Financing Your Small Business

Debt Financing

Bank Loans

Small Business Administration (SBA)

Credit Cards

Home Equity Lines

Retirement Funds

Life Insurance Borrowing

Financial Brokers

Reverse Mergers

Factoring

Revenue Participation/Royalty Financing Merchant Banking SBIC Financing Private Debt

Combining Equity and Debt Financing

An alternative to financing through equity is debt. The advantages of using debt are:

• the time to secure debt financing is usually shorter than equity;

• the cost of the money (principal and interest) is readily measurable;

• documentation costs for the transaction will probably be less than an equity transaction; and,

• the equity of the company is not diluted by new ownership.

The disadvantages to debt are:

• unlike equity, the company has to pay back debt;

• the company must carry debt on its balance sheet as a liability, which may make it less attractive to some investors;

• if the cash flow of the business is tight, debt service can put an undue strain on the finances;

• in many small businesses, commercial lenders require the principals to personally guarantee the debt and possibly pledge personal collateral; and,

• some lenders require rather onerous record keeping by the borrower, such as quarterly and annual financial statements—possibly audited— and impose restrictions on certain business transactions without the lender's consent.

Bank Loans

One of the most common types of financing is bank loans. In order to obtain a bank loan for a new business, you may need to present a business plan or a loan proposal, which are similar documents.

The advantage of seeking a bank loan may be that you or your family has a preexisting relationship or history with a bank that makes the process eas­ier. In any event, a bank will focus on several things in reviewing your loan application.

First, they will want to know about your business (the business plan), how much money you need, and how you intend to spend it. Equally important is demonstrating to the bank how your business intends to pay the loan back and over what time period. Financial projections are most helpful at this time.

Banks are in the business of loaning money—that is one of their main profit centers. Your task is to demonstrate to them that you are creditwor­thy and that the revenues from your company are likely to pay back the loan in a timely manner. You demonstrate your ability to pay back the loan through your financial projections. If you already have a history of running a profitable business, a historical financial statement coupled with a finan­cial projection could win the day.

Unless you have substantial assets in your company and healthy annual revenues, banks are likely to look to the creditworthiness of the owners of the business. In other words, you and your partners' credit histories will be checked and you may be required to submit a personal balance sheet.

Keep in mind that it is a crime to submit false information to a bank—tell it like it is without unnecessary embellishment.

In the case of a start-up business, many banks will require, as a condition of the loan, that each of the founders (and possibly their spouses) guaran­tee the loan. The demand for personal guarantees may also surface when you are signing a lease for your company office or plant. If you have to sign a personal guarantee, see if the bank will agree to remove it after some rea­sonable period. Commercial landlords tend to be more open to the even­tual removal of personal guarantees than banks, but it never hurts to ask.

Banks charge interest for loans, which is deductible as a business expense to the borrower. Interest rates vary among banks and can be influenced by the type of loan made and the perceived credit risk of the borrower. You should explore the various types of bank loans available to your business to see what fits. For example, a line of credit allows you to draw funds when needed and only pay interest on outstanding balances.

Line of

Credit, you may be required to pay out of the line (i. e., pay back all balances) once a year in order to renew it.

An installment loan is usually for a certain sum that you pay back in pay­ments of principal and interest, similar to your home mortgage. Many busi­ness loans have a floating interest rate that adjusts with changes in a stan­dard index, such as the prime rate.

Some banks may require that you provide security or collateral for any business loan. If your business does not have equipment or receivables, they may require you to put up your house and other personal property to guar­antee the loan. If that is not enough, you and your partners, directors, and possibly principal shareholders will most likely have to sign personally on the loans as previously discussed.

If your company is writing a business plan and a bank loan is in the pic­ture, you may wish to specifically address the issues the lending bank will consider in making a loan. As a practical matter, you will probably have trouble getting a loan as a start-up if you cannot demonstrate an ability to repay the loan from revenues. You should probably enlist the aid of your accountant to make certain that you tell your story in believable numbers.

You will also help your case by having substantial clients or orders in the wings to demonstrate imminent revenues. It also helps if you have invested your own money in the venture, as this demonstrates your commitment to the business and its success. In venture circles that is known as having skin in the game. Pledging collateral is another way to put skin in the game.

Another useful approach is to plan your presentation to the bank, prefer­ably on your own turf, so that key employees are included in making por­tions of the presentation. If you are in a position to reduce or cut your own salary for some period of time, that will also impress the bank—they do not relish your seeking a loan to pay your own salary.

Larger, institutional banks are not the only game in town when seeking loans. Smaller, community banks are generally more connected with local people and may be more flexible. Innovative officers in small banks will try
to syndicate or farm out portions of loans to other small banks to increase their lending limit.

You should not necessarily stop with banks as the sole source of lending. Many venture funds, larger companies like GE Capital, and brokerage houses have bank-like divisions that could be a source of debt capital or some combi­nation of debt and equity. American Express has a small business division called OPEN: the Small Business Network (Www. americanexpress. com) that can grant needed lines of credit for small businesses.

HOW TO...Get a Bank Loan

□ Prepare a business plan targeted to a lender rather than an investor.

□ Present believable financial statements and projections that demonstrate that the company will have sufficient cash flow to service the debt and meet its operational budget.

□ Interview the lender prior to submitting the package and find out exactly what type of presentation and information is expected.