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Financing Options and Alternatives

Disclaimer:  Although the information and recommendations provided in our site are presented in good faith and believed to be correct, e-Clarity LLC, makes no representations or warranties as to the completeness or accuracy of the information.  In all cases we urge you to seek professional advice.

Types of loans

In borrowing for businesses, the business can either sell equity in the company or can incur debt.  If the company sells equity in the business, the loan is not repaid but the loaning entity receives an ownership interest in the business and receives a portion of the profits.

If the loan incurs a debt it is normally a short term, intermediate term or long term loan.  Generally, a short term loan is payable within thirty to sixty days, an intermediate loan is payable in one to five years, and long term loans can be stretched from five to thirty years.  In most cases:

  • Short term loans usually cover business operation expenses such as rent, insurance, advertising, inventory or salaries. They are often unsecured and repayment is mostly made by a lump sum, including interest.

  • Intermediate term loans are normally used to purchase business equipment, buy fixed assets or provide working capital. They are usually secured by the new equipment or business assets. They sometimes have low monthly payments, with a large balloon payment at the end of the term.

  • A long term commercial loan for five years or more is used to purchase an existing business, buy real estate, or construct or improve a building. The long-term loan is always secured by the assets for which the loan was made, and usually requires constant monthly payments with a variable interest rate.

Sources of loans

The most common source of small loans for businesses is from personal savings and credit cards.  The advantages are speed and convenience and the disadvantages are depleting personal resources if taking from savings, or high interest rates if using credit cards.  Also, in the early stages of doing business, entrepreneurs often use friends and family who are sources of low-or-no interest loans. 

Beyond these methods, the most commonly available sources of loans are:

  1. Commercial banks.  These banks are generally very careful lenders. Although they accept collateral for business loans, approval rests on your ability to repay the loan as shown by your profit projections, management skills and your personal record.  If you have a good working relationship with your banker, and they have some involvement in the planning process for your new business, your chances for loan approval are greater.

  2. Commercial finance companies are generally the place to go when you are unable to obtain a loan from a bank. Commercial finance companies, like banks, are concerned with your ability to repay the loan, but they are more willing to rely on collateral rather than your business plan, track record or profit projections. If you do not have substantial personal assets or collateral, a commercial finance company may not be the best place to secure start-up capital for a business. Commercial finance company capital is usually several percentage points higher than bank financing.

  3. The Small Business Administration (SBA) is an independent government agency that provides loan guarantees, participates with bank loans, and occasionally makes a limited number of direct loans. To receive financial help from SBA, a business must be unable to secure reasonable financing from other sources.  SBA loan interest rates vary from year to year based on the cost of money to the government and usually mature in 10 years, except for the purchase or construction of buildings that may have a maturity of 20 years. A loan proposal for the SBA is generally more complex and more documented than one for banks. Unlike commercial lenders, the SBA will sometimes ignore a poor track record if a business shows signs of improvement with a good business plan. Click here for information on common types of SBA loans.

  4. Small Business Investment Companies (SBIC) are privately owned companies that are licensed and regulated by the SBA. SBICs were created to supply equity capital, long-term loan funds and management help to small businesses.   Most investment companies prefer to lend to established companies or finance purchases of existing businesses.

  5. Venture Capital Companies.  These firms help expanding companies grow in exchange for equity or partial ownership.  Their investments usually fund certain stages of growth such as:

    • First stage financing: The venture has finally launched and sales are improving.  The funding from this stage is used to fuel sales,
      reach the breakeven point, increase productivity, cut unit costs, and build the corporate infrastructure and distribution system.

    • Second stage financing starts at a time when the company is also accumulating accounts receivable and inventory. Capital from this stage is used for funding expansion and for meeting marketing expenses and entering new markets. 

    • Third stage financing: takes place when sales are rising, accounts receivables are growing, and  second level of managers are in place. Money from this financing is used for increasing capacity, marketing, working capital, and product improvement or expansion. 

    • Mezzanine or Bridge financing is brought when the company is a proven winner and investment bankers have agreed to make it a public company within 6 months. Mezzanine or bridge financing is a short term form of financing used to prepare a company for its IPO. This includes cleaning up the balance sheet to remove debt that may have accumulated, buy out early investors and founders deemed not strong enough to run a public company, and pay for various other costs stemming from going public.
       

  6. Angel investors are wealthy individuals who invest in early-stage deals offered by entrepreneurs and companies in need of capital. Angel investing is one of the better known forms of private equity. Angel Investors typically provide funding for start-up businesses in return for an equity stake. Traditional venture capitalists normally invest relatively large sums; however, Angels contribute smaller amounts to businesses, often at the beginning of the start up cycle. Angels also are able to add non-monetary value to a start up. Angels often take an active interest in the operations of a venture, perhaps drawing on their own entrepreneurial or management experience. They usually look for a return of 5 to 10 times their original investment in 5 to 7 years and are more liberal in their lending criteria than venture capitalists or banks.

Summary

Look in your own area for local funding, which is available in some communities from redevelopment agencies and other local organizations.  Certain business owners and types of businesses might qualify for special loan programs. 

There are many sources of capital for small businesses with good potential. However, there is no substitute for putting your financial assets on the line in starting your own business. Securing capital for any new business will require well developed business plans, financial projections and knowledge of sources of financial support.

Resources

Small Business Administration financing a start-up

Business Finance search for business funding sources

Small Business Administration guide to small business microloans

BankRate small business resources

PricewaterhouseCoopers Money Tree report

Financing your business from Idea Cafe

National Venture Capital Association (select "Venture Capital Organizations" from the drop down menu of "Resources")

NASBIC guide to SBIC financing

Comptroller of the Currency small business financial resource guide

Gathering of Angels web site (Links for information on Angel Investors)

 

Need more help?  Contact us for more information.

 

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