More Information About Starting Your Small Business
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Financing Basics
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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. But it is not enough to simply have sufficient financing;
knowledge and planning are required to manage it well. These qualities
ensure that entrepreneurs avoid common mistakes like securing the
wrong type of financing, miscalculating the amount required, or
underestimating the cost of borrowing money.
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 businessess 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, make
writing one your first priority. All capital sources will want
to see your for the start-up and growth of your business.
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Not All Money Is the Same |
There are two types of financing:
equity and debt financing. When looking for money, you must consider
your company's debt-to-equity ratio - the relation between dollars
you've borrowed and dollars you've invested in your business. The
more money owners have invested in their 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, experts advise that you should increase your
ownership capital (equity investment) for additional funds. That
way you won't be over-leveraged to the point of jeopardizing your
company's survival. |
Equity Financing |
Most small or growth-stage businesses
use limited equity financing. As with debt financing, additional equity
often comes from non-professional investors such as friends, relatives,
employees, customers, or industry colleagues. However, the most common
source of professional equity funding comes from venture capitalists.
These are institutional risk takers and may be groups of wealthy individuals,
government-assisted sources, or major financial institutions. Most
specialize in one or a few closely related industries. The high-tech
industry of California's Silicon Valley is a well-known example of
capitalist investing.
Venture capitalists are often seen as deep-pocketed financial gurus
looking for start-ups in which to invest their money, but they most
often prefer three-to-five-year old companies with the potential
to become major regional or national concerns and return higher-than-average
profits to their shareholders. Venture capitalists may scrutinize
thousands of potential investments annually, but only invest in
a handful. The possibility of a public stock offering is critical
to venture capitalists. Quality management, a competitive or innovative
advantage, and industry growth are also major concerns.
Different venture capitalists have different approaches to management
of the business in which they invest. They generally prefer to influence
a business passively, but will react when a business does not perform
as expected and may insist on changes in management or strategy.
Relinquishing some of the decision-making and some of the potential
for profits are the main disadvantages of equity financing.
You may contact these investors directly, although they typically
make their investments through referrals. The SBA also licenses
Small Business Investment Companies (SBICs) and Minority Enterprise
Small Business Investment companies (MSBIs), which offer equity
financing. Apple Computer, Federal Express and Nike Shoes received
financing from SBICs at critical stages of their growth.
Additional Reading
Raising
Money through Equity Investments - Inc. Magazine |
Debt Financing |
There are many sources for debt financing:
banks, savings and loans, commercial finance companies, and the U.S.
Small Business Administration (SBA) are the most common. State and
local governments have developed many programs in recent years to
encourage the growth of small businesses in recognition of their positive
effects on the economy. 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. The SBA's programs have been an integral part
of the success stories of thousands of firms nationally.
In addition to equity considerations, lenders commonly require
the borrower's personal guarantees in case of default. This ensures
that the borrower has a sufficient personal interest at stake to
give paramount attention to the business. For most borrowers this
is a burden, but also a necessity. |
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