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Business Owner's Manual

Financing your business

Access to capital is a challenge at any stage of business growth, particularly for start-ups, but there are options. This section outlines some of those options and provides information that will improve your chances of getting financing for your business. When you're ready, use the Services Directory and look under "Financing Your Business" to find lenders that meet your criteria.



   
BASIC FINANCIAL PLANNING  

To determine how much you need for your business, you should begin by calculating: (1) your projected first-year revenues; (2) your start-up costs; and (3) your recurring monthly costs. The difference between your revenue and your costs will inform you about the viability of your business and the financing your business needs to get off the ground. It can also serve as the basis of projections for future years. A business counselor can help you with these calculations. You can find a counselor and other sources of advice by using the Services Directory and looking under "Business Advice and Networking."

 

Projected Sales

Projected sales can be estimated using one or more of the following approaches:

  • Compare your business to similar existing companies, taking into account the factors that make your business different. Your research may include data from printed sources, information from industry associations, and discussions with current business owners — if they are willing. A business counselor can also help.

  • Estimate your market share, based on the number of potential customers in the area and the number of competing businesses.

  • Determine the revenue you want for the first year and calculate backward the number of hours you must work (if you bill by the hour) or the number of products you must sell to reach this goal. Then use one of the other approaches to test whether the number is realistic.

 

Start-up Costs

Start-up costs can include the following:

  • Capital costs — equipment, fixtures, furniture, remodeling, and decorating

  • Professional fees — attorneys, architects, accountants, consultants

  • Required permits, licenses, and other rights

  • Starting inventory

  • Advertising and promotion associated with start-up

  • Deposits and advance payments — rent, telephone, utilities, security deposit, etc.

  • Cost of living while the business is getting off the ground (count on a significant period of time without any income)

  • Contingencies (budget at least an additional 15 percent)

 

Recurring Monthly Costs

Below are listed some examples of recurring monthly costs.

  • Salaries/wages/payroll taxes

  • Rent, utilities, phone, and maintenance

  • Additional inventory purchases

  • Insurance and taxes

  • Postage/supplies

  • Ongoing professional fees

  • Debt service (monthly payment on loans)

  • Contingencies (again, plan for an additional 10 to 15 percent)

   
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.

 


   
GETTING READY FOR THE LENDER  

You have been researching your business venture and you're ready get things off the ground. Or, you have already started your small business and need funds to grow. What can you expect when you approach a lender? What are lenders looking for?

 

The Five C's Of Credit

  A trite, but true, summary of what lenders consider:

  • Capacity to repay is the most critical factor, and the lender wants to know the details of your repayment plan. Critical issues include the cash flow from the business, the timing of the repayment, and the probability of successful repayment. Your financial statements and business plan (see below) will be particularly important, and payment history on existing credit relationships — personal or commercial — is considered as an indicator of future performance. If you have serious credit problems, e.g. numerous delinquencies, tax liens, or a bankruptcy, fix the problem first before requesting a loan. On the other hand, if you have excellent credit, it could tip the decision in your favor. Individuals who handle their personal credit well tend to handle their business credit in the same fashion.

  • Capital is the money you have personally invested in the business. Lenders want to know that you've made a significant financial contribution to the venture — from 30 to 50 percent of the funds required — and that you have undertaken a personal risk. (If you haven't, why should they?)

  • Collateral (or guarantees) are additional forms of security you can provide. Giving a lender collateral means that you pledge an asset, such as your home, to the lender with the agreement that it will be a source of repayment in case the business cannot generate the necessary funds. A guarantee is a written promise by a third party to repay the debt if you can't.

  • Character is the impression you make on lenders. A lender must believe you are reliable and will consider your background, experience, and the quality of your references as well as the background and experience of your partners and employees.

  • Conditions focus on the intended purpose of the loan. How will the money be used? The lender will also consider the local economic climate and conditions within your industries and other related industries.

 

Necessary Documents

You should call ahead to confirm exactly what documents the lender requires. The answer is likely to be different depending on the maturity of your business and other factors, but most lenders are looking for the items discussed below.

