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| Financing
Basics |
While poor management is cited most frequently as the
reason
businesses fail, inadequate or ill-timed financing
is a close second. Whether you're starting a business or
expanding one, sufficient ready capital is essential.
But it is not enough to simply have sufficient
financing; knowledge and planning are required to manage
it well. These qualities ensure that entrepreneurs avoid
common mistakes like securing the wrong type of
financing, miscalculating the amount required, or
underestimating the cost of borrowing money.
Before inquiring about financing, ask yourself the
following:
- Do you need more capital or
can you manage existing cash flow more effectively?
- How do you define your
need? Do you need money to expand or as a cushion
against risk?
- How urgent is your need?
You can obtain the best terms when you anticipate
your needs rather than looking for money under
pressure.
- How great are your risks?
All businesses carry risks, and the degree of risk
will affect cost and available financing
alternatives.
- In what state of
development is the business? Needs are most critical
during transitional stages.
- For what purposes will the
capital be used? Any lender will require that
capital be requested for very specific needs.
- What is the state of your
industry? Depressed, stable, or growth conditions
require different approaches to money needs and
sources. Businesses that prosper while others are in
decline will often receive better funding terms.
- Is your business seasonal
or cyclical? Seasonal needs for financing generally
are short term. Loans advanced for cyclical
industries such as construction are designed to
support a business through depressed periods.
- How strong is your
management team? Management is the most important
element assessed by money sources.
- Perhaps most importantly,
how does your need for financing mesh with your
business plan? If you don't have a business plan,
make writing one your first priority. All capital
sources will want to see your for the start-up and
growth of your business.
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Not All Money Is the Same |
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There are two types of financing: equity and debt
financing. When looking for money, you must consider
your company's debt-to-equity ratio - the relation
between dollars you've borrowed and dollars you've
invested in your business. The more money owners have
invested in their business, the easier it is to attract
financing.
If your firm has a high
ratio of equity to debt, you should probably seek debt
financing. However, if your company has a high
proportion of debt to equity, experts advise that you
should increase your ownership capital (equity
investment) for additional funds. That way you won't be
over-leveraged to the point of jeopardizing your
company's survival. |
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Equity Financing |
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Most small or growth-stage businesses use limited equity
financing. As with debt financing, additional equity
often comes from non-professional investors such as
friends, relatives, employees, customers, or industry
colleagues. However, the most common source of
professional equity funding comes from venture
capitalists. These 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 is
a well-known example of capitalist investing.
Venture capitalists are
often seen as deep-pocketed financial gurus looking for
start-ups in which to invest their money, but they most
often prefer three-to-five-year old companies with 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, but only
invest in a handful. The possibility of a public stock
offering is critical to venture capitalists. Quality
management, a competitive or innovative advantage, and
industry growth are also major concerns.
Different venture
capitalists have different approaches to management of
the business in which they invest. They generally prefer
to influence a business passively, but will react when a
business does not perform as expected and may insist on
changes in management or strategy. Relinquishing some of
the decision-making and some of the potential for
profits are the main disadvantages of equity financing.
You may contact these investors directly, although they
typically make their investments through referrals. The
SBA also licenses Small Business Investment Companies (SBICs)
and Minority Enterprise Small Business Investment
companies (MSBIs), which offer equity financing. Apple
Computer, Federal Express and Nike Shoes received
financing from SBICs at critical stages of their growth.
Additional Reading
Raising Money through Equity Investments - Inc.
Magazine |
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Debt Financing |
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There are many sources for debt financing: banks,
savings and loans, commercial finance companies, and the
U.S. Small Business Administration (SBA) are the most
common. State and local governments have developed many
programs in recent years to encourage the growth of
small businesses in recognition of their positive
effects on the economy. Family members, friends, and
former associates are all potential sources, especially
when capital requirements are smaller.
Traditionally, banks
have been the major source of small business funding.
Their principal role has been as a short-term lender
offering demand loans, seasonal lines of credit, and
single-purpose loans for machinery and equipment. Banks
generally have been reluctant to offer long-term loans
to small firms. The SBA guaranteed lending program
encourages banks and non-bank lenders to make long-term
loans to small firms by reducing their risk and
leveraging the funds they have available. The SBA's
programs have been an integral part of the success
stories of thousands of firms nationally.
In addition to equity
considerations, lenders commonly require the borrower's
personal guarantees in case of default. This ensures
that the borrower has a sufficient personal interest at
stake to give paramount attention to the business. For
most borrowers this is a burden, but also a necessity.
More about our
Capital For Businesses Program!
Apply for a Small Business Loan Today!
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