Raising Financing for Your Business

Raising financing may be the most intimidating, and often most difficult, aspect of starting a business. Funding does not come quickly and it is generally harder to obtain than most business owners believe it will be. However, in today’s business climate, there are a wide variety of options available besides borrowing money from a bank. Your success at securing the financing that you need will depend largely on:

• The strength and marketability of your business idea
• How you present your business idea
• Your business plan
• Your credit history
• Your level of preparatin
• Your level of experience and training to operate and manage the business

There are a multitude of business ideas. The key to securing financing for yours is to do your homework and make sure that you present a business idea that sounds profitable to potential investors, without major risks, and on reasonable terms.

Loans

Gone are the days where business owners were dependent almost entirely on banks or loans from friends/relatives. Today, there are many different sources available for business loans.

Loans typically come in three primary forms.

• Short-term business loans provide capital for a business in need of cash to start operations.  These loans are generally for one year or less.
• Intermediate term loans can help start-up businesses pay for equipment and cover large initial expenses.  Such loans are usually for anywhere from one to three years.
• Long-term loans are often used to assist start-up businesses with initial costs such as equipment, furniture fixtures and commercial mortgages.  Such loans are generally from three to seven years and repayment is typically made in installments.

Before approaching a lender it is important that you have a clear understanding of what the loan will be used for and how you can best present such information.  It is equally important that you have a realistic plan for repaying the loan.

When working on a loan request, you want to include the following, some of which will likely be included in your business plan.

• The purpose of the loan
• Specifically how much money will be needed
• A management profile
• An overview of the market including your projected customer base and competition
• Personal and business financial statements and if possible, collateral that can secure the loan

Typically, if a small business owner is requesting a loan, the lender will want to see that he or she is investing a proportionate amount of his or her own money into the venture.  In addition, for a larger business venture, the lender may want to see other sources of financing.

You will also need for a significant amount of supporting documentation when applying for a loan.  Such documentation may include, but not be limited to:

• Incorporation or LLC organizational documents
• Proof of ownership or sale, if you purchased the business
• Material contracts
• Letters of reference
• Financial statements including personal tax returns for the last three to five years, a list of assets and liabilities and even credit references
• Tax returns

Receiving a loan will depend in part on the criteria and expectations of the lender.  While one lender may say no, the next may say yes after reviewing the same loan request, business plan and documentation.  If turned down for a loan, you can benefit from learning why you were rejected.  If several lenders turn down a loan request for the same reason, you will know which area or areas you need to work on, whether it is improving your credit rating or rethinking your plans to purchase real estate for the business.

Once you have been approved for a loan, you need to work with the lender to obtain terms with which you feel comfortable.  The due date and manner of payment will need to be determined.  Will you pay the loan back in one lump sum or in various payments on a set schedule?  Most often loans are made in several payments.  Make sure such a payment schedule will work for your business in conjunction with your projected cash flow.  Also of significant importance is the interest rate.  You should get an idea of the going rate for similar loans and be ready to negotiate.  Some state laws mandate the maximum amount of interest that can be charged on a loan.  Below that, there is flexibility.

You will also want to look at other fees associated with the loan and what is considered a default of the terms of the loan.  Read the loan agreement carefully and have a lawyer review it as well.  Some of the terms are more common than others and some can be negotiated or even waived.

There are several organizations that work closely to help secure loans for minority business owners.  They recognize that minority based businesses sometimes need greater assistance when getting started.

SBA loans

The Small Business Administration (SBA) is a service of the U.S. government designed to help small businesses in numerous ways through a variety of programs.  Created in 1953, the SBA now has offices in all 50 states, plus the District of Columbia, Puerto Rico, the Virgin Islands and Guam.  The SBA does not make direct loans but works in conjunction with lenders.  The loans are made by the lenders and guaranteed by the SBA for as much as 85% on loans of less than $150,000 and 75% on loans of more than $150,000.  This means that if the borrower cannot repay the loan, the government will reimburse the lender for a percentage of the loan.   Lending partners that work with the SBA review the loan application and may accept the application without the need of the SBA guarantee.  Loans can be provided for almost any aspect of business including the purchase of equipment and machinery, inventory, real estate or construction needs.  SBA loans typically have a maximum term of 25-years.  There are numerous SBA programs offered and widely utilized

The SBA has their main headquarters at 409 Third Street Southwest in Washington, D.C.   You can, however, call 1-800-U-ASK-SBA or go to their website at www.sba.gov to find the closest regional office.

