Most of the uncertainty surrounding the outlook for small businesses has its roots in the rising interest rate environment as the stock market historically will decline during times of rising interest rates. When interest rates are rising, business loans (or capital in general) become more expensive thereby cutting into corporate profits. This applies to businesses of all sizes. But it can affect small businesses the most.
A secondary factor can be attributed to political uncertainty as Democrats took over the majority in the House of Representatives to start 2019. As the new House leadership asserts its policy regiment, it's still unclear how this will affect the current business cycle. The uncertainty involves the future of tax cuts and of the state of the commercial regulatory environment.
While interest rates remain at low levels compared to history, the Federal Reserve has signaled multiple hikes possible over the balance of 2019. This poses a dilemma for companies who may need capital in the short term. Understanding how to know when you need more funding can make a big difference in the cost of capital.
Small Business Lending and Drivers of Growth
Many small business ventures begin with an entrepreneur's dream. Many people start businesses because they want to pursue their passion in life, whether it's cooking, creating floral arrangements, renovating homes or some other "labor of love". There is something empowering about coming up with an idea for a business, building it from the ground up and being in control of your own destiny. Risk-averse entrepreneurs may opt to take a more cautious route by purchasing a franchise, which comes with an established brand and proven operational systems. Either way, business ownership is undoubtedly a big part of the American dream.
Over the years, business ownership has become more important as the bond between employer and employee continues to become weaker. The average tenure at a job is now about 4.2 years according to the Bureau of Labor Statistics Employee Tenure Summary (September 2018).
It is not uncommon for someone who has been terminated from a job to then take the opportunity to start a business. In fact, they may have dreamed about being the boss for some time, but were unwilling or unable to assume the risks associated with starting a business while still gainfully employed. Often, this type of entrepreneur launches an enterprise in the same field they have always worked in and vows to do it better.
Entrepreneurs are also becoming increasingly diverse. Most notably, Guidant found that from 2017-2018 there was an 82% increase in minority business ownership mostly attributed to African Americans and Hispanics. There's also a wide diversity of ages for people who are interested in running their own business. According to a study by Guidant Financial, over 54% of business owners it surveyed were 50 years or older. Many of these entrepreneurs are using their small businesses as the crowning achievement of a successful career.
No matter where you are in your journey to owning your business, or what background you come from, knowing how to support your business with financing is one of the most important things you can do to be successful. In 2019 there are a lot of financial questions you'll have to be ready for as a business owner.
Financing and Business Loans
Once you're committed to starting a business venture, it's time to write a business plan which explains what the business is, who the customers will be, the location, and when it will operate. The plan provides a roadmap to profitability and details the inherent assets of the business that will make it successful. This business plan is also an entrepreneur's lifeline to financing - it will be reviewed by lenders who you might approach for capital.
Potential lenders ultimately want to know whether borrowers will be able to repay their loans in a timely manner. They will base the decision on the vision you outline in the business plan, the expertise of those involved in running the company and the financial data provided.
Typical Start-up Costs
Going back to the Guidant study, almost half of the respondents surveyed reported that they used less than $50,000 to start their company.
"Many expect business ownership to be a very costly venture, and while it can be, almost half of all business owners surveyed said they used less than $50,000 total to acquire or launch their business. Another 18 percent spent up to $100,000," according to the study.
Clearly starting your own company doesn't have to completely drain your bank account if you plan it well, but no matter how much you use to get started you'll need the funds to keep the business going long after launch day. And although $50,000 may seem small in comparison to the income that a business can bring in for years to come, it can still be difficult to pull together a big lump sum of money like that to get started.
Plan for the Need for Capital Now
For established companies (more than one year in business), 2019 may turn-out to be a very different commercial environment. As interest rates rise, this not only affects you directly, it affects customers, vendors and suppliers. Doing business will very likely become more expensive and competitive as others look to reduce costs. For younger companies, you may wish to consider conserving cash on hand to the best of your ability and to seek lower-cost capital as soon as is practical. Even if you've had an excellent year in 2018, seeking external funding now could be a good decision as you can lock in favorable rates and have extra cash on hand to tackle your most ambitious projects.
Deciding how much to borrow
Naturally, you need to have an idea how much money you want to ask for before you approach a lender. You will need to justify the requested amount by showing the funding company the return on investment (ROI) in your pro forma financials or business plan. The business plan will describe the elements about the company and management team that will make sure the firm can achieve the target ROI. Draw upon your expertise in the industry to determine a budget that outlines how much money will be required to start the projects you want to accomplish and provide documentation that backs up the assertion.
Ask for more than you've estimated you need. Business owners are wise to borrow more than the estimated budget if they can afford it. Inevitably, surprises and setbacks will occur during the pre-launch phase of the project and you'll need extra capital to see it through. Request an amount that provides enough cushion in case of cost overruns. After all, most companies lose money during their first year of operation and even well-run projects can go over-budget. Estimate the firm's burn rate (the amount of money spent each month on costs) and determine how long you can realistically afford to stay in business before you need to turn a profit.
Source of Funds: Business Loans vs. Friends and Family
In order to get enough cash to open their doors, the majority of new business owners (59 percent) used their own cash, but many relied on more than one funding method. Funding from friends and family accounted for 23 percent of funding methods used, and 401(k) business financing came in third at 22 percent (yes, in many cases you can borrow from your 401k to start a small business without penalty). Surprisingly, only 17 percent of respondents relied on a line of credit and 7 percent an SBA loan to launch their business. A lot of this is due to the limitations that many lenders place on startups which can be confusing.
Identify sources of small business funding
Some entrepreneurs are fortunate enough to have money that they can use to self-fund a new business effort. In such cases, these business owners are able to cover startup costs without getting money from outside sources. Debt financing means that the company borrows money and then must repay the lenders with interest over a specified period of time. Equity financing means that investors put up money to launch a business and receive a percentage of its ownership.
Countless firms are started by individuals who enlist their family and friends to put up money to fund a business venture. Many times the lenders are willing to provide the money with little or no interest. However, there is the inherent risk of strained family relationships and loss of friendship if the business fails and the money is not repaid. Often, the lenders are given a percentage of ownership in the firm. This is known as equity financing.
Entrepreneurs who do not have a network of family and friends who are willing to put up capital often look to venture capitalists who will put up the cash in exchange for a percentage of the company. The hit series Shark Tank has widened the understanding of this type of small business financing.
But once you have started your business it's very difficult to finance the business purely through selling shares. Most entrepreneurs will turn to other kinds of financing, specifically looking at business loans to make up the difference of what they need in order to keep their company running smoothly. An added benefit of using a loan or alternative financing is that you keep full control of your business instead of giving up a piece of it to an outside investor.