When it comes to establishing a successful business, the old adage applies: To make money, you have to spend it. But what if you don’t have enough – or any – to spend? Whether you need start-up funds, a cushion or capital to expand, knowing how to secure financing for a business is crucial.
9 Steps for Securing Financing for a Business
1. Know Your Options
Before doing anything else, educate yourself about the most common ways to finance a business. For entrepreneurs especially, self-funding – or bootstrapping – is sometimes a viable option. Saving up at least $5,000 is ideal, but tapping into resources like the equity of your home; your 401(k); or personal credit cards is generally too risky.
In terms of obtaining funding, there are three primary options: debt financing, equity financing, and mezzanine financing.
Debt financing means taking out a loan or line of credit – e.g., going into debt – to obtain capital. Such financing may be unsecured, but it’s more commonly secured by the collateral of some sort; business assets like inventory and equipment are examples.
Some types of debt financing include:
- Business loans – Business loans and lines of credit from banks are typically only available to well-established businesses with substantial assets and a proven track record. Small businesses rarely qualify.
- Business credit cards – Like personal credit cards, business credit cards carry a lot of risks. However, when used responsibly, they can help to improve cashflow by extending accounts payable periods.
- SBA Loans – These refer to loans that are guaranteed by the small business administration (SBA) – not offered directly by them. You’ll have to be turned down for a regular loan first to qualify, and you must meet the definition of a small business for your industry. However, these are among the best options for obtaining funding.
- Microloans – Offered by the SBA and companies called microlenders, microloans usually provide between $500 and $35,000 of financing. It’s usually easier and faster to qualify for such loans, but they tend to have higher interest rates.
- Factoring and PO funding – With factoring, a company sells its receivables at a discount to get cash upfront. With purchase order funding, companies that sell goods at markups of at least 30 percent can have suppliers paid directly by PO funding lenders.
- Business cash advances – Given that these charge interest rates of 30 to 40 percent over periods of just six to 12 months, cash advances should be avoided.
With equity financing, you sell a portion of your business – an equity stake – to an investor in exchange for cash that doesn’t have to be repaid like a loan.
Some examples of equity financing options include:
- Angel investor funding – An angel investor may buy an equity stake in your company under the condition that they will recoup their money within three to five years. They may also provide valuable assistance in helping you to run your business. However, you must run business decisions by them since they become a partner.
- Venture capital funding – This is similar to an angel investor but involves an entire company rather than one individual. Unless you operate a tech company with proven potential for serious growth, you’re unlikely to obtain this competitive type of financing.
A hybrid between debt financing and equity financing, mezzanine financing refers to a loan that can be converted to an equity stake for the lender in the event of default. You usually need a proven track record, an actual product and a history of profitability to qualify.
Loans from friends and family may be considered, but they can be risky for obvious reasons. If you go that route, proceed as if you are working with an actual lender and drive home the serious risks that are involved for them. Crowdsourcing through platforms like Kickstarter and IndieGoGo are sometimes useful for short-term funding but aren’t viable sources of long-term funding.
2. Know What You Need
Identify a succinct reason for wanting to obtain business financing. How much will you need, what will it be used for, how long will you need it and how soon can you repay it?
3. Figure Out How Much You Can Afford
Calculate your debt service coverage ratio, or DSCR, to have an idea about how much financing you’re likely to qualify for. Divide your periodic cashflow – e.g., the amount of your monthly capital inflow – by the amount of your loan payment for the same period. Know that lenders typically need to see a DSCR of 1.35 or higher.
4. Create a Business Plan
Get assistance from a professional CPA to do this. When creating your plan, be sure to humanize your brand so it is more appealing to lenders.
5. Prepare for Application
If you’re starting a new business, make sure your personal credit score is good to excellent; a score of 700 or higher is optimal. If you have an established business, gather the documentation that you will need, including things like business bank statements, profit and loss statements and business tax returns.
6. Follow Up Promptly
Even if you are very thorough, you will likely be asked to provide additional documentation after applying for financing. Make sure to provide it promptly and thoroughly.
7. Don’t Give Up
If you are turned down, find out specifically why. Use this information to adjust your plan. Ask the lender if they can recommend other lenders that may be more willing to work with a company like yours.
8. Check with Friends and Family
This may work as a last-ditch effort, so don’t count it out.
9. Know What to Watch Out For
Carefully consider the following before securing any type of financing:
- Application fees
- Loan origination fees
- Late payment fees
- Prepayment penalties
- Guarantee fees
- Check-processing fees
- Interest rates
Get Started with Obtaining Business Financing Today
The preceding merely skims the surface of the work that’s truly involved in obtaining business financing. If you are in need of it, understand that the process is usually long and complicated. It helps enormously to have the right help, and E-Marketing Associates can assist you with things like business objectives reporting that can make a difference. Contact us today for more information.