Financing a Business
FINANCING A BUSINESS
Family Business Finance Strategies
Financing a business involves choosing from a vast array of alternatives. Debt or equity? Secured or unsecured? Are you at start-up, already launched, profitable, looking for exit / succession funding? How much resources have you committed to the business?
What does a lender or investor want from someone financing their business? What are some of the myths?
Financing Your Business
How Much are You Putting in?
Probably the most common mistake we find amongst those seeking financing for their business is the idea that someone else will stake them to their dreams without them taking a large share of the risk.
Think about it - how much confidence will a lender or investor have in your proposal if you don't have enough confidence in it yourself to put your own resources at risk? So the most basic rule of financing a business is to commit yourself and your savings or resources to the business.
For a start-up business, which might not be able to obtain funds on credit, the owner will have to come up with capital, such as from personal savings. No matter where else you look for funding, the money you put in is a strong sign of good faith and commitment to other lenders. Consider borrowing from friends and relatives and /or selling off surplus assets to provide the funds you need... like a boat that sits idle most of the year.
"For an established family business, financing is often needed for expansion or to assist with transition of ownership from one generation to the next," according to leading family business expert
"As part of our succession management program, we advise our family business clients to always consider the economics to "build or buy" as part of their growth strategy. Given the current economy, there are many businesses to buy - but certainly not without expert advice".
Schwerzler has been studying and advising family business entreprenuers for more than 40 years and he is the founder of the
Family Business Institute,
headquartered in Atlanta GA.
Financing a business
How Much Do You Need?
Your business plan should tell you. Things like
- initial operating expenses such as utilities, rent, payroll, payroll taxes
- inventory and supplies to get started
- computer system, software
- fixing up your premises, office furniture, production equipment, delivery vehicle
- perhaps funds to buy an existing business rather than starting from "scratch"
In financing a business, not all of these items require cash. Alternatives include renting or leasing and even barter or exchange.
And don't forget the important questions in financing a business that go with "how much?"
- When do you need it?
Utilities are paid after the end of the month, except for a small deposit at the beginning. Payroll is incurred weekly or monthly. Rent is usually paid along with a deposit at the beginning of the month. Inventory can be built up gradually in some cases, and suppliers often grant extended payment terms.
- When are you going to pay it back?
You will want to earn enough to start paying operating expenses from regular cash inflow. Inventory should turn over [be sold and replaced] several times a year so that you can typically sell it and collect for the sale in around 90 days. Assets like production equipment, delivery vehicles, computer system last longer and might take around 5 years to be paid off completely.
- What security do you have to offer?
Also known as collateral, security is what a lender has to rely on if you don't repay. It might be business assets and / or personal assets.
We have a whole section to help you with your business plan, including how to do cash flow projections that help you answer these questions.
Financing a Business With Debt
Financing a business with debt involves a loan - you get the funds and promise to pay them back with interest. Unsecured debt refers to a loan where the lender does not take a specific form of security: for example, a credit card, some lines of credit, private borrowing from family or friends. Secured debt refers to the lender taking some form of collateral in exchange for the loan: for example, title to the vehicle to secure a vehicle loan; mortgage on your private residence or business premises; title to equipment, signs or other assets that are financed.
What the lender is really concerned with is your ability to generate enough cash flow to make your payments, so make sure your presentation focuses on what is important to the lender - a solid plan and the experience and ability to repay.
It is your integrity and business experience that the lender really is relying upon in financing a business.
It follows that your presentation and loan application must emphasize your character and credit-worthiness and business experience.
Financing a business with personal loans is perhaps the most common form of debt - quite literally, you borrow the money personally and invest it in your business. It is typically used at start-up or early stages where the business itself has not established enough history or performance to be able to borrow in its own right.
Financing a business with government small business loans
Here in the USA, there are a variety of government small business loans and programs that can be used in financing a business, including those for female and African American minorities. Through the SBA [Small Business Administration] and some State agencies, most of the loans are actually made and administered by banks and other lenders who will do so because the SBA guarantees your loan if you are approved, so the lender has less risk than if they loaned directly to you. Some of the loans are made directly by the SBA. In general, you must have been rejected by several banks before you can be considered for approval by the SBA, and there is more paperwork and thus a slower approval process. Also, either SBA or its lenders are generally less flexible in changing repayment arrangements if you are unable to meet your agreed commitment.
Financing a business by leasing assets
Especially for start-ups, leasing can be an attractive and viable alternative when financing a business. Your equipment or vehicle vendor wants to sell something to you, so many have leasing programs to facilitate the sale. There are also leasing companies that operate independently of any manufacturer and will lease just about anything you might need. Many leases provide for an option to buy the asset outright for a fairly nominal amount at the end of the lease, which can be attractive if the asset still has useful life.
Leasing also has an advantage if your bank doesn't want to provide all you financing needs - sometimes lenders have limits on how much business they can underwrite with a particular borrower. However, if you have a banking relationship, be sure to discuss potential leases with your banker before signing contracts. As with any other type of borrowing, you must know what you need and how you are going to repay.
To learn more about equipment leasing Small-Business-Equipment-Leasing
Factoring is popular in some industries
An even more specialized source of financing a business that is operating and sells on credit is Factoring its accounts receivable. Basically, you sell your account receivable contract at a discount - you get less cash than if you waited to collect the full amount, but you have the cash now rather than later. It is generally done in certain industries like the garment industry, which has a long cycle from production to retail to payment. It is quite expensive since your discount is paying for the cost of debt [equivalent to the cost of you borrowing the funds from a lender] plus the costs of paperwork and servicing [collecting] and a profit for the factor. A note of caution: investigate your factoring contract carefully. WAtch for "recourse" - often if the factor is unable to collect the account, he will have the right to put it back to you and you might not be able to collect. So, it is definitely not a process to "unload" a portfolio of bad or uncollectible accounts.
