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How Much Money Do You Need?
Or, how much can you reasonably expect to get? Don't get too excited just yet - this is not your chance to ask for a million $currency_text_plural$ when you only need $currency_symbol$50,000. Refer back to your business plan. If it still doesn't answer the question, let's go step-by-step.
What do you need it for?
- Buying supplies and inventory while waiting to get paid
- Paying payroll and rent
- Buying equipment and fixtures
- Getting a computer
- Buying the business
Prioritize those areas where your options are limited to paying in cash, and review your alternatives where there may be another way. For example, it is not necessary to pay all cash for a delivery truck when you can rent or lease one. Next review what might serve as collateral for your loans. Some credit is granted on an unsecured basis, such as credit cards, but most small business loans are secured by the assets of your business or your personal assets or both. Unsecured means that there is no collateral granted for the loan. Examples of unsecured are:
- Credit cards
- Unsecured lines of credit (like you get in the mail)
- Friends or relatives
Secured loans mean that there are assets pledged to secure the payment in the event you are not able to pay. Examples of this are:
- Computer lease
- Home mortgage
- Car loan or lease
- Small Business Administration loan
Common types of collateral are equity in your home, accounts receivable, inventory of the business and equipment. Lenders go through an evaluation of the collateral to determine how much they can lend against it. Some key variables as to what kind of loan terms you can get are:
- Number of years in business - This is your track record and is very important. Banks usually require three years while others are less stringent.
- Size of your company and the amount needed - Financing institutions vary in the way they service the public. For example, you would probably not get a car loan and a large corporate loan at the same place. Do your research. Ask around. Get to the right spot.
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Loans (Debt) vs. Investment (Equity)
|"One of the worst mistakes you can make is to ask for more money than you can afford to repay."|
You are most likely familiar with a straight loan (debt) where the lender gets an interest rate and fees.
Equity is where the money raised gives the investor an ownership interest. This is common in the sale of stock to a limited number of investors or participation by venture capitalists. The sale of stock is highly regulated by state and federal agencies and you will need the help of a corporate lawyer. Normally the initial sale of stock to the public (initial public offering or IPO) is deferred until an earnings history is established.
Sometimes such a discussion arises with friends and family who want to be your partner. Consider this carefully because they will then participate in the increased value of the business and have voting rights.
It is well beyond the scope of this discussion to cover all the aspects of debt and equity. Just be careful! Your lawyer and accountant would be appropriate sources for more information on this subject.
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Where to Get the Money
The chart below will show some differences between some of the types of lenders. Terms will vary considerably from lender to lender; the summaries in the chart are only meant to be representative and give you an idea of what to expect when seeking money from different sources. Important issues to consider:
- Payback program
- Loan size
Some of the pros and cons of the different lenders are briefly listed below. There will likely be one common characteristic among them all. As an entrepreneur, you will be legally obligated to have individual responsibility for the credit obligation of your business. Regardless of legal organization (covered in Session 4), lenders will have documentation to circumvent the organizational structure. This is usually called a personal guarantee. Don't panic! It is very common.
Risk of Loss
Friends & Family
Usually good rate or none
Flexible, best value
Can create friction
Home Mortgages - Traditional or Seconds
8-14% on equity loans
Very long and flexible
80-100% + of home equity value
Cheapest, longest term
Your house is at risk in the event of non-payment
Easy qualifying, no collateral
30 days +/-
Adds to rent cost
Over term of lease
Preserves cash for assets you can't take with you
Hard to get; assets acquired are usually only good at one location; difficult to move
Can get large amounts
Very hard to get; share ownership
25 year payment; all due in 10 years
$currency_symbol$300,000+; 75% of appraisal
Specialized lenders (industry expertise, auto, business brokers, high tech, specialized equipment, computers, phones, etc.)
Accessible through dealer, who is motivated to make sale of equipment or business; payback terms more favorable than bank
Debt service can be high
Same as above; also 100% financing
Longest payback for other than real estate loan
Can be a complex process
An alternative when you don't have many
Expensive; picky about collateral
Generally least expensive
Generally hardest to qualify for
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The Art of Getting the Money
This starts by knowing what your lender wants. A common way is to simply ask. A better way is to ask a friend or business advisor such as your CPA.