Stock Sales

A proven way to raise capital is to sell shares of stock.  While selling stock to the public is generally not an option for a small business, selling stock in a private placement is a way of procuring cash from investors and maintaining control over who become shareholders in your company.   Prior to selling shares of stock you will need to receive Board approval and possible shareholder approval.  In addition you will need to set a stock price and have the stock sales agreements in final shape.

Of course, to even consider selling shares of stock, you need to have a company that shows signs of potential growth and profitability.  Your business plan, financial projections and marketing plan will serve as key factors in convincing someone to purchase stock in your company.  You need to show potential shareholders how their money will be spent and what you foresee as the growth pattern of the business.

To issue private stock, you can make a private placement offering that does not necessarily need to be registered with the Securities & Exchange Commission (SEC).  A number of exceptions are in place to allow the small business owner to issue stock without having to go through the lengthy and somewhat difficult process of registration with the SEC.  However, the offering still needs to comply with state and federal laws.  This will typically require filings with state securities administrators.

While selling shares of stock can provide you with much needed capital, it also means that you will be relinquishing some degree of control.   Shareholders will have a say in electing directors of the corporation.  They can also review corporate books and records and vote on key corporate decisions.  Review the stock sale agreement terms carefully with your attorney and make sure you understand all of the company’s rights and obligations.  It is imperative that you understand exactly what the stock offering will include and that it adheres to securities laws.  A benefit of relinquishing some control through selling stock is that you may be able to utilize the knowledge and business experience key stockholders may bring to the company.

When selling private stock to start a small company, it is likely that you will know most of your shareholders.  Maintaining a good relationship with shareholders is important.  They will be more willing to assist you and buy more shares if and when offered if you keep them informed as to the operations and prospects of the business.

Angel Financing

Angel investors are individuals who personally invest directly in a business.  Often, they invest in early stage business.  The term “angels” comes from investors who used to provide money to salvage a theatrical production that otherwise might not have had the backing to open.  Traditionally, angels have been successful high net worth individuals, looking to get involved on the ground floor of a growing business for any of several reasons, from an opportunity to use their years of expertise to tax benefits to shrewd investment opportunities.  As more wealth has been accumulated by a younger segment of the population over the past decade, angels are now also young investors looking for the next innovative idea to get behind.

It is estimated that over twenty billion dollars are invested in start up or young growing companies by angel investors.

The typical angel investor:

• Is well educated
• Invests in an area of personal interest or industry with which they have been associated
• Does not get involved in the daily routine and operations of the business
• Makes an average investment of anywhere from $10,000 to $250,000
• Look for companies that have large growth potential

Angel investors, once thought to invest more often on a whim or based on their personal impression of a business or the individual behind it, are now exercising greater due diligence.  They look for a sound business plan that clearly demonstrates how the business will work.  Additionally, they want to be convinced that the management will be able to implement the plan.  While angels are typically more patient than lenders, they want to know how soon the business will be able to see a profit or have an exit.  Generally, they do not want to be the only source of funding and want to know where future investment capital is likely to come from.

A meeting with an angel investor should be set up in person.  You should be ready with written material (business plan, projections, etc) and prepared to answer the tough questions.  Angel investors want to see that you:

• Have done your homework and researched the industry thoroughly
• Stand firmly behind your business plan and goals
• Have thought through all aspects of the business from a practical aspect
• Have an experienced management team

Being prepared for meeting with an angel investor requires more than just knowing what is inside of your business plan.  Due diligence on your part is necessary concerning the angel.  Find out what you can about this investor’s background, interests and past investments.  You should know something about the person from whom you are requesting money.  A personal rapport can be a key part of the success of the relationship.

Although you want an angel to invest money, you also need to establish what the business arrangement will include.  Traditionally angel investors were often silent backers putting money into a project that they believed in but having little to do with the business beyond making their investment.  Today, however, you will find angels who want to be involved in all key decisions and those who will provide guidance and expertise from afar.  You need to establish from the onset the amount of involvement the angel investor wants in the management decisions and operations of the business.

