Getting small business financing

Several times a month I get inquiries from people who want to know how they can get a loan to start their own business. The characteristics of these calls are pretty consistent. They say they have a great business idea and are extremely talented, but have no business experience, collateral, or favorable credit history.

Many would-be entrepreneurs subscribe to the "takes money to make money" adage without thinking through some of the basic financial issues. A good financial plan is required in order to ensure that these issues are fully explored to satisfy the needs of potential lenders or investors, as well as the owners. Here are some of the basic questions you should try to answer before seeking financing.

What do you need financing for?

If you are opening a business, you will have both startup costs and operating costs. Startup costs are those that represent your initial investment in products, such as computers, telephones, equipment, or real estate, services such as consulting fees for attorneys or accountants, and government filing fees to start the business. Operating costs include those that are an on-going expense, such as labor, telephone, mailing, loan payments, or office space lease payments.

The financial plan needs to estimate all of these costs as well as expected revenues. If you are selling widgets, the plan should reflect how much you're buying the widgets for, how much you will be selling them for, and how many you think you can sell.

How much do you need?

The type of business you are running will determine this. A sole proprietor running a service business out of their home will be able to keep expenses to a minimum, while a retailer will have significant expenses for office space, inventory, and labor.

The amount you will need to borrow should be enough to cover startup expenses and operating expenses for a long enough period of time until the business is making a profit.

Who will you get it from?

The majority of financing for startup businesses comes from either the business owner, or the business owner's friends or relatives. A small percentage comes from the more traditional means, such as a bank.

There are tradeoffs when seeking financing from friends and relatives versus a bank. On one hand, friends are more likely to lend you money or invest in your company based on their personal relationship with you than a bank. On the other hand, chances are pretty good that the bank has more money to lend than your friends.

Often the entrepreneur does not have a choice. If you have no collateral, no previous business experience, and bad credit, you can pretty much rule out the possibility of getting a loan from the bank. Your best shot then is to get it directly from your friends and relatives or get them to co-sign your loan.

What do you need to show them?

There are two basic forms of financing: debt and equity. Debt financing is your traditional business loan, where you borrow the funds from a lender and make payments plus interest to pay off the debt. Equity financing is obtained by selling a part of the company to investors, who are hoping to get a significant return on their investment if the company is successful.

Obtaining debt or equity financing through an institutional channel such as a bank or venture capital firm will almost always require a full business plan which would also include your financial plan. These institutions want to see precisely both how you plan to make the business successful and what you plan to do with the funds. Even friends and relatives will want to see a business plan if the amount of money you're trying to raise is substantial.

When trying to finance a business, collateral is king. The same way putting a down payment on a home shows that you are risking something in case the value of the home declines or you can't make the mortgage payments, lenders want to see that you are risking something other than just your time.

Another key factor is the experience of the entrepreneur. If you have previously run a successful business, your chances of getting a loan approved or finding investors are much better than if you lack the experience.
 

A well thought out business and financial plan is essential for any entrepreneur who is seeking a significant amount of funding. And in those instances where he or she is not putting up a large portion of their own money in the business or does not have previous experience, it can mean the difference between being an entrepreneur or being a working stiff.