Chapter 4: Steps To Secure Financing

If only it were this easy: Business Idea + Money = Success. Many businesses, large and small, have discovered they cannot buy their way to the top. It takes more than an influx of cash to launch and grow a business. There are few “do-overs” when it comes to seeking financing.

You have only one chance with a potential investor. You may only have ten minutes to tell your story, show your profit potential, “close the deal,” and secure the money you need for your business.

DID YOU KNOW?

• A small business is any independent business with 500 or fewer employees.

• As of 2003, 5.7 million small businesses have at least one employee.

• As of 2003, 17 million small businesses are sole proprietorships.

• Fifty-three percent of small businesses are home-based.

• Women own at least 50 percent of some 10.6 million firms.

• The number of minority-owned firms is growing four times faster than all other U.S. firms.

• Of all employers, 99.7 percent are small businesses.

• Sixty to 80 percent of all new jobs (net) over the past ten years were created by small businesses.

• Eighty-two percent of small businesses use some form of credit for financing.

• Approximately 95 percent of new small businesses rely on personal financing (savings, second mortgages, and family or friend support).

MONEY, MONEY, MONEY

Angel investors invested an estimated $22.5 billion in 48,000 companies in 2004. Venture capital firms estimate that they invest between $3 and $5 billion annually. The Small Business Administration (SBA) guarantees more than $10 billion in loans every year.

Borrowing wisely is important — even if it is from your own piggy bank. Initial financing may be a loan from Mom, but how you approach this business relationship and use the funds is just as important as borrowing from a bank. In the next section I will discuss the various types of personal financing and tips on how to make each work for you.

For the 5 percent of entrepreneurs who will rely on formal “outside” financing, remember that every new business starts with some type of personal financing. Investors and lenders expect you to be financially invested in your dream.

Whether it is a few hundred dollars or thousands of dollars needed to launch your new business, there is money available to people with sound business skills and a solid business plan.

LEARNING YOUR MONEY FORMULA

BE PREPARED

The most common mistakes made by beginning entrepreneurs result from lack of preparation. All of the enthusiasm in the world cannot make up for a failure to research when seeking capital. Before you fill out a loan application or contact an investor be prepared — in your head, heart, and on paper. Create your “elevator pitch.”

DEVELOP AN ELEVATOR PITCH

Imagine you are alone in an elevator with a rich investor. Here is your chance to pitch your idea. Can you capture his attention, sell him on your idea, and intrigue his entrepreneurial spirit before you reach the twenty-second floor?

Your elevator pitch is a brief description that neatly sums up your business concept. It is not a lifeless declaration “I want to start a Chinese restaurant.” It is a statement that captures the excitement and potential of your idea — “I’m starting a trendy restaurant featuring exquisite dinners from every region of China. I have hired a chef from a popular New York establishment and renowned restaurant designer Barbara Lazaroff is working with us.”

Your elevator pitch is also useful in helping you focus on your goals. You will find several ways to build upon your elevator pitch throughout the book.

KNOW YOUR INVESTORS

Understanding the current market, as well as anticipating and addressing the needs and concerns of typical investors, is necessary when creating a business plan. Entrepreneurs need to show that their business will be capable of generating a steady flow of revenue with profits on the horizon.

Show that your team is competent and familiar with the target industry. Otherwise, the risk may seem too great to investors. Many investors rely on the “bet on the jockey, not on the horse” philosophy (investing based on the person in charge).

FOCUS YOUR SEARCH

Focus your search on the sources most likely to deliver. Otherwise, you risk spending countless hours preparing deals that are destined never to materialize or to collapse at the last minute.

PLAN AHEAD

Predicting how long it takes to close a financing deal can be difficult. Misjudging this time can have devastating effects on your business. Planning ahead for secondary, or backup, financing can keep your business from stumbling.

If the capital is needed and the deal still is not closed, be prepared to have your prospects vanish. After all, customers are on a tight schedule too. The best time to raise money is before you need it, not when you need it.

BE FLEXIBLE

A good, solid business plan is a necessity, but entrepreneurs that are too attached to their plans tend to fail. There are several reasons for this:

• The market is always changing. If a business cannot adapt to the market, it will struggle to create revenue. Any sign of stubbornness or inflexibility is sure to send investors running toward an investment headed up by someone who can deal with change.

• Your assumptions are just that. As you set about creating a plan, you base statements and ideas on assumptions that may turn out to be inaccurate. Although time and effort are put into creating projections, remember that they are only educated guesses of projected sales. If sales fall short of these projections, the consequences can be disastrous.

• Consumer demands and trends change. The need for your product may pass or be filled by another vendor, if too much time is spent in development. You need a real product to have real customers, not a product in development.

REMEMBER TO MIND THE STORE

Sometimes entrepreneurs spend too much time searching for capital. Neglecting the day-to-day operations of the business can leave others with little reason to invest. If your are not spending the money you have earned effectively, you might as well not be raising it.

BUILD A STRONG TEAM

Investors pay attention to your management team; it is the infrastructure of your company. Investors want to see that you have strong personnel resources. Investors know that it takes more than one person to make a company succeed. If potential investors have no confidence in your team, they will have no confidence in you.

WRITE A LEAN AND MEAN BUSINESS PLAN

Investors do not have time to read a business plan that resembles a novel. Keep it short and concise without sacrificing essential information. Keep an abridged version or a synopsis of your plan handy in case an investor wants just the meat of it. I discussed how to write a business plan in detail in Chapter 3.

OWNERSHIP VERSUS CONTROL

A founder may hold only a small percentage of the business ownership and retain a large percentage of its control. It works the other way around as well. Or investors can negotiate deals, especially with desperate businesses that have fallen on hard times in which they take over a substantial portion of the control without investing much capital.

STAY ON THE RIGHT SIDE OF THE LAW

No legitimate businessperson intends to break the law; however, taking shortcuts and being ignorant of laws regulating your business can derail even the most well-intentioned entrepreneur. Business law and regulations can be overwhelmingly complex and confusing. Unfortunately, ignorance of these laws does not absolve one from any wrongdoing.

Learn as much as you can about the laws in the following areas:

• Employer-employee laws — Liability, overtime regulations, and workplace safety.

• Protection of ideas — Copyright laws, patents, and trade secret regulations.

• Contractual law — What voids a contract.

• Securities — Know the regulations that govern how you raise capital.

• Industry-specific government regulations — Trade regulations, interstate commerce, and other local, state, or federal laws.

• Environmental laws — Use of natural resources, pollution, waste, and ecological-impact laws.

Hire a Lawyer

Having a corporate attorney is critical for starting a business. Although these specialists are expensive, they have experience in the key areas of employee negotiations, intellectual property rights, setting up stock-option plans, and state and federal tax laws.

Legal errors can be costly. This investment allows you to concentrate on other aspects of the business. Too many entrepreneurs believe they do not need a lawyer. Competent legal counsel may not seem affordable, but ignorance can collapse your business.

Create Strong Agreements

When writing a contract, make sure your interests are protected and leave yourself some options. Stay flexible, but be certain that all agreements are in writing and reviewed by your business attorney.

