How to get started with business financing 2018

The ABC's of Small Business Finance

Every business begins 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 interest. There is something empowering about coming up with an idea for a business, building it from the ground up and being in control of one's destiny. Risk-averse individuals may opt to take a more cautious route of purchasing a franchise, which comes with an established brand and proven operational systems.

Other times, companies are launched out of necessity. 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.

Once you have committed to starting a venture, it is time to write a business plan which explains what the business is, who the customers will be, 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. Importantly, the business plan will be reviewed by lenders whom you might approach for capital.

Potential funders ultimately want to know whether borrowers will be able to repay 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.

  • Deciding how much to borrow

    You cannot approach a lender without knowing the amount of money you will need. The business plan will describe the elements about the company and management team that will guide the firm. Draw upon the expertise in the industry to determine a budget that outlines who much money will be required to start and provide documentation that backs up the assertion.

    Ask for more than you have estimated. Startups owners are wise to borrow more than the estimated budget. Inevitably, surprises and setbacks will occur during the pre-launch phase of the firm. Request an amount that provides cushion in case of cost overruns. After all, most companies lose money during their first year of operation. 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 turning a profit.

  • Identify sources of small business funding

    Some entrepreneurs are fortunate enough to have enough money that they can 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.

Types of small business loans

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.

  • Term Loans

    Term Loans are traditional bank loans to small businesses in which the borrower requests an amount of money and then agrees to pay, with interest, over a specified period of time. In this way, securing a small business loan is indeed similar to getting a mortgage to buy a house. Lenders are typically repaid on a monthly basis. In order to obtain a bank loan, the borrower must meet certain lending criteria, including having a personal credit score above the parameters set by underwriters. Individuals with little or no credit repayment history often find it difficult to secure funding.

  • SBA Loans

    SBA Loans are term loans that come through the auspices of the Small Business Administration (SBA). The agency itself does not provide funding. Rather, the loan comes from an authorized lending partner - usually a bank -- at rates and terms determined by the lender. SBA loans differ from traditional small business term loans because the federal agency guarantees a portion of the loan - often up to 75 percent - in case the borrower defaults. By doing so, the SBA mitigates risk for the lender and provides incentive for banks and lenders to make capital available to entrepreneurs. Often, the interest rates charged are quite attractive.

    The downside of SBA loan applications is that they require a lot of documentation, which slows the loan application process and lengthens the amount of time it takes to finalize the deal. Decisions hinge upon the borrower's credit score, which is a reflection of his or her payment history. However, borrowers with a sufficient level of creditworthiness will find an SBA loan a really attractive option because the interest loans they offer are tough to beat.

  • Business credit cards

    Business credit cards are readily available. Who among us has not received a business credit card mailer in the past few months? They typically come with credit limits that range from $3,000 to $20,000. Often, they are easy to apply for and secure, and many of the companies that issue business credit cards make an initial offer with a low annual percentage rate (APR) for a certain period of time. However, after the introductory period has passed, the interest on credit card purchases can be quite high. Using credit cards to launch a business can mean high repayment costs if it takes a while to repay the debt. Further, if you need to borrow a large sum of money for purchases of property, building renovations, equipment purchases, and inventory, a credit card's borrowing limit may be too low.

  • Business line of credit

    A business line of credit is a form of small business financing in which an entrepreneur has cash available to draw upon when needed. The line of credit provides access to funds. When needed, a business owner taps into the credit line. Interest is paid only on the amount of money that has been borrowed. Business owners like this type of small business financing because of its flexibility and because the interest rates charged are much lower than the rates of business credit cards, which can approach 19 percent APR (annual percentage rate).

  • Equipment financing

    Equipment financing is exactly what it sounds like. With this type of funding, the equipment is put up as collateral. In case of default, the lender can take possession of the equipment and sell it to recoup the loss.

  • Accounts Receivable Financing

    Accounts Receivable Financing is an option that established business owners use when they are caught in a cash crunch. If unanticipated costs or slow-paying customers are impacting cash flow, this type of financing can provide a quick infusion of capital. However, the money usually comes at a steep cost. Essentially, you are selling your future earnings at a discounted price to the funder.

  • Merchant Cash Advance (MCA)

    Merchant Cash Advance (MCA) is a similar form of small business financing. MCAs provide a lump sum of cash that if paid back by providing authorization for the lender to skim your daily credit card receipts until the amount of the loan is repaid. Borrowers are able to pay based on the company's sales. The amount of repayment during a period of time is related to the fortunes of the borrower. During good weeks, they pay more, during slower weeks, they pay less. For instance, if you need to borrow $10,000, the repayment amount frequently is $12,000, which is repaid as a percentage of credit card receipts for the length of time it takes to repay the agreed upon amount.