Debt Financing – Commercial Bank LoansDebt financing does not give the lender ownership control, but the principal must be repaid with interest. Length of the loan, interest rates, security and other terms depend upon for what the loan is being used.
Short-term: Loans for short periods (30-180 days) usually made to cover temporary or seasonal needs for inventory or personnel. These are common for established businesses, but may be hard for a new business to obtain. The key to getting a short-term loan is to always have an identified primary and secondary source of repayment. A short-term loan will probably be either a time loan or a line of credit, both with maturities of one year or less. These types of loans often possess the following characteristics:
Medium to long term: These loans may be repaid over anywhere form 1 to 5 to even 20 years depending on how the funds are used. The source of repayment is the cashflow of the business. Typical uses are for equipment, fixed assets, etc. Most loans to start a small business will be of this type. Often referred to as term loans or installment loans, these usually cost more than short-term credit. The most common uses for long-term loans are to provide working capital, to purchase equipment, or to buy or improve land and/or buildings.
Working capital loans represent funding for all purposes that are not fixed assets or a line of credit. Examples could be general and administrative funds for expanding the business, a percentage of the purchase of permanent assets, the costs of building out leased space or for purchasing furniture, fixtures, or computer and automotive equipment. Banks usually require 20-30 percent as a down payment and will finance the balance for a period of three to seven years.
Loans for equipment generally will be extended for a term consistent with the depreciable value of the assets.
Real estate financing: Real estate is typically financed over a fairly long term, 10 to 30 years. Expect a down payment of about 20%.
Non-Bank Options: Asset-Based LendingSummarized, the term asset-based lending came into vogue in the 1970s to describe an industry that included specialized lending departments of banks, non-bank commercial finance firms, and factoring organizations. Today, asset-based lenders provide a variety of financial services to small, medium, and large businesses through:
secured lending against the assets of a corporation,
loans for machinery and equipment, real estate, leasing, import-export financing, acquisitions, and
factoring accounts receivable.
Today’s small business owner must be knowledgeable about all forms of financing, what they can do, why one method may be better than another, and where sufficient funds can be found. Given the highly regulated credit markets faced by banking institutions it only makes sense to maximize knowledge of lending options for your business.
The small business owner familiar with bank lending will find an asset-based lender capable of structuring similar loans and lending agreements with a willingness to take slightly more risk. Virtually any type of loan a bank can make will have a corresponding asset-based lending option.
The difference between a bank and an asset-based lender can be significant. Asset-based lenders are not regulated and this makes conventional financial ratios secondary in the credit analysis. While banks are virtually confined these days to strict reliance on balance sheet figures, an asset-based lender can look behind the figures at the business strategy, management, market potential, products, etc. Make no mistake, these lenders are as interested in getting repaid as banks and government programs, but they will have a tendency to see if they believe the funds can be put to profitable use.
In its most basic form, equity financing results in the repayment of principal and/or return only if the venture produces sufficient funds/revenues for that purpose; hence the term risk capital. Due to the risk(s), the possible capital sources could be anyone, anywhere, anytime depending on the amount, purpose, and stage of business at issue.
Equity financing will always require consideration of ownership, profit, benefit sharing, operational control, valuation, and exit strategies as important issues to be carefully evaluated.
Although equity financing can cover a wide array of capital source types, there are, in general, several overall categories. The following summaries may help you in the equity search.
Venture Capital/SBICs/Investment Banking
Approximately 500 institutional firms represent sources of equity financing involving investment approaches which are typically characterized by specific, often demanding investment criteria for their financing interest, result in substantial due diligence investigations, and can require significant ownership sharing. The bulk of this capital source is focused to more developed enterprises with few start-up or early stage opportunities. Of the entire equity market for small businesses, venture funds represent less than 5 percent or approximately $35 billion. Pratts Guide to Venture Capital Sources is a comprehensive guide to these organizations.
Friends & Relatives
For most start-up situations or early stage enterprises, capital is typically generated by persuading available friends or relatives to bankroll the venture. Although requiring less in the way of written business materials and perhaps more accessible, there are substantial risks beyond economic considerations which should be seriously evaluated, not the least of which may be disrupted relationships should the business not perform as expected. Since the funding primarily results from the personal relationships involved, complete business plans, a professional support team, and significant due diligence investigations are not characteristic of this funding mechanism. Ownership sharing may or may not be required. Many family members will enter into an agreement through the use of a simple promissory note.