Keep Good Corporate Records

Keeping track of every meeting and transaction is essential to protecting your company. Poor recordkeeping can cause serious problems with the IRS, resulting in serious problems raising future capital. Keep records of these commonly overlooked items:

• Board meeting minutes

• Shareholders’ meeting minutes

• Stock issuance

• Stock transfers

Write Good Employee Policies

Poor documentation and enforcement of employee policies are lawsuits waiting to happen. Although it is necessary to establish a good rapport with employees, do not let their standards fall below your own, putting your company at risk. Set clear policies on Internet use, discrimination, sexual harassment, employee safety, and drug use and enforce them. Your attorney can advise you on specific issues that your employee handbook must address.

Be sure that your employees understand that they are “at will” employees — you can terminate them at any moment without your business being held liable.

Define Partnership Agreements

Partners in a business must share the drive and will to succeed. Define in writing what is expected of each partner. The following points should be addressed in a partnership agreement:

• The amount of capital each partner is expected to contribute.

• A plan of action if the business needs more capital (Where is it going to come from? Are the partners expected to dig deeper into their own pockets?).

• A clear outline of each partner’s responsibilities, workload, and time commitment to the business’s operations.

• A plan of action in case a partner dies or decides to leave the business.

Protect Yourself

Consider the risk of your personal assets. In many states, general partnerships hold the partners jointly liable for outstanding debts, meaning all of your personal assets are at risk if the business encounters a problem. Starting as a corporation or other limited liability entity can help you avoid liability issues.

Secure Your Intellectual Property

Intellectual property issues are as important in low-tech industries as they are in the world of software and computers.

Employees should always be required to sign confidentiality agreements. All company logos and trademarks should be registered, vital documents should be copyrighted, and, if applicable, products patented.

Protecting trade secrets is also important. The future of your business relies on it. Place copyright notices on all documentation and have potential investors sign nondisclosure agreements when meeting with you.

Resolve Conflicts Wisely

In the event of a legal dispute, leave litigation as the last resort. First, attempt to resolve conflicts through mediation, arbitration, and settlement. Although settling may seem like giving up, it is often more cost effective and less time consuming than litigation. Because time and money are at the heart of any business, it is important not to be stubborn; standing on principle could hurt the business.

CAPITAL BUDGETING

Raising capital arbitrarily is no way to run a business. Before looking for capital, determine how much working and investment capital you actually need. The process of identifying and prioritizing the capital investments that increase the value of your business is known as capital budgeting. This process depends on restrictions and priorities.

Restrictions

Choices are restricted because you can only raise so much capital and still service your debts and deliver investor returns. Figure out exactly the money coming in and going out and if any can be set aside for investments.

Priorities

Ranking your projects according to which adds the most value to your business can help evaluate where the money is going. Those projects that add the most value get more investment money.

Maintaining steady cash flow and investments in expansion to add sales to that cash flow is the heart of capital budgeting. Instead of paying off debt, the debt is paid down slowly in order to keep funds for expansion projects available.

Paying off debt over time will cost more, but only in terms of the debt itself. If the business uses its cash flow to expand and sales increase, the amount of capital that is generated from that might outweigh the fact that servicing the debt requires monthly interest payments.

There are three primary methods for ranking projects and their value to the company:

• The Payback Method — A simple method that ignores future possible cash outflows and does not use discounted cash flow (DCF) analysis. This method rates projects on how quickly they will be able to pay for themselves.

• The IRR Method — Projects are ranked through this method by the investor’s rate of return (IRR). This method takes into account cash flow structures by measuring the hurdle rate or the opportunity cost of investment capital, which is manifest as the appropriate interest rate or rate of return.

• The Net Present Value Method — Net present value (NPV) uses DCF analysis to rank projects by their current worth to the company from an opportunity standpoint. The IRR and NPV methods are used far more than the payback method because most businesses think in terms of cash flow. Without adequate cash flow, the owner knows the company is vulnerable to all sorts of unpleasant situations, including the inability to pay suppliers or falling behind in the industry due to lack of expansion.

THE MONEY IS OUT THERE

Lending money to businesses is the foundation of the banking industry. Venture capitalists do nothing but invest in people and ideas. At every level, our economy depends upon borrowing and investing. Even in a down economy, there is money available to start a new venture or to grow a healthy business. If your idea has merit and you can establish a plan, you may have better luck during slow investment periods. During economic booms, investors are bombarded with business opportunities. When few dollars are available to invest, the marginal proposals are quickly dismissed.

SIX WAYS TO FINANCE A BUSINESS

• Give it — The primary source for business financing is ownership contribution.

• Borrow it — Commercial, government, or private loans range from small business seed money to multimillion dollar open lines of credit.

• Sell it — Selling a part of your company to investors can provide needed capital, but sharing ownership has its drawbacks.

• Earn it — Saving requires long-range planning and wise money management, but it is the most economical way to finance growth.

• Pledge it — Private or public business development grants are available based upon your ability and willingness to “give back” to the community.

• Share it — Find an upline sponsor (coach), employer, business, or individual who will subsidize your idea with the goal of enhancing their financial picture.

Money comes from four types of potential “investors,” each with her own motivations:

• Owners — You and your partners are motivated by dreams, desires, and needs. These can often cloud your decision-making abilities.

• Private parties — Family and friends may be motivated primarily by friendship (profits are an added bonus), but it is serious when you enter into a business relationship.

• Commercial profit-making entities — Banks, venture capitalists, and angel investors are seeking profits (interest, ownership) and personal gain (bonuses, recognition, achievement).

• Nonprofit entities — Government agencies and charitable foundations have missions to enhance lives and communities through economic growth and development. They are motivated to “do good,” but that does not mean they overlook good business practices.

BEFORE YOU SEARCH

You must know what you need the money for, how much you need, what you can afford to “pay” for the money, and what you are willing to sacrifice for it. Chapter 8, “Debt Financing Versus Equity Financing,” in How to Get the Financing for Your New Small Business from Atlantic Publishing, www.atlantic-pub.com, will help you make these determinations.

EXPLORING THE OPTIONS

Examining your business and discovering your entrepreneurial style are the first steps in finding the funding that matches your company’s needs. When the need for money arises, entrepreneurs can become consumed by raising capital. Their judgment becomes clouded and their decision-making ability compromised. The cliché “the end justifies the means” is not always true. Your first step in exploring your financing options is to determine what you are willing to sacrifice.

WHAT WILL YOU DO TO FINANCE YOUR DREAM?

Here are a few exploratory questions to help determine your comfort level with various methods of acquiring startup or expansion financing.

• Am I willing to make personal sacrifices? No new car, renting a less expensive apartment, eliminating your daily latte?

• Can I emotionally handle the risk and debt incurred starting a business?

• Do I have a strong vision and can I see myself as successful?

• Am I willing to share the profits with a silent partner?

• Will I resent paying a partner who does not work as hard as I do?

• Is my idea (and future success) more important than my need to control the business?

• Will I be able to tolerate “interfering” investors?

