You need money
to grow a business! Capital can come from many sources, including
personal savings. However, borrowing money from a lender is
a primary source of capital, as is raising equity capital
from an investor. Many resources are available to help guide
a business owner to the best options for financing growth.
Borrowing Money - What to consider before you borrow money.
Borrowing money is one of the most common sources of funding
for a small business, but obtaining a loan isn't always
easy. Before you approach your banker for a loan, it is
a good idea to understand as much as you can about the factors
the bank will evaluate when they consider making you a loan.
This discussion outlines some of the key factors a bank
uses to analyze a potential borrower. Also included is a
self-assessment checklist at the end of this section for
you to complete.
Key Points To Consider - below are some of the key points
your banker will review:
1. Ability to Repay/Capacity . . . The ability to repay
must be justified in your loan package. Banks want to see
two sources of repayment -- cash flow from the business,
plus a secondary source such as collateral. In order to
analyze the cash flow of the business, the lender will review
the business's past financial statements. Generally, banks
feel most comfortable dealing with a business that has been
in existence for a number of years because they have a financial
track record. If the business has consistently made a profit
and that profit can cover the payment of additional debt,
then it is likely that the loan will be approved. If however,
the business has been operating marginally and now has a
new opportunity to grow or if that business is a start-up,
then it is necessary to prepare a thorough loan package
with detailed explanation addressing how the business will
be able to repay the loan.
2. Credit History . . . One of the first things a bank
will determine when a person/business requests a loan is
whether their personal and business credit is good. Therefore
before you go to the bank, or even start the process of
preparing a loan request, you want to make sure your credit
is good.
First get your personal credit report. You can obtain a
report by calling TransUnion, Equifax, TRW or another credit
bureau. It is important that you initiate this step well
in advance of seeking a loan. Personal credit reports may
contain errors or be out of date. In many cases, people
find that they paid off a bill but that it has not been
recorded on their credit report. It can take 3 to 4 weeks
for this error to be corrected -- and it is up to you to
see that this happens. You want to make sure that when the
bank pulls your credit report that all the errors have been
corrected and your history is up to date.
Once you obtain your credit report, how do you know what
it says? Many people receive their credit reports yet have
no idea what the strange numbers signify. The following
should help in interpreting and checking your personal credit
report.
First, check your name, social security number and address
at the top of the page. Make sure these are correct. There
are people who have found that they have credit information
from another person because of mistakes in their identification
information.
On the rest of your credit report you will see a list of
all the credit you have obtained in the past - credit cards,
mortgages, student loans, etc. Each credit will be listed
individually with information on how you paid that credit.
Any credit where you have had a problem in paying will be
listed towards the top of the list. These are the credits
that my affect your ability to obtain a loan.
If you have been late by a month on an occasional payment,
this probably will not adversely affect your credit. However,
if you are continuously late in paying your credit, have
a credit that was never paid and charged off, have a judgment
against you, or have declared bankruptcy in the last 7 years,
it is likely that you will have difficulty in obtaining
a loan.
In some cases, a person has had a period of bad credit
based on a divorce, medical crisis, or some other significant
event. If you can show that your credit was good before
and after this event and that you have tried to pay back
those debts incurred in the period of bad credit, you should
be able to obtain a loan. It is best if you write an explanation
of your credit problems and how you have rectified them
and attach this to your credit report in your loan package.
Each credit bureau has a slightly different way of presenting
your credit information. You can get specific information
on "how to read the report" form the appropriate
company, but here's a few tips to get you started:
TRW . . . In the last few years TRW has prepared credit
reports with words and not numbers. Good credits should
read "Never Late", "Paid as Agreed".
TransUnion . . . On the right side of the page on the credit
report are number and letter combinations. "I"
means installment credit. "R" means revolving
credit. The key information is in the numbers. A "1"
means perfect credit since you have always paid your bills
on time. "2" or "3" means you have been
2 to 3 months late in paying your bills. Too many of theses
will hurt your chances in obtaining credit. A "9"
means delinquency in paying your bills and a charge off.
