It can include personal funds and also funds invested by family and friends. Equity funding is money that remains in the business indefinitely. Unlike a loan, it has no set pay-back schedule.
If you don’t have enough money to start a business on your own, you can turn to various kinds of lending institutions. Generally, you will need to be willing and able to invest most of the initial equity in your business. Lending institutions are typically reluctant to provide more than half the start-up funds for a small business. Any loan you get from a lending institution will have a predefined repayment schedule. Under that schedule you must repay specified amounts of principal and interest within a specified amount of time.
Commercial Loans
Commercial loans are the most common kind of small business loan. They come from your local bank, savings and loan, or credit union. The terms and requirements of these different institutions vary widely. If you’re interested in a commercial loan, familiarize yourself with basic lending terminology and read the pamphlets various lending institutions have available. Then make an appointment with a loan officer. Show up on time, professionally dressed for the business world (not the martial arts world), and present your well-thought-out and professional-looking business plan. After you sell the lender on the potential of your business and your ability to run it, they can help you get started on the loan application process.
Government Loans
Another possible source of funding is government loans. Government loans come in two kinds: guaranteed loans and direct loans. Guaranteed loans are loans made by commercial lending institutions backed by a government loan loss guarantee. In other words, the government program functions something like a cosigner. Direct loans are loans made by the government, typically to members of a specific group or for specific purposes.
The SBA loan program offers guaranteed loans. The SBA has a congressionally mandated program whose purpose is helping small businesses gain financing. Most SBA loans are made through the 7(a) Loan Guaranty Program. These government-guaranteed loans are made by banks and other lending institutions. The average SBA loan is for 50 to 75 percent of the start-up costs of a small business, typically around $175,000. The average maturity is about eight years. The SBA also offers a “MicroLoan” program, in which the amount borrowed is less than $10,000 and the repayment period is less than six years. Sometimes (but not always) these loans have a higher interest rate than what the bank offers. Usually, however, they have fewer qualification requirements than the bank’s conventional loans. If you don’t qualify for a loan directly from a bank, you may be able to qualify for an SBA loan.
Be aware, however, that the SBA loan program is a government program and, as such, has government-style quirks. For example, if you borrow money from your uncle Fred, he will probably write you a check and you can spend the money as you see fit. If you borrow money from Uncle Sam, however, the process is not that straightforward. Most SBA loans don’t make payments directly to you. They pay the people you are buying goods and services from. If you want to use the money to buy, for example, a desk, you have two choices. You can go out and buy the desk, submit the receipts, and have the lending institution reimburse you. Or you can go out and get an invoice for the cost of the desk, and the lending institution will pay the store directly.
Furthermore, an SBA lending institution will earmark percentages of the money for specific categories. If you estimated in your application that you will need $3,000 for inventory and $5,000 for fixtures, don’t expect the SBA to allow you to spend $2,000 for inventory and $6,000 for fixtures. Also, you need to make sure that when you say “inventory” and “fixtures” you mean the same thing the SBA program means when they use the terms. The government is not thinking, as you are, about how you will use these things; they’re thinking about how they could sell them and get their money back should you default.
One special SBA program is the Minority Prequalification Loan Program. If your business is at least 51 percent owned and managed by a member of an ethnic minority, the SBA will find you an intermediary to help you put together a loan application and find a lender.
The government also offers direct loans to special groups. For example, the SBA has a loan program for disabled veterans and for Vietnam veterans. The Handicapped Assistance Loan Program offers start-up loans to business owners when either the owner is disabled or disabled individuals work 75 percent (or more) of the staff hours. Special loan programs for women or minority-owned businesses are also available. If you think you might be eligible for a direct loan, check with the SBA or your state lending agencies. SBA offices are listed in the telephone directory under “U.S. Government,” or you can call the Small Business Answer Desk at 1-800-8-ASK-SBA.
Private Family Loans
In your investigation of commercial and government loan programs, don’t neglect one of the most common sources for loans: friends and family. Many, perhaps most, new businesses are funded by family members. Often, the best place to borrow money is from relatives. But sometimes, the worst place to borrow money is from relatives. On the one hand, who is more likely to appreciate your vision or to want to see you succeed than your family? On the other, if your business doesn’t succeed, you will lose not only your money but that of the family member who invested in you. Think through the long-term implications of borrowing from family.
If you decide to use a relative’s or friend’s money, treat the loan as an “arm’s-length transaction,” the same as you would if it were from a bank. Give them your business plan. Decide the amount of interest and the payback schedule. Make sure the arrangement is in writing. Then stick to the terms as though your future family relations depended on it.
Sometimes a family member who cannot give you cash will be willing to cosign a commercial loan. Again, be sure you don’t stick them with your bad management. A cosigner is equally responsible for the loan repayment. If you can’t repay your debt, they must.
Apply for a Loan
One of the best ways to boost your chances for getting a bank loan is to do some groundwork before you apply. Learn about banking procedures, policies, and constraints. Put together a business plan that anticipates what the loan officer will need from you. Banks typically have an application form they want you to fill out. But applying for a loan involves more than just filling in all the blanks. Put some time and effort into your business plan. Doing so will help you stand out from other loan applicants.
Compile the evidence you need to present yourself as a good credit risk. What does a good risk look like?
1. You are someone of good character. You are willing to work hard. You have a proven reputation as a responsible citizen.
2. You have what it takes to run the business. Your credit report shows you have a good track record when it comes to handling money. You have the business skills—acquired through education, practical experience, or both—that you need to make the business a success.
3. You have quite a bit of your own money invested. By investing your own money, you show that you are likely to work to build your investment and theirs.
4. You have collateral to support your primary repayment source.
If any of these statements aren’t true, you may need to find an alternate source of funding. If all of them are true, make sure you have the evidence to show your lender.
A word on credit reports: Expect your lender to check yours. Before you apply for a loan, before your lender points out credit trouble, order a copy and address any problems that might be on it. The largest supplier of consumer and business credit reports is Experian (formerly TRW Information Systems). If you wish to purchase a copy of your credit report using a credit card, you can call them 1-888-EXPERIAN. They can get you a copy in about a week. They also have mail-order forms available on their Web site. If you need help reading your credit report, or if you need to repair poor credit, the Experian Web site (www.experian.com) has information to get you started.
When you’ve thought through the questions your loan officer might ask and put together your loan application in a neat, easy-to-read format, it’s time to present it. Make an appointment. Dress professionally. Show up on time. Allocate