Coast River Business Journal, April 2013
Kevin Leahy, Executive Director CEDR and CCC SBDC
The first step in financing your business is to decide how much you need.
If you are starting a new business, you should look to your calculations on business startup expenses to help determine how much you need.
If you have an existing business, you may have either short- or long-term borrowing needs. Your monthly cash flow projection should provide a good picture of your short-term needs. The price of a major item, such as a fixed asset or the purchase of another company, will dictate your long-term borrowing needs.
You may wish to add a comfortable cushion to your estimate of cash needed, just to be safe. It is easier to raise all the necessary funds at once than to have to go back to lenders or investors at a later date and ask for more. However, it's best not to overestimate your needs by very much if it means you have to give up ownership or pay interest for these funds.
Sources of funds
Most small-business owners suggest that you search close to home for funds during the early stages of your business. Personal savings, consumer loans from banks and mortgage companies, and either investments or personal loans from friends and relatives are common sources of start-up capital. After you have established a profitable track record, you will have more options available for raising capital.
Equity funding consists of equity from your personal contribution to the company or equity you have raised from outside sources, or both. When you raise equity from outside sources, you sell a partial interest in your company. Equity funding can be obtained from private investors, venture capital firms, friends, and relatives. You should be very careful not to give up control of your company when raising outside equity. The easiest way to ensure that you retain control is to keep at least 51 percent ownership in the company.
The advantages of equity funding are that it has no fixed costs-you do not have to make regular interest payments-and that higher equity levels allow you to leverage your company by negotiating favorable loan terms. The major disadvantage of equity funding is that you may have to sacrifice ownership and future profits to attract investors.
Personal contribution is important to show commitment
Venture capitalists want a high return on investment
Maintain 51% of equity for control
Personal Sources. YOU should invest some personal funds into your business. These funds may come from your savings, or they may come from personal debt that you incur for this purpose. Consumer loans, such as a home equity loan, are common personal sources of equity capital. Your willingness to place personal assets at risk will be an important factor when you approach investors or lenders about financing your business.
Venture Capital. Venture capitalists are looking for a high return on investment and are therefore willing to take risks. Generally, they want a 25 to 40 percent return. They do not want to be involved in the operation of your business, but they do want to be kept informed, and they expect to be consulted on major issues. Venture capitalists look for innovative ideas and are usually interested in companies that market a product rather than a service. When venture capitalists make a decision about whether to invest in your company, the quality of your management team and its track record will be weighed heavily.
Debt funding is available from commercial banks, nonbank institutions, friends, and relatives. Debt funding can take the form of personal loans or business loans. In addition, some start-up businesses can take advantage of operations related financing.
Personal contribution is important to show commitment
Business loans for start-ups are hard to obtain; personal loans may be a solution
Personal Loans. You may incur personal debt for your company by borrowing from a bank on a secured or unsecured basis, by borrowing against the cash value of ' your life insurance, by obtaining a home equity loan, or by borrowing from friends and relatives. Be sure that the cost of the loan is reasonable and that you have a sound plan for repayment.
Business Loans. Your business may qualify for a term loan or a line of credit from a commercial bank or other entity. It is important to the viability of your company that you match the type of credit you obtain with your needs. Banks will want your personal guarantee on any loan they make to the company. Be aware that banks are generally not interested in financing start-up businesses, and that service businesses, which offer little or no collateral, are usually the hardest of all to finance. The amount of equity in your company and the quality of your financing proposal will be the 2 biggest factors in determining whether you will be successful in obtaining bank credit.
Term Loans are set up on an installment basis with a regular amortization schedule, usually requiring monthly payments. Term loans should be used to finance fixed assets. Term loans are made on a secured basis, and lenders rarely will advance 100 percent of cost. An advance ratio-the amount of money a lender will advance against the value of the collateral used to secure the loan-in the range of 75 to 80 percent is common for assets such as real estate and some equipment that have reasonable liquidation possibilities. An advance ratio against other fixed assets, such as leasehold improvements, will be much lower. You may be asked to supplement the collateral package with personal assets, such as marketable securities or your residence.
Lines of Credit are generally extended for a period of one year, at which time they ordinarily will be renewed if the performance has been satisfactory. A line of credit allows you to manage your cash flow by providing the flexibility to borrow and repay throughout the year. Lines of credit should be for the purpose of financing your current assets, accounts receivable, and inventory. A line of credit may or may not be on a secured basis.
Most government-assisted loans will require your personal guarantee on the debt as well as some level of equity in the company.
There are many options to get “access to capital”, and it can be overwhelming at times. Make an appointment at our Clatsop Community College Small Business Development Center to talk to one of our counselors to help you get a clearer understanding of your options. We can assist you through the entire process. Counseling is always free, and confidential.