Business Financing Sources
There are many ways to get the finance required. Many either charge high
interest rates or want part of the business or both. Often these money sources are hard to find, take long time in deciding, extremely selective or can help only a very few firms. It is up to you to decide whether the price is worth the service offered.
The following are the main sources of money for your business:
- Your personal savings. This money usually becomes the equity of the business. This method of funding is clear, simple and clean. Unfortunately it is not always enough to launch the enterprise. most new enterprises need. $200,000 to $300,000; few people have that much cash available. Most firms that branch off from existing firms usually use internal funds to finance new businesses.
- Your family. One or more members of your family might be willing to fund the business either through an equity stake or by providing a loan. but it is unlikely that you will be able to cover the $200,000 to $300,000 that is required.
- Your friends. Friends might also provide debt equity capital but it is unlikely that this would be very considerable.
- Your bank. This is often the best place to obtain part if the finance required. Most banks are very happy to make you a loan especially if you have a good credit rating and long standing relationship with the bank. On the downside, the loan is more often short term, high interest rate, small amount and backed by lots of collateral and is for an on-going business then the bank is safe. If the bank does not receive repayment within 60 days or specified time period they can very easily sell the collateral and recover the debt. In short, the bank is not a good place to get long term, unsecured, large, start up loan.
- Venture capital group. These are people who have a few hundred thousand dollars available money they are willing to invest in a small business.
- Going public. Here you offer for sale shares of stock in the company for purchase by the public. You are raising equity money not debt and you are giving up some ownership. Most of the firms do this by giving less than 50% of the firm thus retaining control themselves. Often however this does not generate enough capital. Firms must apparently sell more than half of the stock thus apparently losing control of the business. This might not be bad as it sounds since few of the other public shareholders would own 10% and the original shareholders may own 40% remaining the largest minority shareholder. Many firms are controlled with much small portion than this. The public offering procedure can be fairly complex. Your best bet is to contact your lawyer and banker. Many booklets are available for free or at low cost.
- The SBIC (or Small Business Investment Corporation). They are government backed, flexible financing devices designed to provide both equity and long term funds to both urban and rural small firms. They are licensed by the SBA, and are privately owned and operated. They get their capital from private investors and the government. They make loans or buy stock; loans may be unsecured or not fully collateralized. The SBIC may be a subsidiary of a private, separate, profit-making firm. These institutions were organized to provide financing to small firms having difficulty obtaining capital. They also provide management counsel and have some good tax advantages. The advantages are that the SBIC is very selective in making an investment, and their is a very low average per state (approx. $2,000,000).
- The Small Business Administration is an agency of the Federal government. It has two major services: finance and management counseling. It was designed to help small businesses obtain long-term bank loans by guaranteeing the loan to the bank, thus protecting the bank and making them more willing to provide debt funds.
- The Farmer’s Home Administration (FmHa) provides services similar to those of the SBA, but can guarantee much larger loans, up to $33 million, averaging $900,000. FmHa has a minimum equity requirement of only 10 percent. They 1800 county offices and so are highly accessible.
- Other non bank lenders include Money Store Investment Corporation, Springfield, NJ. They offer guaranteed loans in twelve different states. Merril Lynch Small Business Lending Company serves all states with offices in most major cities (Check your local directory for the number). ITT Small Business Finance Corporation, Minneapolis, provides loans nationally.
- Small Business Innovation Research (SBIR) is a federal program. It requires federal agencies with large research and development budgets to devote about 1% to help in small business research. Generally the agency has a list of the products that it needs. They make this list available on request. If a small firm normally very high tech feels that it can provide on these products, they make a concrete scientific proposal. The advantage is that if approved the proposer can win a grant for $30,000 t $50,000 for further research. This is not loan stock or equity capital it is a conditional gift. If that research proves satisfactory, the company can get a second grant ten times the initial amount. As a third benefit, the company may end up with a final product that not only is purchased in large quantities by the government agency but is also marketable to the private sector. The disadvantages are that the funds are purely for research not for company management purposes. This is not a program to help small retailers, manufacturers or services to start up standard routine business operations. Secondly, this is only for very high tech operations only. Third, the proposal usually should be very comprehensive, technical, detailed, advance and quite sophisticated. Fourth, even then only a small portion of proposals are accepted. Fifth, the system is rigid to the extent it is directed at solving a specific, designated technical government need.
- An angel or financial backer is a person who has access to substantial funds. He or she may have a desire to help small business start ups or expansion with substantial debt or equity capital, or both, The backer may sit on the Board of Directors and may play an active role in the management of the firm. Often the backer is doing the same thing with numerous companies and brings a wealth of knowledge, experience and skills. There are some disadvantages principally that such individuals are hard to find. They have numerous requests for funds that they could not reasonably accommodate. They may not have adequate funds to provide. Alternatively they may want a large stake in the stock that might result in loss of control for the original founders of the company.
- Hidden sources. Sometimes a part of the companies assets, rights, inventories or prepayments can be converted to capital. For example you may be able to raise cash by selling off unneeded land or buildings or selling these even if they are needed and then leasing them back thus freeing up cash. Many companies frequently tie up lots of money in machines, truck fleets, etc, so that the business does not have funds for tools, inventory i.e. working capital. They should decide in advance whether they wish to be in the trucking business, real estate business etc. Sometime the company may own patents, copyright, foreign rights, franchises or licensing arrangements that they do not longer need and these they can sell to another firm.
- Business Development Corporations (BDC). These groups are exempt from some of the 1940 Investment Company Act, and so have added freedom to invest. On the other hand they must keep a large portion of their portfolio in the form of securities that cannot be purchased on margin, they must give proven management counsel to their portfolio companies and most of their board must be outsiders, holding only a small percentage of the BDC stock. Other than that they act largely the same way as a venture capital group.
- State Departments of Economic Development. Nearly every state has programs to assist business start ups, expansion or firms that want to move into the state and need capital for operating, equipment, or fixed assets. These funds are either loaned directly to the company or represent back up funds to support guaranteed bank loans. For example the bank makes a loan to the company but it is guaranteed by the state. If the business defaults the state covers the loss.
- The Economic Development Administration (EDA) is a federal government program to help economically depressed areas. The government has designated many counties in the country as depressed. Companies in those counties may be eligible for a federal loan. Most of these loans are for under one million dollars. Generally, the EDA requires the business to provide a portion of the financing as equity funding before a loan will be made.
Where to find these people. Your best bet is to check with one or more of the following sources: your local banker, lawyer, SBA, the local chamber of commerce, the yellow pages, or your CPA. If these sources don’t know the exact name and addresses they usually can refer you to someone who does know.