Finding Angels

For years it was typically through friends and business associates that one would need to network in order to find the name of angel investors.  Such investors kept a particularly low profile.  Today, however, angels have, in some cases joined together to form groups and are also listed with business and investment organizations. Individually, angel investors still fly below the radar, but in newly formed groups they are more accessible then in the past… many now having a web presence including posted guidelines telling entrepreneurs what types of businesses they are interested in backing and how to best go about reaching them.  Unlike venture capitalists, who invest money from a variety of other sources, the angels in an investor group invest their own money.  Angel investors may be inclined to fund very early stage companies and take greater risks.

The Internet has been particularly helpful in linking new business owners up with such groups.  Websites, such as AngelList.com feature links to a variety of angels located throughout the country.  Angel investors are often more likely to invest in business ventures in their state or region of the country. In many cases they focus on specific areas, such as the angels at angelmoney.com, who focus on investing in emerging technology businesses.

Lease Financing

It has become increasingly more common in recent years for companies to lease equipment.  Each leasing agreement needs to be read through carefully to understand the terms and conditions within.

Typically a lease can run anywhere from one to five years.  Most equipment necessary in commercial businesses today, including technical equipment, can be leased.  Some leases provide an option to then purchase the equipment at substantially less money when at the end of the term of the lease.

By leasing equipment, if structured properly, you can maintain your credit availability, as the lease debt does not have to be considered a direct liability on your financial statements.  This is advantageous, as it does not limit your ability to borrow from lending sources.

Advantages of lease financing:

• It offers fixed rate financing.  You pay at the same rate monthly.
• Leasing is inflation friendly.  As the costs go up over five years, you still pay the same rate as when you began the lease, therefore making your dollar stretch farther.  (In addition, the lease is not connected to the success of the business.  Therefore, no matter how well the business does, the lease rate does not change.)
• There is less upfront cash outlay.  You do not need to make large cash payments for the purchase of needed equipment.
• Leasing better utilizes equipment.  You lease and pay for equipment only for the time you need it.
• You typically have an option to buy equipment at end of lease term.
• You can keep upgrading.  As new equipment becomes available you can upgrade to the latest models each time your lease ends.
• Typically, it is easier to obtain lease financing than loans from commercial lenders.
• It offers potential tax benefits depending on how the lease is structured.

One of the reasons for the popularity of leasing is the steady stream of new and improved technology.  By the end of a calendar year, much of your technology will be deemed “dinosaurs”.  The cost of continually buying new equipment to meet changing and growing business needs can be difficult for most small businesses.  For this reason leasing is very advantageous.  Leasing can also help you enhance your status to the lending community by improving your debt-to-equity and earnings-to-fixed assets ratios.

There are a variety of ways in which a lease can be structured.  This provides greater flexibility so that the lease is structured to best accommodate the individual cash flow requirements of a specific business.  For example, you may have balloon payments, step up or step down payments, deferred payments or even seasonal payments.

Disadvantages of Leasing

Leasing is a preferred means of financing for certain businesses.  However it is not for everyone.  The type of industry and type of equipment required also need to be considered.  Tax implications also need to be compared between leasing and purchasing equipment.

• You have an obligation to continue making payments.  Typically, leases may not be terminated before the original term is completed.  Therefore, the lessee is responsible for paying off the lease.  This can pose a major financial problem for the owners of a business experiences a downturn.
• You have no equity, until you decide to purchase the equipment at the end of the lease term at which point the equipment has depreciated significantly.
• Although you are not the owner, you are still responsible for maintaining the equipment as specified by the terms of the lease.  Failure to do so can prove costly.

Venture Capital

Venture capitalists raise money from various institutional and pension fund investors to back start-up and growing companies that show strong potential to develop and become big.  Venture capital firms go through a process of raising funds from foundations, endowment funds, retirement funds, corporations and foreign investors.  Similar to a mutual fund, a venture capitalist firm pools investment dollars and then looks for solid investments.

Most often, venture capitalists look for very big returns, making them more selective than angels who may invest in smaller businesses.  They are devoted to raising money for new and emerging business ventures so they want to maintain a strong track record in raising fund for successful companies.  Therefore, they are most often seeking to invest in companies that will grow quickly and see large profit margins.