• Am I open to unsolicited advice from investors?

• Is my idea strong enough to support partners?

• Can I afford the interest rate?

• What are the risks in paying “too much” for a loan?

• Will I have the ability to repay the debt on time?

• Am I ignoring warning signals (about people, situations, and risk)?

• Should I stop and regroup before proceeding?

• Is my business plan ready to go?

AVAILABLE FINANCING SOURCES

The overview below outlines the types of financing available to businesses. Making the decision to start or expand a small business opens up a variety of considerations and options. Many burgeoning companies spend far too much time chasing down funds from sources that do not mesh with their business. Making the right deal with the right investors or lenders provides you with the opportunity to grow in a manageable and hospitable environment. Making the wrong deal with the wrong investors can cause serious problems down the road, setting you up for conflicts and even potential failure.

GIVE IT — YOUR PERSONAL INVESTMENT

Investors and lenders will expect you to provide a significant amount of the capital necessary to launch or expand your business. When an entrepreneur puts assets on the line, it sends the message that he is committed to making the company a success, making it easier to acquire supplemental funding from outside sources. (There are a few exceptions, such as seed money programs created to assist economically disadvantaged at-risk individuals.)

Investing Your Money

Nearly 80 percent of entrepreneurs rely on personal savings to begin a new enterprise. Using personal savings secures the entrepreneur’s control and ownership of the business. Because it is your money, no debt is incurred and future profits are not shared with investors.

Converting personal assets to business use is the same as giving your business cash. Not only will you avoid purchasing these items, but you will also be able to depreciate them. Your accountant will set up the conversion and depreciation schedules. For many people, their greatest personal asset is their home.

Lines of credit, refinancing, and home equity loans are often used. Raising cash this way can be risky. Personal credit cards, signature loans, and loans against insurance policies and retirement accounts are other common ways of raising start-up capital.

Home Equity Loans

You will need to know the equity you have in your home. For less than $500, an appraiser or real estate agent can locate home sale comparisons for you to use as an estimate.

If you own your home outright, you can refinance without staking all of the equity you have in your home, leaving room for future refinancing should something go wrong. If you own 20 percent or less in equity, by no means should you ever consider borrowing against that. The funds you gain will be minimal and the second lender will not hesitate to foreclose should trouble arise. The best way to determine feasibility is by following these steps:

1. Get your home appraised; if the value has gone up, you may own more equity than you think.

2. Figure out exactly how much you still owe on your mortgage.

3. Take the appraisal valuation and subtract your debt to determine the amount of equity.

4. Figure out your percentage by dividing your equity amount by the valuation amount. If it is less than 50 percent, you should find a different source of capital for your business.

5. If your equity is more than 50 percent, you may be in business. Now is the time to get loan quotes.

6. Figure out how your business plan will be affected by this cash infusion and make projections for how long it will take for the loan to be paid off.

Pay down the principal balance of the debt in order to get out of debt faster and regain the equity on your home.

Leveraging Your Credit

Leveraging your personal credit worthiness is another way to support your business. A new business has no established credit. Your signed personal guarantee will help establish credit for your business. Ask your attorney about personal liability issues for all business debts. Protecting your personal credit and financial health is a key reason to incorporate.

BORROW IT — LOANS TO REPAY

Borrowing can save your business or act as a noose around your company’s neck. When looking at various types of loans, consider such issues as collateral required, interest rates, and repayment terms.

Loans from Family and Friends

Asking for help from those closest to you can be another smart move when looking for capital. Since you already have a relationship with friends and family, there are no questions of trust and a willingness to help already exists.

Interest-free or low-interest loans from relatives or friends can help a start-up business gain important supplemental capital without having to take out a bank loan or give up control and profits to investors. You may even have an angel investor in the family.

Loans from Commercial Lenders

A bank loan is the typical source of outside funding for businesses. In fact, Small Business Administration (SBA) and state government loans are actually bank loans in which the government agency provides financial support and underwriting.

Having a sound business proposal is the key element to obtaining a loan from a bank, credit union, or commercial lender. The lender will factor in personal credit history, outstanding debt, and past business performance when reviewing a loan application for a new business.

Lines of Credit

A tempting source of short-term small borrowing for small businesses are micro loans. These alternative loans are often safer with lower interest rates. They can help fill the gap between expenditures incurred while manufacturing and delivering and the time it takes customers to pay in full. Lines of credit are useful for making sure payroll is met.

SELL IT — SHARED OWNERSHIP

Investors are a type of owner, which means you must be willing to “sell” a portion of your business and future profits. Some investors are active participants in daily operations, while others offer guidance and support through board meetings. Still others prefer to let you do it all while they reap the rewards.

Friends

Friends can also be a great source of investment money. Unless your friend is a professional investor, you will be able to negotiate a fair and less costly investment agreement. The trust factor works here as it does when borrowing money from family. When considering these investors, ask yourself five questions:

1. Will this person panic about money after investing?

2. Does this person understand the risks and benefits?

3. Will this person want to take control or become a nuisance?

4. Would a failure ruin your relationship?

5. Does this person bring something to the table, besides cash, that can benefit my company and me?

Angel Investors

Angel investors are wealthy individuals, or small groups, who help launch small businesses by providing capital. These investors, who expect returns in seven years or so, look for businesses they believe are going to fill a gap in the current market.

Angel investors tend to be successful entrepreneurs who want to stimulate unique business concepts and product ideas. They often specialize in investing in specific industries, so finding the right angel for your business is important.

These investors are experienced businesspeople who will notice if your business plan is filled with unrealistic projections and expectations.

Angel investors think long term and are willing to take risks beyond those of a traditional lender. Typically, they receive an equity share or partial ownership of the company in exchange for their funding.

Venture Capital Firms

Like angels, these investor firms help small businesses expand by exchanging capital for equity or partial ownership. The difference between an angel investor and a venture capitalist is the source of the money — angels invest their own money while venture capitalists invest other people’s money.

Venture capitalists follow more stringent investment guidelines and are not as “emotionally” involved in your success.

They want to invest significant funds (rarely less than $5 million) in high-growth industries. They look to cash out in three to five years.

Venture capitalists play an active role in your company management, such as a board position. Expect these investors to have their own agenda that may not complement your business vision and direction.

EARN IT — CREATIVE WAYS TO RAISE CASH

Some entrepreneurs have discovered nontraditional ways to launch or expand a business. Networking with other entrepreneurs and local established businesses is an excellent way to find creative solutions to financing your company. Here are some creative ways other entrepreneurs have used to earn cash and discounts.

Saving

Trimming costs, taking advantage of banking discounts and rebates, and starting a business savings plan should have first priority. Make regular deposits to start your future.

Bartering

The world’s oldest economic system is a great way to pay for products and services your company needs. The Web has made connecting with other interested parties easy and has introduced bartering programs in which a series of barters can be put into play to earn bartering points.

Buying Groups

These groups maximize vendor/supplier discounts and reduce costs for entrepreneurs needing everything from office supplies to raw materials. Some are free; others have a membership fee.

