risk situations — sometimes the only source. But the borrowing expense is high.

Venture firms conduct an in-depth review of your business, and the results of their "homework" can be helpful.

You lose some autonomy because a venture firm may demand active participation in a business. However, the firm's expertise and perspective can be a valuable addition to your management team.

Tips:

Giving up ownership and sharing decision making can be difficult, but 49 percent of a successful venture is better than 100 percent of a business which fails due to insufficient capital.

Make sure that you understand all of the terms of the arrangement. Have your attorney/accountant review the details before you sign.