Financing Your Business

Finding the Money

As the old adage says, “You need to have money to make money.” Most businesses will require a significant amount of money to get started. This start-up money not only has to pay for the expenses of obtaining everything you need to begin your business, but it also needs to pay for day-to-day operation of the business until your revenue stream starts flowing.

This may be the most difficult task in starting a business.

Personal Resources

Many businesses start with the personal resources of the owner or partners. Savings accounts are ideal but many entrepreneurs have not accumulated enough money in their savings to successfully launch a business. Credit cards are often used to finance a new business and, while this may work in some cases, there may be better options.

Friends and relatives may be a great source of capital. The money loaned is often interest-free or loaned at a low interest rate. But just like a credit rating, relationships can be hard to repair if something goes wrong.

Professional Sources

The most common source of funding for new businesses is a loan from a bank or credit union. These require a detailed description of your business and its strengths and risks (a business plan) so that the lending institution can determine how likely it is that the loan will be repaid in full.

Venture capital firms may provide funding in exchange for equity or partial ownership. This funding is an investment and they will require a sound business plan to ensure they have a good chance of realizing a high return on their investment.

Borrowing Money

Banks make money by lending money. So to make more money, they want to provide loans. But they also need to make sure they aren’t going to lose money, which happens when businesses default on their loans. To protect themselves from this default, they often deny loans to small business owners with little experience and no proven track record.

To get over this hurdle, you need to prove you are prepared to run a successful business, and that their money is safe in your hands. You must present yourself and your business plan in a very organized manner. You’ll need to know exactly how much money you require, exactly what you’ll do with it, and how quickly you’ll be able to pay it back.

Short Term vs. Long Term

The terms of business loans varies considerably from lender to lender. So the specific loan you apply for will depend largely on who the lender is. But most loans fall into one of two categories: short term and long term.

Short Term Loans

Any loan with a maturity period up to one year is considered a short term loan. Working capital and accounts receivable loans and lines of credit are usually considered short-term loans. These are best used for business enhancements to accomplish a specific goal, while your business is already making a profit. Short term loans are not usually a good way to borrow start-up capital.

Long Term Loans

Loans with a maturity between one and seven years are considered long term loans. These are often used for major business expenses such as purchasing property, facilities, durable equipment, furniture, vehicles, etc. Real estate and equipment loans may have even longer terms, up to 25 years.

Writing a Loan Proposal

If you’ve already written a business plan, your loan proposal should be fairly easy to write. But since the bank will approve or deny your request based mostly in your loan proposal, it is important that it represents you and your business properly.

Remember, the bank wants to loan you money so that they can make money, but it is a risk. You have to make them feel comfortable enough to take that risk.

You will need to include the following on your loan proposal:

General Information

Business name
Business address
Names of principles
Social Security numbers for each principle

Purpose of the loan

Why you need it and exactly what it will be used for

Amount required

Specify the exact amount you are requesting

Business Description

History and overview of business – If this is a new business, there will be no history. But include how the events leading up to the formation of the business. If this is an established business, offer the age of the business, the number of employees and current business assets.

Ownership structure

Give the legal description of company structure.

Management profile

Detail each principle in your business including their background, education, experience, skills, accomplishments and any other information that is a benefit to your business.

Market Profile

Explain fully but concisely your product or service and detail the markets in which you will be selling.
Identify your competition as well as your competitive advantage in your market.
Develop a profile of your target customer and show how your product or service meets his or her needs.

Financial Information

Provide financial statements as well as balance sheets and income statements for the past three years. If this is a start-up business, provide a projected balance sheet and income statement.
Provide your personal financial statement as well as any other principle owners.
Detail the collateral you are willing to put up as security for the loan.

Reviewing the Loan

Again, the when reviewing a loan, a lender wants to be sure you can repay the amount borrowed. In addition to the business plan, the bank may order copies of your business credit report. A start-up will not have a long credit history. If your business does have some credit history, check with the major credit reporting agencies to make sure they have accurate information.

Using the credit report, if available, letters of recommendation and the information you have provide in your loan proposal, the lender will try to determine:

Are you personally invested in the business? Lenders assume that the more personal capital you have to lose, the harder you will work to make the business a success. They’d prefer to see that your personal investment is equal to at least 25% to 50% of the amount of the loan you’ve requested.
Do your credit report, work history and letters of recommendation paint a picture of a creditworthy business? This is probably the most important aspect they will look at.
Do you have the experience and training needed to make your business a success?
Do the materials you provided, including your business plan and loan proposal, demonstrate a solid understanding of how to run a successful business as well as the commitment needed to follow through?
Will the business have enough revenue to make the required monthly payments on the loan?