Loans and other forms of financing can provide the catalyst for growth or sustain the business during cyclical variations in your cash flow. When should you seek a loan? What types of loans are available? This section summarizes the basics about business loans and financing.
Prepare for Requesting Funds
Take another look at your business plan and make sure it is up to date. The plan should reflect the current state of your business and industry, your anticipated needs, and how financing will play a role. Be sure you have done everything you can to manage your existing cash flow effectively. Know your current costs, both ongoing and one-time. Understand your income patterns, if any. Determine which costs are essential and which are optional. Defer expenses for optional costs until the business is better established. Be ready to explain exactly how you plan to use additional funding. Know your debt-to-equity ratio. Add any documentation to the appendix section of your business plan.
Understand the Various Types of Financing
All loans are not equal. It’s up to you to become educated about the types of financing available, including the amount, cost, terms, and other factors. In general, two types of business financing exist:
- Equity financing. Ideally, equity comes from the established value of your business. However, if your business is small or new, you may need to acquire equity through other sources. These sources may include investments from yourself, family and friends, employees, or customers. The greatest source of equity comes from venture capitalists. These investors are taking a risk in investing in your business, with nothing more secure than the hope that your business will generate higher than average profits. In most cases, venture capitalists expect your business to offer stock to the public in the future. If this happens, venture capitalists will convert their interest in your business and reap the benefits. See Locating Private Investors for more information about equity financing.
- Debt financing. Debt financing usually occurs through financial institutions such as banks, government-sponsored groups such as the Small Business Association, or family and friends. Debt financing is usually short term, with payback and interest expected relatively quickly. The financing is secured against the business and perhaps even your personal assets. However, unlike equity investors, the financial institution does not acquire a stake in your enterprise.
Financing is usually provided for a specific purpose, such as establishing a line of credit or purchasing equipment. You may be required to demonstrate that you and other investors have invested equity into the business already, so that lenders trust that you are serious about the enterprise.
In addition, most financial institutions will request the following information:
- Credit history for you and your business
- Ability to repay the loan, documented through cash flow statements and a list of available collateral, that is personal and business assets that could be sold to repay the debt, if needed
- Experience of the business owners within the industry
- Past and projected sales and profits
- Competitors and their strengths and weaknesses
Note that if you have been maintaining an updated business plan, most of this information should already be within that document.
Before Making Your Funding Choices
Make sure you have the answers to these questions:
- Why do you need the funding at this time? How much?
- How long have you been in business?
- Who is providing the funding? What is their track record with other businesses? Do they understand your industry?
- What do they expect in return?
- How will you manage any repayment?
- What happens if your business fails to meet their expectations?
- How much collateral, if any, do you willing/have to put up for the loan?
- What do you need the money for?
- How much money do you need?
- How long will it take you to pay it back?
- How long have you been in business?
- What is the current financial shape of your business?
- How much collateral, if any, do you have to put up for the loan?
- How quickly do you need the money?