The most common sources of financing for new ventures include personal savings, family and friends, credit card advances, life insurance and second mortgages. Many potential small-business owners need additional financing and must seek funds from other sources.
When seeking funds from almost any available source, one principle applies: The investor or lender expects the small-business owner to take a significant financial stake in the business. This means the owner must have personal funds to invest in the business, usually between 20 percent and 50 percent of the total funding needed.
Another important fact to remember in financing a business is that the No. 1 cause of failure among small businesses is under capitalization. You need to make sure the start-up capital you plan to personally invest, coupled with the money you plan to get from other sources, will be enough to get the business off and running until profit is achieved.
Before approaching any investor or lender, the small-business owner must develop a written, comprehensive business plan, complete with cash projections, financial ratios, marketing information, biographical information on the principals, etc. This plan, along with the business’ and owners’ full financial statements, will communicate the start-up concept in a well-prepared, objective, professional format.
Two basic types of financing are available to a small business: equity financing and debt financing.
Equity Financing. Equity financing is defined as ownership dollars which are not repaid, but instead may entitle the investor to a control in the business and a percentage of future profits. The owner, therefore, becomes a partner or shareholder in the business. Equity financing could consist of capital distributed by the owner or partners. Corporate equity instruments include common stock, preferred stock, convertible debentures and debts with warrants
The best source of equity financing for the fledgling small business is a non-professional investor such as relatives, friends, business associates, suppliers or customers.
Another source for equity financing is venture capital provided by venture capital firms or private investors, often referred to as “Angels”. Venture capitalists and “Angels” make dollars available for new, relatively risky business ventures. Usually, venture capitalists have definite preferences concerning the location and industry of their clients. Venture capital firms are often controlled by banks, other financial institutions, insurance companies and large corporations. “Angels” are frequently wealthy individuals looking for investment opportunities.
Less than three percent of all proposals are funded using venture capital. Venture capitalists traditionally deal in large sums of money, from $500,000 to tens of millions, and are looking for a better-than-average return on their investment (10%-15% after taxes), meaning they deal mostly in rapid growth industries. The individual investor will usually make smaller investments in business start-ups and, although looking for a good return also, is often less demanding.
Debt Financing. Debt financing consists of borrowed dollars which must be repaid with interest, but normally does not give the lender any ownership control. There are numerous sources available to the small-business owner for debt financing, both commercial and governmental.
The owner should carefully investigate all possible sources for debt financing to ensure that the business receives the most favorable terms available. Commercial loan approval is based on the business owner’s ability to repay the loan as indicated by his or her past business experience, personal credit rating, and by the business’ profitability.
Banks are often extremely cautious when it comes to making start-up loans, due to the high risk associated with new businesses. But, once the business is established, short-term loans are a specialty of banks, and they include accounts receivable financing, inventory financing, unsecured lines of credit, and commercial loans to satisfy special business needs. Some banks will also provide medium- and long-term loans to small businesses, usually to increase working capital, to purchase or lease equipment, or to finance real estate.
The small-business owner should maintain a close working relationship with his or her banker. This relationship will help ensure that when debt financing is required, a better understanding of the necessary qualifications will exist on the business owner’s part, while the banker will have a closer familiarity with the business.
Commercial finance companies provide small-business loans very similar to the type provided by banks. Unlike banks, these companies specialize in higher risks and their interest rates on all loans usually run slightly above bank stated rates. Commercial finance companies customarily evaluate loans more on the strength of a firm’s collateral rather than on the firm’s track record or potential for profit.
Several sources in the federal government are available to the small-business owner for debt financing. The U.S. Small Business Administration (SBA) is the most well-known source because of its responsibility for assisting small-business concerns in obtaining commercial loans which they would be unable to secure on their own.
The SBA offers virtually no direct loans, other than disaster assistance loans. Today, SBA’s financial assistance to small firms is done through a government guarantee on loans made through banks or non-bank lenders. Under the guaranty concept, commercial lenders make and administer the loans. The business appliesto the lender for financing. If the lender requires an SBA guaranty, the lender forwards the loan application to the SBA for approval. The SBA’s 7(a) loan is the most popular of available SBA programs. Eligibility for the 7(a) loan is based on business size and type, use of proceeds and availability of funds from other sources. A 7(a) loan may be used to purchase land or buildings; to cover new construction; to acquire equipment, machinery, furniture, fixtures, suppliesor materials; for long- or short-term working capital; to purchase an existing business; or to refinance existing business debt. SBA’s 7(a) Loan Program has a maximum loan amount of $2 million. SBA’s maximum exposure is $1.5 million or 75 percent of the maximum loan amount. The SBA considers the same criteria as a commercial lender in evaluating the loan application for approval, including equity investment, credit history, capacity to repay, management experience, character, collateral availability, and condition of the industry. A list of eligible SBA lenders can be obtained from the SBA or at www.sbrn.org. The SBA district office is located at 7825 Baymeadows Way, Suite 100-B, Jacksonville, FL 32256, and can be reached by telephone at (904) 443-1900 or www.sba.gov.
Another SBA loan program, the 504 loan, is long-term financing for acquiring land and buildings, for construction or renovation of existing facilities, and for purchase of equipment and machinery. Eligibility also depends on creation or retention of jobs. SBA 504 loans are packaged and processed by certified development corporations (CDCs). For a list of area CDCs, contact the SBA or go to www.sbrn.org.
Other government loan programs available to help businesses start or expand include the State ofFlorida’s Black Business Investment Board, which provides businesses owned by African Americans with financing. The First Coast Black Business Investment Corporation can be reached at (904) 634-0543 and Essential Capital can be reached at (904) 398-9411.
For existing and potential business owners who may not meet conventional lending criteria and need very small amounts of capital, between $5000 and $25,000, there is the SBA’s Community Express Loan Program, as well as the First Coast Micro Loan program. For information, contact the Small Business Development Center at UCF.
Little if any grant money is available to start a for-profit small business. Some high-tech research grants are available but on a very limited basis. Vocational rehabilitation grants may be available for the disabled. Information on grants available to non-profit organizations may be found on the Internet and at the public library.
Although there are many and varied sources of financing for the small business, obtaining these funds requires that the owner provide a substantial portion of the capital needed from his or her own personal funds. In addition, the owner must present a complete business plan and financial statements. Preparation and persistence are key ingredients to success.