Financing Your Business Start-Up
Funding your small business may be the most difficult task you will encounter (although not necessarily the most important; finding a viable market is!). There is much to be said for "bootstrapping" your business (i.e. getting by with savings and money generated by the business.) In some cases, this may be the only way to get your business groing. However, in many circumstances this is not feasible and under capitalization can be a very serious problem!
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Start-Up Financing Sources
Most people immediately think of commercial banks when they dtermine a need for business financing. Unfortunately, as a source of start-up funding, banks end up far down on the list of likely sources. Instead, most small businesses are financed through private and other sources. Some of these sources include:
- Personal Savings
- Loan from Family or Friends
- Personal Bank Loan
- Refinancing or a second mortgage on real estate or other assests
- Cash Value of Assests You Could Sell or Pledge as Collateral
- Cash Value of Life Insurance, Stocks or Bonds.
- Credit Cards
- Investments from Partners
- Advance Payments from Contracts
- Credit from Suppliers and Vendors
Note: Bank Loans and Refinancing are generally contingent upon the owner having a regular source of income, (i.e. a job) thus, if you plan to travel this direction, you may need to secure this financing while you are still employed!
Commercial Bank Financing
Most small business start-ups are inherently risky and commercial banks are traditionally risk averse. Bankers are neither investors in small business nor speculators, but they will lend money to a small busines if its repayment is relatively assured. Commercial banks generally provide financing at comparatively low rates but in return expect a strict repayment schedule and detailed record-keeping. Their main concern is whether or not you will be able to repay the loan in full and on time. The bank's lending officers look for specific criteria when evaluating your loan proposal. They will rate you on the following characteristics:
- Experienced Management: Are you familiar with the busines and do you know the industry?
- Substantial Investment: Are you willing to make a substantial investment of time and money?
- Strong Credit History: Have you borrowed similar amounts and repaid them in a timely manner?
- Responsible Character: Can your references vouch for your honesty and good business sense?
- Good Collateral: Do you have satisfactory collateral appraised high enough to secure the loan?
- Adequate Cash Flow: With the loan, will the business generate enough dollars to pay off the loan and then some?
Meeting the preceeding criteria can be very difficult for a start-up business. Often one or more of the criteria cannot be met. It may be especially difficult to convince a banker that your projections of sales and cash flow are realistic. This can be accomplished but only by exhibiting extensive knowledge of the business and the market. The bank will expect to see a formal business plan, complete with pro-forma financial statements and will expect you to complete a personal financial statement.
Loan Insurance and Guarantees
When all the bank's criteria have been met, the banker will look for additional means to secure the loan. This can be done through a variety of methods:
- Personal Guarantee: First of all, you will be required to personally gurantee the loan. If your business fails, you personally will be responsible for repaying the loan
- Co-Signer: If your ability to repay the loan - should the business fail - is in question, the bank may require that you find another person with the financial capacity to guarantee repayment.
- SBA Guarantee: The Small Business Association (SBA) primarily assit small start-up businesses by providing commercial loan insurance. The first step to take advantage of these programs, is to get a bank committed to your project.
Your first step in evaluating any business prospect should be a feasibility study to determine the potential of your particular product or service. The cash flow projction is a basic piece of any feasibility study. In it you estimate revenues and expenses of your business, generally on a monthly basis, for a year or two. This analysis is important in that it will tell you (and your banker or investor) what amount of funds you will need to invest in the business to keep it running until sales reach a point where they will support the business. This analysis will also illustrate the burden placed on a fledging business by borrowed funds and will assist you in the making the difficult financing decisions. Be aware that banks vary in their aggressiveness over time and between one another and that bankers thensleves vary according to their own background and experience. Thus, you must be persistent and willing to shop around.
Related Articles
- Pre-Business Plan Start-Up Questionnaire
- Business Plan Guidelines
- Small Business Start-Up Checklist
- Small Business Entities
- Visit the Entrepreneur Education Portal!