Rebate Programs, Co-op and Marketing Funds, Support Freebies

These vendor-sponsored programs can be used to reduce your inventory costs, pay for advertising expenses, train employees, improve productivity, and decrease turnaround times.

Competitive Awards

There are local, state, and national “contests” where companies compete for financial and support awards based on inventions, technological advances, excellent customer service, and hiring practices.

Employee Ownership Programs

Earn the money you need to launch a franchise. Domino’s Pizza rose to the second largest pizza chain by assisting employees in owning their own franchise store.

PLEDGE IT — GOOD FOR YOU AND YOUR COMMUNITY

There are private organizations and public agencies that help businesses in exchange for their “giving back” to the community. Their helping hand can come in the form of one of the following:

• Direct grants that require no financial repayment.

• Grants that are repaid from future revenues; zero repayment should your business fail.

• Economic development programs that are designed to maximize your business’s financial impact on the community.

• Location grants that offer a financial incentive to locate or move your business to provide economic stimulus to a community, city, or state.

• “Soft” loans that offer less stringent qualifications and “softer” terms and conditions. These can be no-interest or low-interest loans.

• Tax cuts, deferrals, and deductions that lower your business, personal, or property taxes.

• Subsidies that pay for a portion of the cost of approved products or services. Your repayment is made by actively promoting your use of these goods/services.

• Technology grants and support that transfers technology rights and sharing information that may be worth millions to a fledgling company.

• Support in the form of free advice and access to resources that saves you consulting fees and improves your chances for success.

Your repayment could come in the form of being located in an economically depressed area, hiring special needs or high-risk employees, volunteering within your community, or mentoring others. The financial benefits for your company and your community can be substantial. In addition, being a good citizen never hurts your company’s brand and community image.

SHARE IT — WIN-WIN SITUATIONS

Beyond every successful business is an assortment of people and companies that financially share your success. It is a simple concept — if you sell more hot dogs at your corner stand, the bakery that supplies the buns sells more too. Who in your personal or business life could benefit from your entrepreneurial success? Who might subsidize your idea in exchange?

FACTORING ACCOUNTS RECEIVABLE

Factoring companies exist to buy a small business’s accounts receivable, immediately releasing anywhere from 50 to 80 percent of the value of those receivables directly to the business. The remaining balance is relinquished once the receivables are collected, with the factor’s help, and the factor takes 1 to 5 percent off the top. Factoring is an expensive way to obtain cash, but can work effectively for businesses that do not qualify for any other forms of financing. Beware of missed repayment deadlines and escalating fees; they can keep you stuck in the factoring cycle for daily working capital.

OTHER FINANCING OPTIONS

There are still many different financing options that may be right for your business. Creatively raising capital is what running a business is all about. Very few businesses receive their capital from a single source and those that do usually are not around for long.

The best approach to raising capital is a diverse set of funding sources, each tailored to a specific need of the business. Each type of funding has different benefits and drawbacks, as well as different turnaround times and amounts of paperwork. Here are some alternatives to traditional sources of funding:

• Customer financing

• Purchase order financing

• Credit card financing

• Strategic alliances/mergers

• Leasing versus buying

• Employee stock ownership plans (ESOPs)

Weigh the positives and negatives before determining what alternative funding sources are right for your company. Taking the first source of capital that presents itself can be damaging to your company in the long run.

These funding sources are usually considered supplemental to traditional sources of financing. They are business practices that should be considered to keep your business in good financial shape. Having multiple sources of funding is the best way to finance a venture.

Customer Financing

Businesses recognize that they need one another to survive and this recognition often leads to alliances and teamwork. When one business can help another, and in doing so, help itself, it makes sense to form a good relationship.

Perhaps your company needs a new piece of equipment that will help you serve the needs of your largest customer. Ask that customer for the money to buy the equipment and, in return, fill their orders for free, paying them with credit instead of cash.

This arrangement worked well for American Design, a Seattle ad-specialty manufacturer. They received $30,000 from one of their largest customers to buy a new embroidery machine to be paid back with credit. According to the founder, the deal was fast and easy.

One thing to watch for, though, are the demands the lending company will place on your business. You must specify that they can only have so much product a month or they might order more than you can produce, without infusing any cash into the business.

A standard customer financing agreement has a minimum payback period of six months, depending on the size of the loan. Make sure you specify a minimum payback period that your business can handle.

Purchase Order Financing

Some small banks will extend lines of credit to local companies with whom they have good relationships, based on that company’s contracts or purchase orders. This type of financing is primarily used for solving issues of cash flow. Purchase order financing can help float a business through a busy season, enabling the business to maintain its inventory to generate higher sales.

Purchase order financing allows the company to take on larger orders. The money that ordinarily comes in after the fact is borrowed from a lender and used to help finance the order itself. This financing can help a business grow quickly, providing it stays current with its accounts receivables.

The financing rates on this type of credit line are often high, so entrepreneurs should exercise caution when entering into such an arrangement. When Chelsea Marketing and Sales began purchase order financing in 1991, they eventually had to take out a second line of credit in order to pay for the first. They did manage to retain all of their equity. It was difficult and complicated, but it worked and the company grew to more than $13 million in sales in a short period of time.

Credit Card Financing

When used carefully, credit cards can supply supplemental or emergency cash flow. The “buy now, pay later” philosophy is one that can work well for businesses that may not have the capital needed to pay bills but expect to soon.

Many businesses will try to finance their entire operation using personal and business credit cards. It is not recommended. The interest rates are high, and once you have reached your limit and you no longer have adequate cash flow, you could be out of business. Using a personal credit card to fund a business is in direct violation of the consumer-cardholder agreement. Although it is a breach of contract, thousands of companies do it.

Get a business credit card account. Once your business has established itself, you will notice that credit card offers are coming in by the score. Banks that would never give a small business a loan for $100,000 will extend a $100,000 credit line to the same small business. The interest rates are much higher, anywhere from 11 to 25 percent. The rates are rarely fixed and, if you fall behind on payments, they rise immediately.

Still, these interest costs are often lower than the bank’s loan fees, driving many businesses to use credit cards in lieu of bank loans. This extends the time it takes to pay off the credit card and saves money by swapping balances with another card with a better interest rate.

Credit cards should be used primarily for fast capital that will be repaid in a short amount of time. The longer it takes you to pay off the existing balance, the more the money you borrowed costs you.

Brents Sportswear, while attempting an expansion overseas in the fall of 1996, saw cash flow begin to steadily diminish. The founders, thinking cash-flow loss was temporary, used cash advances of $150,000 on their credit cards to make payroll. The company did not recover, as the owners had hoped. They were unable to pay even the minimum on the balance. The founders’ credit was not completely ruined. Soon after filing for bankruptcy, they were receiving pre-approved credit card offers, claiming that they could help rebuild their now-ailing credit.

On the other side of the coin is a West Coast manufacturer who has figured out how to use credit cards in an effective way. The founder got his suppliers to agree to charge his purchases the day after his card statement closed. Although typical billing cycles are 30 days, this founder was able to extend this period considerably by asking a small favor of his supplier. Because he spends nearly $1 million on that card every year, his Frequent Flier miles pay for all of his business travel.