  • Personal tax returns for each owner.

  • A Personal Financial Statement for each owner. This document indicates net worth — assets (cash, real property, cars, etc.) minus your liabilities (unpaid bills and loans). It will give a lender evidence of personal assets that could be pledged to secure a loan.

  • Financial documents for the business, described below. Existing businesses should submit historical information — either records prepared by an accountant or business tax returns — from at least two consecutive years. Start-ups should prepare projections for the first two or three years of operation. Online self-calculating worksheets and interactive instructions for start-ups are available at the Edward Lowe Foundation Web site by choosing "Thinking About Starting a Business" or "Just Starting Out" under the "For Business Owners" category.

  • A Balance Sheet provides a snapshot of the company at a specific time. It shows what the company owns, including its cash on hand and its debts or liabilities (generally, loans from others). It also shows the capital ("equity") put into the business.

    Note: The projection or "pro-forma" balance submitted by a start-up should show the business' projected opening equity (the money you expect to put in) and liabilities. Projections for additional years may not be necessary.

  • A Profit and Loss Statement (a "P & L") shows the profit or loss of the business for a specific period, usually a year. It shows the sales, less the cost of goods or services sold, less other expenses. A Profit and Loss Statement should reflect all expenses, even if you haven't paid them out, and all income, even if you haven't collected it.

  • A Cash Flow Statement represents a reconciliation of the income and expenses of your company to the actual cash inflow and outflow. Certain transactions such as borrowing money, receiving capital, or purchasing equipment are not income and expenses, but they do have an obvious effect on your cash flow. These items are reflected in a Cash Flow Statement. This is a complicated document and difficult to prepare. For help, contact an accountant or use the Services Directory and look under "Business Advice and Networking."

 


   
MEETING WITH THE LENDER  

The meeting is your opportunity to make a positive impression on the lender.

Expect the lender to want to meet with the whole management team. No matter how good the idea, inexperienced management causes concern for a lender. If your experience is in the technical side of the business, be sure to have a key employee or advisor who can support you on the sales/ financial side and be sure to bring this individual to the meeting.

Prepare for the meeting by reviewing your business plan and financial statements and by anticipating the questions that will come up. You should be able to explain each part of your plan and answer questions such as these:

  • How much do you know about the industry and current trends? Who do you know in the industry?

  • How do you plan to minimize risk?

  • How would you handle a delay by the Buildings Department in approving your plans for renovation and expansion (or any other situation that would adversely affect the business)?

  • What are the assumptions behind your sales forecasts, margins, etc.?

Most of all be positive and enthusiastic. Lenders are impressed by entrepreneurs who exhibit a real passion for their project. Whatever you do, let that passion come through.

 


   
ADDITIONAL LIBRARY RESOURCES  

The resources listed below are available at the Science, Industry, and Business Library (SIBL). Some items can be checked out for borrowing from the first floor circulating collection. Others can be found in the reference collection on the library's lower level. Check the Libraries' online catalogs (LEO for circulating items, CATNYP for reference) to find the call numbers and locations of suggested print resources. Your local library also may have similar titles.

 

Print Resources

Catalog of Federal Domestic Assistance

The Compete Small Business Sourcebook

Encyclopedia of Associations: Regional, State, and Local Organizations

Free Money to Change Your Life

Free Money from the Federal Government for Small Businesses and Entrepreneurs

Funding Sources for Community and Economic Development:  A Guide to Current Sources for Local Programs and Projects

Galante's Venture Capital & Private Equity Directory

Government Assistance Almanac

Loan Financing Guide for Small Business Owners - D. Neil Berdiev

Pratt's Guide To Private Equity Sources

Small Business Sourcebook

 

Electronic Resources

Use the SIBL Electronic Information Center to find articles about small business financing. Search in the following for the largest number of available periodical articles:

  • EBSCO Host
  • General Business File / Business & Company Resource Center (Gale)
  • Dow Jones Interactive News Service
  • PROMT (Gale)

 

Internet Sources

Small Business Administration

Entrepreneurial Edge (business builders)

GovLoans.gov

http://activecapital.org/