How -- and where, exactly -- are you supposed to find the money you need to get your business up, running and turning a profit?
That's probably the most common question ever posed by would-be entrepreneurs everywhere.
And here's the most common answer: You reach into your own pocket for some of the money. And into somebody else's pocket for the rest.
No matter the source, borrowing to finance your business is never really easy -- and it shouldn't be, given the substantial risk that lenders and borrowers face. But you should expect to do some short- or long-term borrowing in the beginning and at key points throughout the life of your business.
For many new businesses, the primary source of financing comes straight from the owner's pocket in the form of savings or other personal assets such as a home, vehicles, investments, etc. But if your own pockets are empty you can look to others.
Millionaire Malcolm Forbes once quipped: "I made my money the old-fashioned way. I was very nice to a wealthy relative right before he died." While deathbed hovering may not be a desirable business finance strategy, borrowing from family members and friends is a rather common way to raise the money that you need, especially when the capital requirements are relatively small.
Needless to say, borrowing from loved ones can become a minefield. Tread carefully, especially since there's a very real chance you could lose their money. The easiest way to avoid unnecessary blowups and long-term damage to your personal relationships is to take the same business-like approach you'd use with a bank.
Provide deep and meaningful details. Spell out your business plan. Make sure everyone understands how you'll use the money, the terms of repayment, how often you will provide financial updates, and the risks. Once everyone knows what they're getting into, write everything down. Nothing informal. Nothing done on a handshake.
Access to credit is vital for most small businesses, and plastic is an increasingly popular tool to get it. Why? Business credit cards can be more flexible than a bank line of credit and offer lower annual percentage rates. One thing to remember: If you're a sole proprietor, you're still personally responsible for the debts racked up on your business credit card.
The idea of crowdfunding, also known as crowd financing or crowd-sourced capital, is appealing to some entrepreneurs. The concept is simple enough: Get lots of people to make small investments in your big idea. The reality is more complicated than we can cover here. Suffice to say, crowdfunding comes with its own unique regulations, difficulties and obligations and may not be suited to your business.
But if you don't have doting grandparents who happen to be loaded to the gills or friends who believe in your dream so much that they'll bet their own futures on your success, or the crowd couldn't care less about you, eventually you'll find yourself making a pitch to a rather sober-faced banker.
Banks, savings and loans, commercial finance companies and government agencies are the most common sources of debt financing.
Typically, banks are the major source of small business funding. Their principal role has been as a short-term lender, offering demand loans, lines of credit and single-purpose loans for machinery and equipment.
In addition to the traditional term loan and revolving lines of credit most often provided by commercial banks, other types of debt financing arrangements, such as asset-based financing from business financing companies, lease and equipment financing, and sale and leaseback arrangements have gained popularity.
Banks generally have been reluctant to offer long-term loans to small firms, because of the higher risks such loans entail. Fortunately, the U.S. Small Business Administration can alleviate the chronic heartburn many institutional lenders get when it comes to small businesses. The SBA's loan guarantee programs reduce risk and make lenders more receptive to making long-term loans.
It's a common misconception that the SBA lends money. It doesn't. The SBA partners with lenders, community development organizations, micro-lending institutions and the like. So, when you apply for an SBA loan, you're actually applying for a commercial loan through a bank or some other approved lender. But the loan is structured according to SBA requirements and with an SBA guarantee.
The SBA has a number of different loan programs, but we'll focus on the most frequently used, known as the Regular Guaranteed Loan -- or 7(a) loan, as it's often called.
Here's how it works:
Let's say you go to your bank for a small business loan. The bank, which has it's own internal credit standards and policies for approving loans, has a few choices.
In this last case, the lender submits the application on your behalf and its behalf. Why don't you do it? Because you are the bank's customer, and the bank is the SBA's customer.
If the application is approved by the SBA, you get the money you need from the bank, and the bank gets the peace of mind it needs, knowing that if you default on the loan the SBA will pay the bank a portion of your unpaid debt.
And that reassurance gives banks a lot of confidence to lend to small businesses for everything from startup costs, to inventory, equipment, working capital and more. Learn more about SBA Loans.
Each year, a couple hundred different Minnesota lenders use the SBA’s 7(a) Lender Guaranty Program. In fact, the SBA typically has guaranty loans with most every bank in the state. And Minnesota’s SBA District Office consistently ranks among the nation’s leaders in total loan approvals.
Finally, unless you find a magic lamp with an extremely generous genie inside (not likely) or you win the lottery (only slightly more likely), there's no such thing as 100% financing for your business.
As a sign of your commitment and willingness to share the risk, private lenders and government loan programs alike will insist that you have some real financial skin of your own in the game.
That can mean you'll be required to bring anywhere from 20 to 50% equity to the table. Just how much depends on the project, your own personal financial resources, the type of industry your business is in, how you'll use the money you borrow, and your lender's general loan policies.
And that's not all. In addition to the equity you'll have to provide, lenders commonly require that you have substantial collateral; and that you're willing to provide a personal guarantee that the loan will be repaid.
Consultants at our Small Business Assistance Office can help you understand more about financing your business. And our network of Small Business Development Centers has experts located in nine main regional offices and several satellite centers statewide.
Our Guide to Starting a Business in Minnesota provides a detailed look at this and other important issues.
Refer to this information, Financing Your Business, from the U.S. Small Business Administration.