Credit cards can work both ways for companies. When handled correctly, they can supply a great deal of emergency and short-term funding, sometimes less expensively and more easily than other sources of capital. Using them incorrectly not only can cause the business to suffer, but the founder’s personal credit history also may be irreparably damaged.

To sum up, the good points of credit cards include:

• They are easy to obtain.

• Lines of credit can be as high as $100,000.

• They are accepted almost everywhere.

• The money is immediately available for emergencies.

• Incentive programs, such as Frequent Flier miles, can save money on other expenses.

• There is little paperwork and no extensive forms to complete.

The bad points include:

• The interest rates can be as high as 25 percent.

• Interest rates are not locked and will rise considerably if you fail to make minimum monthly payments.

• Many cards have hidden fees, making them more expensive.

• Mismanagement of cards can ruin your personal credit.

• Having to make monthly payments on cards combined with other loans can cause huge cash flow problems for your business, forcing it into a cycle of debt.

Mergers/Strategic Alliances

Merging with a larger company can be wise if the business considering the merger feels choked by competition or wishes to shift gears and gain capital for a new venture. Many mergers often lead to the founders of the small business either being bought out or being reduced to a minor decision-making role.

Mergers with similar-sized businesses may be a better decision. Combining resources and brain power along with complementary products, skills, and specialties to create a new partnership can be a solution for smaller businesses and increase their competitive advantage against major industry players.

A business in need of capital can ally with a larger business, supplier, or customer that has an interest in its technologies. Often some kind of value is exchanged. The larger company may demand exclusive rights to proprietary products, equipment, or ideas; a long-term purchasing agreement or set pricing from a supplier; specific distribution rights of products in certain locations; or special discount programs.

A strategic alliance can be a win-win situation. There are such risks as being bought out by a larger company, restricting future growth, damaging other business relationships, or potentially violating laws regarding free trade, price setting, or fair competition.

Employee Stock Ownership Plans

For mature businesses that have confidence in their cash flow and earnings potential, Employee Stock Ownership Plans (ESOPs) are a great way to provide internal funding. Employees become investors in the company, which improves morale and drive to succeed.

Once the ESOP is established, it borrows money from a bank or other financial institution in order to buy stock from the company. The stock is purchased from the treasury or the owners and is used as collateral for the bank loan.

The business then uses the money from the sale of the stock for whatever purposes it needs. In exchange, it services the bank loan through tax-deductible contributions to the ESOP.

The lender makes out well too, as half of the interest on the loan is tax deductible. The ESOP is very attractive to many businesses, because it can be a win-win-win situation: the lender gets a tax break, the company gets funding, and the employees get to invest.

Leasing Versus Buying

Leasing can work far better than buying with borrowed money for many small businesses. A major advantage to leasing equipment is that leasing allows you to have up-to-date equipment, avoiding costly replacement as items grow obsolete. Also, leasing is usually less expensive than servicing a bank loan, allowing young businesses to conserve capital.

Businesses spend hundreds of billions of dollars a year leasing equipment. More than 80 percent of all businesses lease at least some portion of the equipment or property that they use.

A lease takes the form of a contract. Your business (the lessee) makes payments of a specific amount to the lessor over the course of the lease. How much is paid and how often are determined by the value of the equipment and its accompanying service agreement.

The two major areas of leasing for businesses are:

1. Equipment leasing in which businesses can lease everything from furniture to manufacturing equipment to fleets of vehicles.

2. Real estate leasing provides storage space, offices, retail space, parking, and warehouses. Also popular is the “sale and lease-back” method of real estate leasing, in which a company sells space to someone in order to gain capital and then leases it back from them.

Differences in Lease Types

There are two primary lease types: the operating lease and the capital lease.

The Operating Lease

Operating leases require smaller monthly payments than standard bank loans. At the end of the lease term, the equipment or property is not fully paid for, leaving what is known as “residual value.”

Once the lease term is complete, the lessee has the option of purchasing the equipment at the residual value, walking away, or renewing the lease based on the residual value. This purchase option is standard on an operating lease.

The lessor is responsible for all of the maintenance and service on the equipment. These service costs are factored into the monthly payments on the lease. Most operating leases come with this kind of service contract. The lessee reserves the right to terminate the lease at any time, even before the end of the lease term.

The Capital Lease

The payments on a capital lease are larger than those on an operating lease because the equipment is paid off in full by the end of the lease term. The lessee does not receive any tax benefits, such as depreciation, associated with owning the equipment. Capital lease payments are comparable to those of a standard term loan. This type of lease is far less common for businesses that wish to conserve cash by leasing instead of buying.

Deciding Whether to Lease or Buy

Although leasing does have its advantages, so does outright ownership. Whichever is going to be less expensive in the long run should not be the only factor in making the decision. Here are some additional items to consider:

LEASING VS. BUYING
Leasing	Buying
• Smaller periodic payments • Service contract • Noncommittal • Smaller down payment • Option to buy • Protects from owning obsolete equipment • Increases company flexibility • Helps cash flow • More equipment can be obtained at once • Preserves capital • Improves credit • Counts as an expense, not as a debt, so leverage stays low	• Ownership • Resale value • Tax savings on depreciation and interest • Usually less expensive in the long run • No restrictions on use of equipment • No penalties for termination of lease or misuse of equipment

Consider your company’s leverage and how much debt it has assumed. Leasing helps keep leverage low by preventing you from having to borrow to purchase equipment.

If you want your business to grow quickly, leasing will provide the opportunity to have more equipment available, which means the capacity to fill more orders, including large orders that other firms in your industry might not be able to handle.

One reason to lease instead of buy is to ensure your business is using up-to-date equipment. Technology is advancing at an unprecedented rate and purchasing computers can be a big mistake, as they may be obsolete before you finish paying for them.

INVESTING IN YOUR DREAM

Whether you want to start a home-based business or build a 100-employee manufacturing plant, you will be your company’s initial investor. In launching a new business, your personal financial history plays a critical role in obtaining credit, avoiding deposit fees, and outfitting your company. Although business experts advise against signing personal guarantees, it may be the only option until your business is credit-worthy.

All entrepreneurs dream of easy, low-interest loans, plentiful investors, and parents who ask, “How much do you need?” The truth is most small business start-ups are self-financed. Ninety-five percent of small business financing comes from personal resources, which means you need to look for every dime you can muster. The first place to start is with your credit.

YOUR PERSONAL FINANCIAL HEALTH

Often after losing one’s job, returning to the workforce from an extended absence, or tiring of being underemployed, an employee begins to consider starting his own business. Each of these situations may have created financial issues that need to be repaired. Improving your personal credit score will help you leverage your creditworthiness and underwrite your business venture.

The first step is to obtain a copy of your credit history and Fair Isaac Corporation (FICO) score from the three largest credit reporting agencies — Experian, TransUnion, and Equifax. The federal Fair Credit Reporting Act (FCRA) requires these agencies to provide you with a free report every 12 months. For complete information, visit www.ftc.gov/bcp/conline/pubs/credit/freereports.htm.