For a business loan, the most common things are:
- Business financial statements
- Business tax returns
- Business Plan with budget or projection
- Personal financial statements
- Personal tax returns
Step two is to be ready to answer questions about your business, and be ready to highlight your financial performance both in the past and in the future. You will be more impressive if you have carefully thought-out and become familiar with your plan. Bring your accountant if you need help.
Be prepared to tell them why you need the money. "I just need the money," does not inspire confidence or the fact that you have thought it through. Earlier in this session you studied a number of different purposes. Give them some detail.
Propose a repayment plan. Examples of different structures are:
- A line of credit, payable at your discretion but subject to renewal annually by the bank
- Term loan payable monthly over ___ years starting on ____ date
Most places have some flexibility. Potential lenders appreciate that you are thinking about paying them back instead of just getting the money.
Other tips to keep in mind:
- Needless to say, being well dressed and neat in appearance at bank meetings will reflect positively.
- Most lenders (including the SBA) will want to see your business plan.
- Keep your lenders informed on the status of your business: the good and the bad.
- If you are unable to make a loan payment on time, call your lender in advance, advise him/her of the problem and request the extension you need. Explain the sources of repayment.
- Virtually all lenders will do a personal savings and corporate credit check through a company called TRW or other means. Be prepared to discuss any prior credit issues/problems. The best access to a lender is by a referral. Lending is a people business. Have your CPA or attorney or friend introduce you to a lender.
- The first thing that will spook lenders or investors is the fear you are "puff" rather than "substance." Avoid giving the impression of being an over optimistic, "pie-in-the-sky" operator.
- Most start-up businesses don't find a place for expensive entertaining. Your lenders will be more interested in knowing how their money is being used to grow your business.
- Do not depend on a bank to loan you money to start a business. Most small businesses are funded by personal savings.
- Make a shrewd appraisal to minimize your risks and to limit losses to a predetermined limit.
- Your suppliers and vendors can be sources of financing. For example, if you need an illuminated sign for your store front, the company you contract with to make the sign may provide financing so you can make monthly payments rather than pay cash. (They want your business.) Examples:
- Longer payment terms
- Advertising and marketing assistance
- Furnishing or financing of equipment, signs or inventory.
- Advertising and promotional programs
- Bartering, which is to trade by exchange one commodity for another, can provide a source of financing. For example your advertisements in the local newspaper might be paid for by the bagels you make!
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After You Get the Money
Getting the money is only the first step. You should strive to be a good customer so you can get cooperation if you need help later. A good customer sticks to his/her agreement. Make sure you understand the requirements and perform to them as much as possible. In a business relationship, lenders will ask for regular financial statements, which you should produce on time.
There may be covenants. A covenant is a written agreement in which you promise to meet specified obligations such as submitting the agings of your accounts receivable. The "agings" report will show the lenders if your credit customers are paying on time or not.
Be proactive. Contact them if there is a problem. Be sure to stay in touch even if nothing new is going on. Get to the next highest level within the organization.
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Sources of financing can surface from unexpected sources: List at least five of them:
Some possible answers are:
- Suppliers: Ask for longer terms of payment.
- Your landlord: Ask the landlord to provide you with tenant improvements.
- Your customers: Ask for either cash or prompt payment.
- Your capital investments: Ask the suppliers of your fixtures, equipment and signs to finance your purchases. They will be interested in doing so in order to get your business.
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Business Plan for Session 8: How to Finance Your Business
We heartily recommend that you download the individual business plan template for this session Business Plan Template Document 8 and complete it now.
Instructions on filling in the business plan template:
- Each box has a permanent title in CAPITAL LETTERS
- Below each title is a sentence starting with an "Insert here" sentence. This will suggest information to insert. The boxes will enlarge as you take up more room so use all the space you need.
- After completing each box, delete the "Insert here" sentence, which will leave only the permanent title of the box and the information you have filled in.
We suggest that you fill in each section of the business plan
as you proceed through the course.
The template for all sessions 1-12 can also be downloaded into your computer as a single document:
Include sufficient research findings and background materials. Make it interesting up by the use of background data, your biography, charts, demographics and research data. When your business plan is completed, print off and assemble the 12 sections.
Many other business plan formats are available in libraries, bookstores and software.
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SESSION 8 Quiz: How to Finance Your Business
Proceed to Session 9: E-Commerce