This could make it difficult in obtaining a loan
If you need assistance in interpreting or evaluating your
credit report you can ask your accountant or a friendly
banker. If your credit report has a few problems on it,
you may find that another bank may evaluate your credit
report differently.
3. Equity . . . Financial institutions want to see a certain
amount of equity in a business. Equity can be built up in
a business through retained earnings or the injection of
cash from either the owner or investors. Most banks want
to see that the total liabilities or debt of a business
is not more than 4 times the amount of equity. (Or stated
differently, when you divide total liabilities by equity,
your answer should not be more than 4.) Therefore if you
want a loan you must ensure that there is enough equity
in the company to leverage that loan.
Don't be misled into thinking that start-up businesses
can obtain 100% financing through conventional or special
loan programs. A business owner usually must put some of
her/his own money into the business. The amount an individual
must put into the business in order to obtain a loan is
dependent on the type of loan, purpose and terms. For example,
most banks want the owner to put in at least 20 - 40% of
the total request.
Example: A new business needs a $100,000 to start. The
business owner must put $20,000 of her own money into the
new business as equity. Her loan will be $80,000. The debt
to equity ratio is 4:1. Note also that this is only one
of many factors used to evaluate the business -- just having
the right debt/equity ratio does not guarantee you'll get
the loan.
The balance sheet indicates the amount of equity or net
worth of a business. The net worth of the business is often
a combination of retained earnings and owner's equity. In
many cases, owner's equity will be shown as a loan from
shareholders and therefore a liability. If a business owner
wishes to obtain a loan, she will be obligated to pay the
bank back first and not herself. Consequently, it may be
necessary to restructure the liability so that it becomes
owner's equity or subordinate the loan. If the current debt
to net worth is 4 or over it is unlikely that the business
will be able to obtain additional debt/loan.
4. Collateral . . . Financial institutions are looking
for a second source of repayment, which often is collateral.
Collateral are those personal and business assets that can
be sold to pay back the loan. Every loan program, even many
micro loan programs, requires at least some collateral to
secure a loan. If a potential borrower has no collateral
to secure a loan, she/he will need a co-signer that has
collateral to pledge. Otherwise it may be difficult to obtain
a loan.
The value of collateral is not based on the market value.
It is discounted to take into account the value that would
be lost if the assets had to be liquidated.
SBA Loan Programs - The SBA offers a range of loan options
for almost every type of business.
SBA's 7(a) Loan Program - Details on the SBA's most basic
type of loan.
Prequalification Programs - For some programs, a business
must prequalify for participation.
Micro loans- SBA's program to give very small loans.
Capital Alternatives - Options and possible alternatives
for your business' need for capital.
Certified Development Company (504) Loan Program - SBA's
program for long-term financing to a non-profit Certified
Development Company to support economic growth within a community.
Equity Financing - Explanation of equity financing, including
venture capitalists.
Most small or growth-stage businesses use equity financing
in a limited way. As with debt financing, most of the time
additional equity comes from non-professional investors
such as friends, relatives, employees, customers or industry
colleagues.
However, the most common source of professional equity
funding is that group of investors known as venture capitalists.
Venture capitalists are institutional risk takers and may
be groups of wealthy individuals, government-assisted sources
or major financial institutions. Most specialize in one
or a few closely related industries. The high tech industry
of California's Silicon Valley offers many shining examples
of capitalist investing.
While public perception of venture capitalists may be of
deep-pocketed financial gurus looking for "that hot
new business" in which to invest their money, in reality
they most often prefer three-to-five-year old companies
that offer the potential to become major regional or national
concerns and return higher-than-average profits to their
shareholders.
Venture capitalists may scrutinize thousands of potential
investments annually, while investing ultimately in only
a handful.
Small Business Investment Companies (SBIC) - SBA-approved,
private-public partnerships helping small businesses succeed
in today's environment.