FICO is a scoring system in which your debt-to-income ratio, total indebtedness, and other credit factors are reduced to a numerical credit score. The higher the score, the better your credit rating and the more likely you will be to repay a loan. A strong FICO score means less potential risk for the lender and lower interest rates for you. To learn what your score means, visit FICO at www.MyFICO.com. Check the reports for accuracy. Credit issuers use the FICO score to assess your credit worthiness and income-to-debt ratio.

Fix It

Upon reviewing your credit reports (be certain to obtain a detailed report, not just a FICO credit score), look for discrepancies and errors. Errors, which can range from a simple clerical error to a serious case of identity theft, are common. It is up to the individual to dispute them. Each credit bureau has its own procedure for disputing financial activity; you may have to file multiple disputes for the same creditor error.

If you received your credit report through the mail, information will be provided on how to request an investigation of a disputed listing. Investigations can also be filed online. Check the credit bureau’s Web site for complete instructions.

You will have to write a letter (or complete an online form) explaining why you believe a listing to be incorrect. If you have paperwork supporting your claim, send a copy along with your letter. Your letter should be sent via certified mail with a return receipt requested to prove mailing and receipt. Online claims typically are assigned an identifying number.

You may also want to contact the creditor in writing, requesting a resolution to the error before filing a credit bureau investigation claim. If you do not receive a resolution within 30 days, start the credit bureau investigation procedure. Sometimes getting even obvious mistakes corrected can be difficult. Be diligent and clearly document your case.

Clean It Up Yourself

There are legitimate nonprofit credit counseling services available. Contact them as a last resort. Their methods can get the bill collectors off your back and repay everyone, but using a credit counselor can negatively affect your credit score. If you determine you need credit counseling, contact the National Foundation for Credit Counseling, www.nfcc.org, for a legitimate referral. Do not pay anyone who promises to clean up your credit. The process is a do-it-yourself job.

Improve Your Credit Score

Even if your credit score is low because of valid credit problems, making some changes can boost your score. There is no fast way to improve your credit.

• Contact your creditors about removing poor notations. If you have cleaned up your act, some creditors may be willing to remove older unfavorable entries. Keep your tone friendly and firm. If you are unsuccessful with the customer service person, ask to speak with a supervisor. Keep a log of your conversations. It takes time for changes to appear on your credit report, so it may benefit you to ask for a letter of confirmation.

• Look for errors such as business obligations (which were not personally secured) mixed in with your personal data. Also watch for accounts that are not yours.

• Do not close accounts in an effort to raise your credit score; doing so has the opposite effect.

• If you do cancel accounts, keep the oldest one open to give you a longer history.

• If you have credit cards close to being “maxed out,” transfer balances to reduce the percentage of used versus available credit. The amount of “available” credit on a card is a plus for you.

• Try “rapid rescoring.” In this process, legitimate corrections and credit card payoffs are updated quickly with the credit bureau for a fee. You cannot do this process by yourself; you will need to find a lender who is a customer of a rapid rescoring service to handle this process on your behalf. The fee can run as much as $75 for every account that needs to be adjusted; however, these adjustments can make the difference in obtaining a lower interest rate.

CREATE AN ASSET LIST

Anything of value that can be converted to cash is an asset. If you earnestly want to raise money to start a business, look at every potential source for cash. Converting assets to cash means selling them for the best price you can get. Thanks to the Web and such sites as eBay, Yahoo auctions, and Half.com, selling personal possessions has never been easier.

Start compiling your personal asset list, but remember that cashing in insurance policies, bonds, and other investments is risky.

Asset List
Asset Category	Items with Potential Value	Converting to Cash
Cash	Savings and checking	Not required
College funds	College savings	Beware; raiding college funds can be too “easy” and are difficult to replace
Investments	Stocks, bonds, mutual funds, etc.
Retirement	401k, pension plans, Roth IRA, IRA	Beware; may trigger federal and state tax penalties and income taxes
Insurance	Life insurance
Home(s)	Home, rental property, vacation homes
Vehicles	Recreation vehicles/property
Antiques and collectibles	Artwork, coins, stamps, sports memorabilia, books	eBay, consignment shops
Personal possessions	Household goods, clothing, electronics, etc.	Garage sale, consignment shops, classified ads, eBay

OTHER ASSETS

Other Ways to Raise (or Save) Cash

• Collect on outstanding debts owed to you.

• Ask for deposit refunds from utilities.

• Take advantage of all early-pay or cash discounts.

• Whenever possible, avoid delivery or shipping charges.

• Join a co-op or buying group.

• Open wholesale accounts and ask for commercial discounts.

• Negotiate long-term customer discounts based upon future purchases.

For some home businesses, a successful garage sale may be enough to pay for the necessary business licenses, equipment, and business cards to get you started.

BARTERING

Although bartering is still a taxable activity based on value exchanges, it can be an excellent way to obtain what you need now, allowing you to deal with tax implications later. Your accountant can advise you on how bartered transactions are taxed.

Bartering can be done on an informal basis directly between you and local suppliers or through a barter exchange. Barter exchanges have an advantage in that you can earn “points” that can be spent with other exchange members.

Say you sell computer printers and need some photography for a brochure. Through the exchange you find someone who needs a printer. The exchange is made and you receive 1,000 barter points that you spend with a local commercial photographer. The commercial photographer uses the 1,000 barter points you “paid” him to obtain the business cards he needs and has points left for another need.

When bartering, be specific about what you have to offer and what you seek. Agree on the value of each item traded. When exploring bartering, be aware that “over-bartering” can adversely affect your cash flow.

NEITHER A LENDER OR A BUYER BE

These wise words from William Shakespeare offer sound fiscal advice, but the bard was actually referring to the personal problems borrowing can create: “For loan oft loses both itself and friend.”

To make your entrepreneurial dreams come true, you may have to visit the Bank of Mom and Dad. Universally, more than half of all start-up capital comes from family and friends. In fact, experts believe family or friend loans and investments easily exceed all monies invested by venture capitalists.

Family or friend financing can be through a loan, a gift, or an investment. The following will explore each and help you avoid potential pitfalls.

SHOULD YOU ASK?

The following are some things you should think about before you ask your family or a friend to help finance your business venture.

• Is there money available? Not all families are open and honest about their financial status, so money may not be available for lending.

• Do you feel “entitled?” Money can cloud your judgment, trigger “entitlement” issues, and create animosity, particularly among siblings.

• Can they afford to “lose” the money? Should your business fail, will they be at financial risk?

• Will you treat them as a creditor? When cash gets tight, will you let payments slide because they will “understand” better than the bank?

• Could you lose a friend or alienate a relative? If you are unable to repay the debt or if the investment does not yield what you promised, will it affect your relationship?

• Is it a loan, a gift, or an inheritance “payout?” Be clear and formalize the transaction. A written “statement of gift” or contract will clarify the transaction. If it is a loan, you want to be able to deduct the interest. If it is a gift, you will need to meet IRS regulations to avoid additional taxes.