To learn more about factoring Help-With-Factoring
Home equity loan
Another source for financing a business, especially these days with low interest rates, is a home equity loan. If you have built up equity in your home, a lender will loan you money and take back a mortgage on your home as security [sometimes it will be a "second" or even a "third" mortgage if there are other mortgages already registered]. But remember, if you don't repay, you risk losing your home, so it is always important that you are confident that you are able to make all payments as scheduled.
Cash surrender value [CSV] of life insurance
You might have been paying for a life insurance policy that builds up a cash value in addition to the face value it would pay. Most insurance companies will loan you money with the CSV as security. This is a rather expensive method of financing a business and should probably be considered only for those near retirement and whose beneficiaries could operate with the reduced benefit they would receive if you die while the loan is outstanding [life insurance proceeds first go to pay off the loan and accrued interest, reducing the benefit paid to beneficiaries].
Charge cards can also be a source for financing a business when you are first getting started. Generally expensive, but use bankrate.com to find cards with lower interest rates. Always make at least the minimum payment on time since problems here affect your credit rating faster than with almost any other type of debt.
Financing a business by borrowing from your IRA
Here in the USA, corporate downsizing has been prevalent for some time now, so many people who have built up substantial retirement accounts are now setting up their own business. The 2002 IncomeTax amendments contain a provision that could help you in financing a business..., you can borrow up to $50,000 or one-half of your IRA balance if you are self-employed with no employees. And the interest you pay off on that loan goes back in to your own IRA so you are "paying yourself". But, you are risking your retirement security, so be careful.
FAMILY BUSINESS FINANCE EXPERT
Financing a business with equity
Financing a business with equity is essentially different from borrowing in that the investor becomes a part-owner. While they might not attend daily / weekly meetings, you can expect their representative to monitor your management actions and to be watching over your shoulder.
What does a venture capital investor look for? Well, it's a bit different in focus from a lender. Venture capitalists do not want to be around forever in your business - they generally want to see an exit strategy that will see them out in about 5 years, with a high return on their investment.
The two usual exit paths are sale to another company or "going public" with an IPO [initial public offering]. Either of these paths are facilitated when your company shows good revenue growth and profitability. Unlike lending, the venture capitalist does share in profit growth.
Venture capitalists are interested in both high technology and various other industries, and they will look for a balanced management team - technology, finance, marketing, etc. - since it will take this type of management team to produce the revenue and profit growth that will drive increases in value and thus high returns.
Venture capitalists fund very few of the huge number of potential businesses that contact them every year, and most that are funded are not start-ups - they are already launched and have probably reached profitability. The venture capitalists will also probably be much more attracted to a company that includes management that has already had one or more successful launches - for the obvious reason that they know how to manage the growth for returns.
The angel investor or accredited investor is a special type of venture capitalist. Usually an individual with substantial net worth and income, he provides capital to startup companies and takes a personal stake in your venture. He might accept less control and a slower return on investment than other venture capital firms, but his investments share the high levels of risk and a potentially large return on investment so his investment criteria are similar.
Venture capital and angel investor resources
Meeting angel investors and venture capitalists and matching them with investment opportunities can be difficult for 2 reasons - the sheer number of opportunities and investors, and qualifying or matching to get a good fit between investor and suitable opportunity.
To answer the question "Are you Venture Worthy?", we recommend a resource where you can learn about venture capital and working with angel investors - for startup companies seeking investors or established family businesses seeking funding for growth or to fund the succession process.
Going public [IPO]
Going public with an IPO is a complex and massive undertaking so it's not a primary method of financing a business. Before the late '90's, the criteria for going public was an after-tax profit of $1 million a year, excellent growth potential and an ongoing need for large amounts of capital.
With the "dot-com's" in the late 1990's, the criteria seemed to change radically... it almost seemed that if you had profits you weren't even considered, and in some cases if you even had an established revenue stream you couldn't attract attention. Going public became aa primary way of financing a business - even before the business had proven its viability. Huge amounts were invested in operations that had nothing, including management or even a valid business plan! Thus were born the "dot-bombs".
But the situation has returned to a more rational basis - profitability and growth potential are again required. The actual process can take a year and consume huge amounts of two valuable resources - money to pay for all the fees and commissions, and executive time. It can be a real drain and distraction to senior management so it works mainly for companies that have established and deep management capability to "run the show" while others "ride the IPO". If you are short of operating funds, don't even think of IPO as a way to finance your family business out of a tight corner.
PLANNING FOR RETIREMENT: CASHING OUT
Government and other grants
Besides the usual sources for financing a business - debt and equity - there is another in the US, Canada and many other countries - government and other grants. [A grant is different from a loan in that a grant does not have to be repaid]. Much information on these, including so-called information books and lists, is available on the Internet. It can be a quagmire, and difficult to know if you will qualify or how much you will get [depends on program funding availability, decision of some bureaucrat, etc.] so it's not such a reliable source, but if you have some time, you might get the seed funding you need. Like anything else with government, read and study the program criteria and make sure that your application is letter -perfect and addresses the goals of the program to which you are applying.
One of the most difficult aspects of financing a business is choosing just which approach is best for you. fortunately, there is lots of help available.
"WITHOUT A GOOD QUESTION A GOOD ANSWER HAS NO PLACE TO GO..."
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