Venture capitalists generally invest in several businesses at a time to limit their risk.  Typically, they will also become involved in the business, providing their experience and expertise in the industry.  This is, in part, because unlike angels who are investing their own money, the venture capitalist firm is investing the money of other people or institutions.

Like most other types of financing, venture capital is usually part of the equation.  A venture capital firm may want to know that there are other sources of funding.  In many cases, venture capitalists look at the long-term picture and if the business grows according to the plan, it may receive several rounds of funding.  However, the business must account for how all funding has been used and follow the goals and plans set forth in accordance with the previous round(s) of financing.

There are also various types of venture capitalists.  Some will focus on providing seed money for a new business venture, while others will come in only later on in the development of the business.  Venture capitalists may specialize by investing in specific industries or types of businesses.  They may only serve a specific geographic region or only provide funds for expansion purposes of an existing business.  It is important that you research the investing criteria of a venture capital firm before approaching them.

It is also imperative that you be well prepared before meeting with such a venture capitalist. This means you will need to present a well-honed business plan and, as is the case with most potential investors, be able to answer all the hard questions about the business. This includes:

• Having a clear vision of the business and being able to articulate that vision.
• Understanding potential obstacles that you may encounter and having plans for dealing with such obstacles or setbacks
• Having a clear idea of how long it should take to show a profit
• Presenting a strong, experienced management team
• Providing a well-planned marketing strategy that defines your target market and how you plan to reach them
• Demonstrating enthusiasm and confidence that your business can meet any challenges and succeed
• Presenting a large market opportunity
• Showing proprietary technology or rights

If a venture capital firm is interested in your business, it will do its own due diligence and evaluate the background and history of the management team, the financial projections and the market in which the business is involved.  A venture capital firm might be interested in providing seed money to a new business but may hesitate if, for example, they become aware of potentially steep competition in the marketplace.  All potential investors will do research to determine the validity of their investment. Venture capitalists may go farther and dig deeper since they are usually dealing in larger amounts of money and are responsible to many investors.  Therefore, be ready to hand over all documentation requested, ranging from your Bylaws to recently executed contracts so that they can evaluate your business thoroughly.

If all goes well and a venture capitalist is interested in working with you, a term sheet will be issued.  This is a proposed contract of sorts, which includes how much the venture capitalist is willing to invest, the conditions of the investment and how the money is expected to be used.  A lawyer should be present who is familiar with reviewing such term sheets and negotiating this type of deal.

Bank Financing

Traditionally, banks are more conservative with their investment dollars.  Unlike many venture capitalists or angel investors, they are far more likely to approve a loan for an established business over a start-up or emerging company.  This is largely due to the fact that they are investing the money of their depositors.

However, thanks to government agencies such as the SBA (mentioned above), which work with many banks, small business owners can get business loans from banks with a strong business plan and well prepared business loan request.  And, banks are more likely to give modest sized loans, whereas venture capitalists are looking for much larger deals.

First and foremost, prior to approaching a bank, you should have all of your key documents in order, starting with a solid business plan.  You will also need to have the most recent financial statements available, projections for the business (this is typically in the business plan) and a repayment plan, plus collateral.

Collateral may include:

• Hard goods such as equipment
• Real estate
• Stocks or bonds
• Other personal assets
• Personal guarantees

Banks also want to know that you are making your own investment in the business.   A bank is more likely to approve a loan if (pending a solid business plan) they see that the owners are investing a good percentage of the necessary start up capital into the business.

In order to maximize your chances of receiving approval on a business loan from a bank it is wise to look at the situation from the standpoint of the lender.   A lender wants to know:

• Exactly how this business will operate and why it is anticipated that it will make money
• Exactly how the money will be used
• How you plan to repay the loan and over what time frame
• That you are willing to take a significant financial risk in the business
• That you are responsible and can manage this business
• Who else is involved in management or operations and that they will also be responsible for the proper use of the money from the loan

The smaller the business, the more closely the individual behind it will be evaluated.  Most small businesses, in the forms of sole proprietorships or partnerships, are closely tied to the experience, know-how and overall character of the owner(s).  Therefore, you need to make sure that you get your own financial records in order before asking for a bank (or any lender) for money to start a business.  A solid personal credit rating is also very important since the small business is typically an extension of the individual starting it.