• Can you protect their investment? Unless your relative is a professional investor or banker, he or she probably is not appropriately cautious about assessing the risk. Likewise, accepting money from people you care about increases your responsibility to accept and spend it wisely.

KNOW HOW MUCH YOU NEED

When seeking financial support, determine how much you need, when you need it, and when you can repay it. Inadequate financing and poor cash flow increases your family’s or friend’s financial risk. As you review your plan and assess your potential for success, factor in the personal costs of losing their investment or gift.

BORROWING FROM FAMILY OR FRIENDS

Borrowing from relatives or friends can be the easiest (and sometimes the only) way to accumulate enough seed money for your new business venture. Whether you need $1,000 or $100,000, it is in everyone’s best interest to follow sound business practices when borrowing from acquaintances. It is tempting to be lax and forget to sign a contract or not set an appropriate repayment schedule. Borrowing money on a handshake can create problems for you later on. You should negotiate fair loan terms and sign a formal loan document.

Deduct The Interest As A Business Expense

A contract or promissory note is your proof to the IRS that the loan is a legitimate business loan and not a personal loan where interest is not tax-deductible.

The Irs

The IRS has regulations regarding gifts and loans. For this financial change to be considered a loan you will need to:

• Have an enforceable agreement such as a promissory note.

• Pay an appropriate interest rate. Low- or no-interest loans may be classified as gifts, thus triggering gift taxation rules.

• Have a reasonable repayment schedule. Loans with no repayment schedules also may be deemed as gifts.

• The lender must include interest paid as other income.

LOAN AGREEMENTS

Your loan agreement can be a verbal commitment; however, getting it in writing is a much smarter way to do business. If you are uncertain what necessary elements should be outlined in the note, seek legal advice.

Promissory Notes

A promissory note is a written promise to repay a set amount within a set period plus a specific amount of interest. It does not need to be notarized to be valid and can be completed by both parties. For smaller dollar amounts with simple terms, a do-it-yourself promissory note may be all you need. You and the lender will sign one original, which is kept by the lender. Once you repay the note, the original is returned to the borrower.

You can find fill-in-the-blank promissory notes at your local stationery or office supply store, as part of business form software packages, or free online at Internet Legal Research Group, www.ilrg.com/forms/promisry.html.

For larger sums and more complicated repayment terms and conditions, you should have an attorney prepare the note. It is also in your best interest to have an attorney review any loan agreement prepared by the other party.

Circle Lending, www.circlelending.com, is an online resource for financial transactions between family and friends. For a fee, this service will prepare and administer (accept payments) your promissory notes for a fee.

ASKING FOR A LOAN

Here are ten guidelines to help you obtain financial support from family and friends. Remember that this support is a business transaction based on your personal pledge of repayment; failing to honor your commitments can end friendships and divide families.

• Start by explaining your idea using your “elevator pitch” and ask if they might be interested in providing some financial support.

• Make an appointment for an appropriate time to talk and share your business plan.

• Provide a copy of your complete business plan to be read later.

• Be prepared to discuss your commitment and intentions. Assure them that you are entering this arrangement with a signed note and consider this a business deal.

• Do not let your excitement improperly color your presentation. It is easy to get overly excited and overstate the potential for success when you are talking to friends or family members. You want them to enter into this arrangement knowing all the facts.

• Make a full disclosure. When presenting yourself and your business plan to a professional lender or investor, you will do everything you can to present your case positively and honestly. It is wise when dealing with a friend or family member to be as open and honest as possible. You want the money, but you do not want them to make a poor financial decision.

• Understand that borrowing from family and friends always comes with hidden strings. Your personal connection opens the door to unsolicited advice, unspoken expectations, and disappointments. However, it can also be a wise investment with ample rewards for everyone.

• Schedule a time to return to discuss your plan along with repayment terms and potential investment earnings. Return with a promissory note outlining all details. Encourage them to have their attorney review the document before signing.

• Do not make assumptions that a friend or relative will overlook a late payment or that the loan will “disappear” should your business fail.

• If this arrangement is an early payout of a trust or inheritance, see your attorney and your accountant regarding tax and inheritance implications.

THANKS FOR THE GIFT

Depending upon your family circumstances, your proposal to borrow money for your business may be answered with, “How about if we give you the money?” Often parents and other relatives continue to feel a sense of responsibility for the well-being of their adult children; others simply enjoy sharing the wealth and helping you realize your dreams. Few gifts, however, are without strings.

Some strings may be hidden or implied ones that parents can attach. Will the money be spent wisely? Do you really need that much? How about we give you the money and you can hire your younger sister too? You know your family dynamics — what strings might make this gift unacceptable for you?

Keep in mind that there are federal tax laws regarding financial gifts and some states have gift taxes. Gift taxes occur when you transfer any property (including money) to another without expecting something of at least equal value in return. If your mother deeds you a piece of property to build your business, it is considered a gift.

The IRS works from the viewpoint that all gifts are taxable with exceptions, such as:

• The gift is less than the annual exclusion amount (in 2005, this is $11,000 per giver, so your mother and father together could give you $22,000 before it becomes taxable).

• The gift is from a spouse.

• The gift is to a qualified political or charitable organization.

• The gift pays for tuition or medical expenses.

For gifts worth more than the annual exclusion, refer to IRS Publication 950, Introduction to Estate and Gift Taxes. Your investment counselor, attorney, or CPA should be consulted regarding taxable gifts. These gifts are not tax-deductible for the giver.

MONEY FROM TRUSTS AND INHERITANCES

There are many different types of living trusts through which family assets are administered, each with its own set of stipulations. Before withdrawing funds from these, speak with your financial adviser as to potential penalties and tax obligations.

Usually an inheritance is willed after the death of a loved one. However, like living trusts, inheritance trusts are set up to administer assets that will be passed on at death. These assets are not passed on to individuals but to the trust. If the funds are coming from a family member’s inheritance trust, the administering trustee will outline the proper procedure or changes required for an early distribution.

YOUR LOAN PROPOSAL

Loans are about trust and risk. Lenders want to trust that the loan will be repaid and to risk as little as possible. Your loan request should be a reasonable amount and you should document how the money will be spent and that you will meet the scheduled payments.

The loan proposal acts as your ambassador. Even if a lender believes in you, agrees your business is worth the risk, and is impressed by your business savvy, other decision-makers in the organization may not agree. Ultimately, it comes down to your loan proposal.

MORE THAN AN APPLICATION

You have probably obtained a mortgage, car loan, or credit card, so you are familiar with loan applications. Commercial lenders will have a standard loan application form that you will complete and SBA-backed loans usually have a complete application package. A few lines on a form cannot tell the story of why you should be granted the loan. Many lenders allow you to provide additional documentation that supports your ability to repay the debt, explains potential problems, and builds confidence in your business concept.

A good proposal will contain everything the lender needs to know in order to be convinced that you are a competent entrepreneur, that your business is capable of growth, and that you are not a high credit risk. Be complete, neat, and organized.

Many loan proposals are immediately rejected simply because they are messy. Most lenders refuse to sift through disorganized paperwork. It reflects poorly on your business and indicates a potential management problem.

