Financing Your Business – The Basics

While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second.  Whether you’re starting a business or expanding one, sufficient ready capital is essential.

Before inquiring about financing, ask yourself the following:

• Do you need more capital or can you manage existing cash flow more effectively?
• How do you define your need?  Do you need money to expand or as a cushion against risk?
• How urgent is your need?  You can obtain the best terms when you anticipate your needs rather than looking for money under pressure.
• How great are your risks?  All businesses carry risks, and the degree of risk will affect cost and available financing alternatives.
• In what state of development is the business?  Needs are most critical during transitional stages.
• For what purposes will the capital be used?  Any lender will require that capital be requested for very specific needs.
• What is the state of your industry?  Depressed, stable, or growth conditions require different approaches to money needs and sources.  Businesses that prosper while others are in decline will often receive better funding terms.
• Is your business seasonal or cyclical?  Seasonal needs for financing generally are short term. Loans advanced for cyclical industries such as construction are designed to support a business through depressed periods.
• How strong is your management team?  Management is the most important element assessed by money sources.
• Perhaps most importantly, how does your need for financing mesh with your business plan?  If you don't have a business plan, write one.  Lenders will want to see your plan for the start-up and growth of your business before they finance it.

There are two general types of financing: equity and debt financing.  The more money, or equity, you have invested in your business, the easier it is to attract financing.  If your firm has a high ratio of equity to debt, you should probably seek debt financing.  However, if your company has a high proportion of debt to equity, you should increase your equity before you borrow additional money.  That way you won’t be over-leveraged to the point of jeopardizing your company’s survival.

Equity financing can be sought from non-professional investors such as friends, relatives, employees, customers, or industry colleagues, although venture capitalists are the most common source.  Most specialize in one or a few closely related industries.  Most venture capitalists prefer three-to-five-year old companies that have the potential to become major regional or national businesses and return higher-than-average profits.

There are many sources for debt financing: banks, savings and loans, commercial finance companies, and the SBA are the most common.  Many state and local governments have small business lending programs.  Family members, friends, and former associates are all potential sources, especially when capital requirements are smaller.

Traditionally, banks have been the major source of small business funding.  Their principal role has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment.  Banks generally have been reluctant to offer long-term loans to small firms.  The SBA guaranteed lending program encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available.  

Check out the SBA Loan Programs section of www.SBA.gov for more information on SBA lending.  If you’re ready to begin the loan application process, start with SBA’s online Lender Match – a free online referral tool that connects small businesses with participating SBA-approved lenders.