6 Ways To Finance Your Small Business

Finding capital to fund a new business or to meet the capital needs of an existing business can be a daunting.  In an attempt to make the process less daunting, this post will review six frequently used small business financing methods.

1. Bank Loans

The first place and perhaps most logical place to look for a small business loan is the bank.  When it comes to business lending, banks have strict lending criteria.  To minimize the risk of lending to a small business, banks typically only provide loans to businesses that have been operating for at minimum two years.  Two years of historical financial statements showing positive cash-flow and profitability provide banks with confidence in a small business’ ability to repay the loan.  In addition to a review of the small business’ books, a bank will also typically require the loan to be guaranteed by business assets of equal value to the loan.  In the absence of guarantees against business assets, the bank will ask for a personal guarantee from each business owner.  For businesses with operating history and pro forma financial projections, bank loans might be a viable financing options.  Entrepreneurs who have started a new business that has few collateralizable assets generally do not meet the lending criteria.

2. Government Business Loans

Government business loans provided by and administered through the Small Business Association (SBA) are an alternative to standard bank loans.  The SBA provides small businesses with three different loan programs, the 7(a) loan, the 7(m) loan, and the 504 Loan.  The two loans of most interest are the 7(a) and 7(m).

7(a) loans, like bank loans are obtained through a commerical lending institution.  Though both loans are processed and originated through a bank, the 7(a) loan provides banks with guarantees if the small business borrower defaults.  As a small business owner, you are still responsible for repaying the loan.  The SBA simply provides banks with incentives to lend should you fail to uphold your responsibilities as a borrower.  SBA 7(a) Loans have a maturity of 10 years, and if not used for working capital, can have a maturity of up to 25 years.  To apply for an sba loan, visit a local Small Business Development Center.  Representatives at these centers, which are run by the SBA, provide assistance with filling out the loan application.  The SBA 7(a) loan is ideal for entrepreneurs looking to fund their new business.  Given the lack of collateral against the loan, the entreprenuer will have to provide a personal guarantee that the loan will be repaid.

7(m) loans, are in a sense, a “mini” version of the 7(a) loan.  The maximum loan amount under the 7(m) loan is $35,000.  The loan can be used for any puprose other than that to repay exisitig business debt. Unlike the 7(a) loan, the 7(m) loan is not obtained though a commerical lending insitution (read bank).   The 7(m) loan is obtained through participating non-profit organizations who in addition to providing the loan, also provide resources and technical assistance with running a small business.  Scheduling an appointment with a local chapter of the SBDC is again, the place to start.

3. Home Equity Lines of Credit (HELOC)

Home Equity Lines of Credit can also be used to fund a new or existing business - assuming of course, that you own a home that is not underwater.  If you are unable to obtain a bank loan or an SBA loan, and own a home, then a HELOC might be the way to go.   In all three cases, that of the bank loan, SBA loan, the borrower is ultimately reponsible for the repayment.  HELOC are an extremely risky form of financing a business.  Defaulting on a HELOC is very likely to cause the house to be foreclosed upon.  Under a standard bank loan or an SBA loan, your primiary residence may not be at risk should you default and file for bankruptcy protection.  Its best to speak with a lawyer about how defaulting on a HELOC or the aforementioned loans impact your primary residence.

4. Credit Cards

For those truly audacious, credit cards can also be used to finance a business.  They are after all, short term revolving lines of credit.  Note that using a business credit card does not mean that the business owner is personally free in the cause of business bankruptcy.  For new businesses with limited assets, the bank may require a personal guarantee on business credit card debt.  A business owner’s personal liability on business credit card debt is a function of whether a bank requires a personal guarantee and the type of business (LP, LLC, Corporation) the business is incorporated under.  Using credit cards is also risky because the interest rates are extraordinarily high.  These should only be used as a last resort.  As with any loan, be sure to understand the personal risks taken should the business file for bankrupty and have balances on the credit cards.

5. Friends & Family

The quickest way to obtain financing for a business is through family and friends.  While the mechanics of obtaining a loan through personal relationships is simple, the emotional turmoil and impact it has on these relationships may not be.  A simple way to obtain loans from friends is through a Promissory Note.   A Promissory Note is a written guarantee that the loan amount will be repaid at a specified date in the future and will bear an agreed upon interest rate.  These notes also happen to be the simplest legal documents to create and finalize.  If you need capital and want to get started as quickly as possible, asking friends and family, and providing a Promissory Note in return is a good way to go.  Again, just be sure to understand the implications such loans will have on personal relationships.

6. Cash Savings

If you have a discretionary fund or are willing to, despite the penalty, withdraw capital from a retirement accounts, then use hard earned cash to get things started.  Cash Savings, your, or someone elses, are afterall, the bases for any of the options discussed above

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March 23, 2009 | small business 

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