Essential Components of a Loan Proposal

Including a full business plan with your proposal is a good way for lenders to get to know your business. Of course, the plan should be modified to suit the needs of the lenders, as opposed to the needs of investors.

Loan Request Summary

• No longer than two to four pages.

• The amount you hope to borrow.

• How the money will be used.

• Type of loan applied for (line of credit, term loan, etc.).

• Repayment schedule and source of repayment.

• Collateral offered.

• Financial performance summaries: past, present, and projected.

FINANCIAL STATEMENTS

The type of financial statements you must provide depends on the stage of growth in which your business is in.

Financial STATEMENTS BY BUSINESS TYPE
Start-up Businesses	Established Small Businesses	Larger Businesses
1. Projected balance sheets and income statements for the next three years. 2. Owners’ personal financial statements. 3. Social Security numbers for checking owners’ credit reports. 4. Detailed information about the collateral pledged.	1. Historical balance sheets and income statements from the past three years. 2. Projections for the next three years. 3. CPA-audited financial statement or tax returns, depending on the lender’s needs. 4. Owners’ personal financial statements.	1. Historical balance sheets and income statements from the past three to five years. 2. Projections for the next three to five years. 3. CPA-audited financial statement, assuring that your financial statements conform to GAAP (generally accepted accounting principles) standards. 4. Owners’ personal financial statements.

Make sure your projected balance sheets, income statements, and cash flow projections are achievable. The lender will often condition the loan based on calculations from your projections, so do not think you will not be held to them. Break down the projections for the first year by month. Projections for following years may be broken down quarterly.

Summarize key points for the lender on a separate summary page. Also include a page of explanations for anything in your financial statements that might be misinterpreted. This page will prevent the lender from making any false assumptions about the status of your business. Clarify — up front — anything you think might be misinterpreted.

You may also include the following:

• Collateral value summary.

• Appraisals of property.

• Inventory value summary.

• Accounts receivable and payable summaries will help the lender determine how long it takes customers to pay you and how long it takes you to pay suppliers.

Researching your lender’s specific financing guidelines and providing the necessary information in an organized and efficient manner expedites the loan process.

YOUR FINANCIAL STATEMENTS

Keeping track of a business’s accounts can be a complicated endeavor, which is why most businesses keep an accountant on staff or use an accounting firm. When doing business, every transaction needs to be documented, tracked, and organized, making it much easier to compile financial statements at the end of the month, quarter, or year.

The four most common types of financial statements and their components are income statement, statement of capital, balance sheet and cash flow statement. See the chart below for the components and applications of each type.

Financial STATEMENTS TYPES AND COMPONENTS
Type	Components	Applications
The Income Statement	1. Categorized revenues from a single business period. 2. Categorized expenses from a single business period. 3. Difference from revenues and expenses indicating net income or net loss.	1. Represents bottom line. 2. Indicates where money is being spent. 3. Indicates where money is coming from.
Statement of Capital	1. Owner’s capital account (how much of the business he owns). 2. Net income or net loss from a single business period (as derived from income statement). 3. Change in owner’s capital account based on net income or net loss (any net income becomes the owner’s).	1. Helps owner to decide whether to reinvest net income, keep some profit as personal income, or withdraw completely. 2. Indicates to owner whether or not his personal stake is at risk.
The Balance Sheet	1. Listing of all current assets (everything a business owns). 2. Listing of all current liabilities (everything a business owes to creditors). 3. Value of owner’s capital account. 4. Company’s financial condition (liabilities + owner’s equity = assets).	1. Indicates a company’s financial condition at a specific moment in time, as opposed to a full business period. 2. Helps owner get a clear picture of assets and liabilities.
Cash Flow Statement	1. Categorized list of all sources of income for business (sales of assets, revenues, financing, etc.). 2. Categorized list of ways income is used (purchases, debt repayment, operating losses, etc.).	1. Indicates whether business’s cash flow is increasing or decreasing. 2. Helps owner monitor possible cash flow problems.

Financial statements are like a heart monitor for business. Without them, it would be impossible to recognize downward trends or to know when to enact countermeasures to reverse these trends. Work with an accountant to make sure you understand these documents. Otherwise, you may not notice the early warning signs of an impending disaster.

Having accurate financial documents also can help you gain financing, as these statements are often included in your business plan or loan proposal. Investors and bankers are going to feel more comfortable about investing in a business that keeps track of its money in an organized and communicable way.

After you have completed your business plan, you will know your current and future financial needs. Once you have determined how much money is needed at each stage, look for sources of financing.

No matter how much capital you need to launch a new business, your personal financial resources are the first place to look. Investors and lenders will not come on board unless you have made a significant financial commitment.

HOW TO WRITE A LOAN PROPOSAL

Approval of your loan request depends on how well you present yourself, your business, and your financial needs to a lender. Lenders want to make loans, but they must make loans they know will be repaid. The best way to improve your chances of obtaining a loan is to prepare a written proposal.

Components of a well-written loan proposal

General Information

1. Business name, names of principals, Social Security number for each principal, and the business address.

2. Purpose of the loan — Exactly what the loan will be used for and why it is needed.

3. Amount required — The exact amount you need to achieve your purpose.

Business Description

1. History and nature of the business, including details of what kind of business it is, its age, number of employees, and current business assets.

2. Ownership structure, detailing the company’s legal form.

Management Profile

1. Develop a short statement on each principal in your business. Provide background, education, experience, skills, and accomplishments.

Market Information

1. Clearly define your company’s products as well as your markets.

2. Identify your competition and explain how your business competes in the marketplace.

3. Profile your customers and explain how your business can satisfy their needs.

Financial Information

1. Financial statements — Balance sheets and income statements for the past three years. If you are starting out, provide a projected balance sheet and income statement.

2. Personal financial statements on yourself and other principal owners of the business.

3. Collateral you would be willing to pledge as security for the loan.

HOW YOUR LOAN REQUEST WILL BE REVIEWED

When reviewing a loan request, the lender is primarily concerned about repayment. To help determine this ability, many loan officers will order a copy of your business credit report from a credit reporting agency. Work with these agencies to help them present an accurate picture of your business.

Using the credit report and the information you have provided, the lending officer will consider the following issues:

• Have you invested savings or personal equity in your business totaling at least 25 to 50 percent of the loan you are requesting? A lender or investor will not finance 100 percent of your business.

• Do you have a sound record of creditworthiness as indicated by your credit report, work history, and letters of recommendation?

• Do you have sufficient experience and training to operate a successful business?

• Have you prepared a loan proposal and business plan that demonstrate your understanding of and commitment to the success of the business?

• Does the business have sufficient cash flow to make the monthly payments?

There are many other ways to get financing for your business. For this information and much more, I recommend How to Get the Financing for Your Small Business (Item # HGF-01) from Atlantic Publishing, www.atlantic-pub.com. I covered some of the information from that book within this chapter, but there is much more to learn and the book contains extensive resource listings for financing options and procedures on how to acquire less conventional financing.

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