Funding your start-up business may be the most difficult
task you will encounter (although not necessarily the most important; finding
a viable market is!). There is much to be said for "bootstrapping"
your business (i.e., getting by with savings and money generated by the
business.) In some cases, this may be the only way to get your business
going. However, in many circumstances this is not feasible and under capitalization
can be a very serious problem for start-ups.
Start-Up Financing Sources
Most people immediately think of commercial banks when
they determine a need for business financing. Unfortunately, as a source
of start-up funding, banks end up far down on the list of likely sources.
Instead, most small businesses are financed through private funding and
other sources. Some of these sources include:
- Personal savings
- Loan from family or friends
- Personal bank loan
- Refinancing or a second mortgage on real estate or other
(Note: Sources 3 & 4 are generally contingent upon
your having a regular source of income, i.e., a job; thus, if you plan
to travel this route, you need to secure this financing while you're still
- Cash value of assets you could sell
- Cash value of life insurance, stocks or bonds
- Credit cards
- Investments from partners
- Advance payments from contracts (not a likely source)
- Credit from suppliers
Commercial Bank Financing
Most small business start-ups are inherently risky and
commercial banks are traditionally risk averse. Bankers are neither investors
in small businesses nor speculators, but they will lend money to a small
business if its repayment is relatively assured. Commercial banks generally
provide financing at comparatively low rates but in return expect a strict
repayment schedule and detailed recordkeeping. Their main concern is whether
or not you will be able to repay the loan in full and on time.
The bank's lending officers look for specific criteria when evaulating
your loan proposal. They will rate you on the following characteristics:
- Experienced management - Are you familiar with the business
and do you know the industry?
- Substantial investment - Are you willing to make a substantial
investment of time and money?
- Strong credit history - Have you borrowed similar amounts
and repaid them in a timely manner?
- Responsible character - Can your references vouch for
your honesty and good business sense?
- Good collateral - Do you have satisfactory collateral
appraised high enough to secure the loan?
- Adequate cash flow - With the loan, will the business
generate enough dollars to pay off the loan and then some?
Meeting the preceding criteria can be very difficult for
a start-up business. Often one or more criteria cannot be met. It may be
especially difficult to convince a banker that your projections of sales
and cash flow are realistic. This can be accomplished but only by exhibiting
extensive knowledge of the business and the market. The bank will expect
to see a formal business plan, complete with pro-forma financial statements,
and will expect you to complete a personal financial statement.
When all the bank's criteria have been met, the banker
will look for additional means to secure the loan. This can be done through
a variety of methods:
- Personal guarantee - First of all, you will be
required to personally guarantee the loan. If your business fails, you
personally will be responsible for repaying the loan.
- Co-Signer - If your ability to repay the loan - should
the business fail - is in question, the bank may require that you find
another person with the financial capacity to guarantee repayment.
- SBA or FAME Guarantee - The U.S. Small Business Administration
(SBA) and Finance Authority of Maine (FAME) primarily assist small start-up
businesses by providing commercial loan insurance. The first step, to take
advantage of these programs, is to get a bank committed to your project
- for it is a bank that will make applications to SBA or FAME. SBA or FAME
will have similar requirements of you in terms of experience, character,
credit worthiness, collateral and cash investment. The primary difference
is that they may be willing to accept more risk than the bank in the name
of promoting small business. (Note: Even if you do get a guarantee from
SBA or FAME, these agencies will still hold you personally responsible
for the debt.) Finally, guarantees do not mean low interest loans. The
loan is made at the bank's current rate and a fee is charged by the guarantee
Your first step in evaluating any business prospect should
be a feasibility study to determine the potential of your particular product
or service. The cash flow projection is a basic piece of any feasibility
study. In it you estimate revenues and expenses of your business, generally
on a monthly basis, for a year or two. This analysis is important in that
it will tell you (and your banker or investor) what amount of funds you
will need to invest in the business to keep it running until sales reach
a point where they will support the business. This analysis will also illustrate
the burden placed on a fledgling business by borrowed funds and will assist
you in making the difficult financing decisions. Be aware that banks vary
in their aggressiveness over time and between one another and that bankers
themselves vary according to their own background and experience. Thus,
you must be persistent and willing to shop around.
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