Once you have decided on a small business idea whether it is importing from China
or opening a bakery, you need to learn about Funding a Small Business. Either you
have the money yourself or you need to get it from someone else. Do you have savings
that you can tap into? Even if you do, you may still need a commercial loan.
Funding a Small Business With Your Own Money
This obviously is your first option. If you have savings, retirement plans, stocks
and other sources that you can tap into, this will be your least expensive borrowing
option. How about that family inheritance that you did not know what to do with?
Funding a Small Business by Borrowing
Funding a Small Business by Debt Financing
There are four typical ways to obtain funding within the debt financing category:
Friends & Family - Anyone who you have a close relationship with.
Investment Angels - Individuals and small companies willing to lend their own money
Traditional Lending Institution - Banks, Commercial Finance Institutions.
Government - Small Business Administration (SBA) Guaranteed Loans
Friends & Family
on your relationship, some friends and family members may give you an interest free
loan. When you do agree to do this, make sure that you put everything in writing
even if it is an interest free loan from your favorite aunt Betsy. You'll need to
prove to the Internal Revenue Service (IRS) that it is a loan and not a gift. Otherwise,
you will be subjected to a gift tax. Family loans can get complicated if the relationship
deteriorate overtime. So getting the loan details in writing will help things run
smoother in the long run.
These are private individuals who are
not family or friends but they want to invest their own money in your business. Angels
are either affiliated (someone who has come in contact with you) or nonaffiliated
(someone who has never been in contact with you).
Affiliated Angels include a business
associate, a supplier or vendor, a professional such as your doctor, or even owners
of similar companies not in direct competition with you. Nonaffiliated Angels can
be other entrepreneurs, middle managers, or professionals. They all have money that
they want to invest in other entrepreneurs.
Traditional Lending Institution
organizations offer debt financing in forms of loans which you have to pay back with
interests. There are many different kinds of loans including: line of credit (short-term
loan that provides cash to your checking account), installment loans (to be paid
back in equal monthly payments).
The Small Business Administration
(SBA) in the United States has a desire of helping small businesses succeed. One
of the ways is to provide financial support to those in need of funding. There is
an abundance of types of loans. Here are some examples:
7(a) Loan Guarantee Program
- SBA guarantees up to $750,000 or 75% of the loan amount which ever is lower. For
amounts $100,000 or less, the guarantee is 80%.
CAPLines - it's a revolving credit
line similar to a credit card. These are working capital loans to be use on a short
term or cyclical basis.
International Trade Loan Program - open to individuals who
can demonstrate that the loan will expand existing export markets or establish new
ones. SBA can guarantee up to 75% of an amount up to a maximum of $1,250,000 in
combined working-capital and fixed-asset loans.
Funding a Small Business by Equity Financing
Under this broad category of financing, you are trading a certain percentage of your
company (part ownership) for money to be used for your small business. This is the
most complex of all financing options. Solid finance and legal advice are required
if you do desire to pursue this option.
Why pursue Equity Financing? Not everyone will be able to obtain a debt financing
especially if your debt to equity ratio is high (amount owed vs. amount owned). Traditional
lending institutions will likely turn you away if you have very little money of your
own money to begin with. In such situations, equity financing may be your only alternative.
There are three ways to raise equity financing:
Friends & Family - Anyone who you have a close relationship with.
Small Business Investment Companies (SBIC’s) - companies licensed by SBA to supply
equity capital to small businesses.
Venture Capitalists - they will want to be part of your management team in running
your company with the goal of taking your company public in the future.
All common sense practice from debt financing also apply here and even more
so. You love your aunt Betsy dearly. You are so glad that she has money to invest
in your Import From China Business but how would your view of aunt Betsy change if
she was part of your management team? Get everything officially drafted in writing.
Business Investment Companies (SBIC’s)
These are privately held Venture Capital companies
licensed by SBA to invest their own money or government borrowed money in small businesses.
8(a) Program - starter program for minorities (certified MBEs - Minority Business
Enterprises) in the U.S. Individuals who participate in the 8(a) program are also
eligible for the 7(a) Loan Guaranty program.
invests in companies that they believe have the best potential to make a large return.
Investors typically want to make 5 times their investment within 3 to 5 years. Some
Venture Capitalists focus on start-ups but many look for high potential 3 to 5 year
old small businesses. They usually focus on specific industries. High tech as a
high growth industry receives a lot of Venture Capitalist attention. There are other
industries of interest. The key is to find the right Venture Capitalist for your
small business idea.
Remember that Venture Capitalists have a right to be part of
the management team of your firm. So if you quit your day job because you want total
control of your small business. Think twice before taking the Venture Capitalist
There are two broad categories of Funding Sources available to the small business
Debt Financing - you receive money as a loan where you pay back with interest.
Equity Financing - you receive capital or ownership dollars in exchange for ownership
of your company.
Funding a Small Business by Credit Card Loan
As you are getting into your small business, it is tempting to use your credit cards
to finance short term debt. They are convenient. Every financial institution wants
you to have one.
All good rules apply for a business credit card as they do for personal credit cards.
By all means, credit cards when used properly can really benefit a small business.
When they are abused, you are cheating yourself. The most expensive bank loan is
still cheaper than taken credit out from your credit cards. When is the last time
you saw a commercial bank loan for 15% to 22% interest rate?
Many small business
owner are at the brink of bankruptcy from carrying a significant credit card debt.
So borrowing from credit cards should be your last resort not your first.