How to Finance Your Business

First Things First How Much Money Do You Need? What do you need it for? Unsecured Loans Secured Loans Collateral Loans vs. Investment Where to Get the Money Types of Funding Sources Lender Comparison Table The Art of Getting the Money Business Loans Repayment Plan Other Quick Tips After You Get the Money Activities SESSION 8 Business Plan SESSION 8 Quiz [Back to top] First Things First Money makes your business go. But don't try going to a bank to get it when you've just started in business. Banks normally make loans only to businesses with operating histories. This section will give you some alternatives, some strategies and some things to think about as you go about finding the money to make your business work. Our first reminder is that personal savings should be considered the primary source of funds for starting a business. If you haven't started already, start now to begin accumulating cash through personal savings. Also, don't overlook the Small Business Administration (SBA) loan guarantee programs available for start-up businesses. With a SBA guarantee program in hand, your bank will be happy to talk with you! Refer to the Resources section to get more information. [Back to top] 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 Naira when you only need NGN50,000. 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    OR 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. [Back to top] Loans (Debt) vs. Investment (Equity) Testimonial John Marder Banker "One of the worst mistakes you can make is to ask for more money than you can afford to repay." Transcription - html 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. [Back to top] 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: Cost 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. Type Cost Payback Terms Sizes For Against Personal Savings No cost None Easy, cheap Risk of Loss Friends & Family Usually good rate or none Very flexible Flexible, best value Can create friction Home Mortgages - Traditional or Seconds 7-9% 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 Credit cards 16-23% 40-60 months 3,000-10,000 Easy qualifying, no collateral Small amounts Suppliers Free 30 days +/- Inexpensive, unsecured Short term Landlord 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 Venture capital 25-40% 5-7 years NGN500,000+ Can get large amounts Very hard to get; share ownership Commercial mortgage 7-9% 25 year payment; all due in 10 years NGN300,000+; 75% of appraisal Specialized lenders (industry expertise, auto, business brokers, high tech, specialized equipment, computers, phones, etc.) 12-18% 5-7 years Varies Accessible through dealer, who is motivated to make sale of equipment or business; payback terms more favorable than bank Debt service can be high Leasing companies 12-18% 5-7 years Varies Same as above; also 100% financing SBA 7-9% 7-20 years NGN50,000-1,000,000 Longest payback for other than real estate loan Can be a complex process Finance companies 14-30% 1-3 years NGN100,000+ An alternative when you don't have many Expensive; picky about collateral Banks 6-9% 1-5 years NGN50,000+ Generally least expensive Generally hardest to qualify for [Back to top] 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! [Back to top] 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. [Back to top] Activities 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. [Back to top] 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. Section 8: Financing MS Word 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: Section 1-12: All MS Word 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. [Back to top] SESSION 8 Quiz: How to Finance Your Business The best source of money to start my business is:  A bank  My savings  Sell stock to my friends or the public You want to start a business that will require lots of money. The venture could fail if conditions change. Your banker will loan you the money but wants your personal guarantee and the equity in your house as collateral. You should:  Start on a very small basis without bank debt.  The very nature of an entrepreneur is to be willing to risk personal and family money: go for it. Your business plan is going to be an important tool in your financing program. You will use it with bankers, suppliers, landlords and even customers. Why is a meticulously prepared business plan so important in accomplishing your financing objectives?  To impress them with your ambitious goals  To reassure them of your business conservatism You have an outstanding installment loan with your bank and find that you are unable to make a payment on time. You should:  Make the payment as soon as you can even if it is a late one.  Call your lender in advance and tell him/her you will be late in making the payment.  Call your lender in advance, advise him/her of the problem, and request the terms you need to a stretch out payments, including explaining the sources of repayment.  Call the lender and ask that that loan be renegotiated. The WORST advice in dealing with a lender would be:  Never exaggerate and get your lender involved in your growth plans.  Generate high expectations and keep the bad news from him/her.  If you see clouds on the horizon, let your lender know about your fears. 6. You can get added support from lending sources by:  Keep them informed of the good and the bad.  Entertain them lavishly.  Use the "no news is good news" philosophy. What is the LEAST likely way that a supplier could help finance your new businesses?  Extend longer repayment terms.  Guarantee your lease obligation.  Furnish or attractively finance your equipment or signs.  Furnish free advertising and promotions. Personal liability for a business loan can be avoided by organizing the business as a corporation.  True  False Equity financing means:  Money borrowed on a fair ("equity") basis.  Borrowed money that is paid back in installments.  Money that stays in the business as an ownership interest. Most lending sources (SBA, for example) will require submission of a business plan.  True  False