Financing for a small business can come in a variety of forms and is the foundation for a successful business. We encourage all entrepreneurs and business owners to investigate a variety of financing options.
Equity vs. Debt Financing
There are numerous community resources that can educate business owners on the financing process and where to locate private investment from either venture, seed, or angel investors. In order to grow, a company will face the need for additional capital, which it may try to obtain in one of two ways: debt or equity.
When a company borrows money to be paid back at a future date with interest it is known as debt financing. It could be in the form of a secured as well as an unsecured loan. A firm takes up a loan to either finance a working capital or an acquisition. Debt financing is a time-bound activity where the borrower needs to repay the loan along with interest at the end of the agreed period.
Your options for debt financing extend far beyond the traditional bank loan. As the alternative lending market has grown, so too have the types of debt financing available to small businesses. Debt financing can be used to generate smaller amounts of capital ranging from $1,000 to $100,000. Traditional sources of debt financing vary but some examples are Small Business Administration Loans, Term Loans, and Financing Options.
Examples of Debt Financing Include:
• Term Loans
• Government Assisted Loans
• Asset-Based Financing
• Demand Notes
Equity financing is when a company raises capital by selling company stock to investors. In return for the investment, the shareholders receive ownership interests in the company. Equity financing involves the sale of the company's stock and giving a portion of the ownership of the company to investors in exchange for cash. The proportion of the company that will be sold in an equity financing depends on how much the owner has invested in the company and what that investment is worth at the time of the financing.
In equity financing, someone invests money in your business in return for a percentage of ownership. Equity financing may come from a private or “angel” investor, a friend or family member, or by selling shares in your business to investors. There are also institutional forms of equity financing, such as venture capital. Venture capital funds aggregate and manage money from wealthy investors, then invest it in fast-growing businesses. Equity investments generally occur for larger investments ranging from $200,000 to millions of dollars; if your business requires a smaller sum, then debt financing is your best option.
Examples of Equity Financing Include:
- Informal Investors
- Private Stock Offering
- Venture Capital Funds
- Initial Public Offering
To get more information on equity and debt financing options, you can contact a local banker in our community who will be glad to assist you with your financing needs.
Grants & Incentives
The City of Greenville has a variety of grant opportunities available to entrepreneurs and existing businesses that are expanding. These grants are highly sought after and are awarded competitively. To learn more about the grants and incentives offered by the City of Greenville, click here.
Expectations of Lenders
A lender wants to be assured that your company can and will repay the loan as agreed, and that the loan will not burden you with too much debt, which could cause you financial problems.
To get this assurance, the lender will evaluate your business plan to learn about you, your associates, your objectives, and your plans for the company. The lender will be looking for the “Five Cs” of credit:
- How much of your own money do you have invested in the business?
- How much do you have in reserve, in case of unexpected needs?
- What is the fair market value of the security that you are offering to guarantee repayment of the loan?
- Does it meet the classic criteria for good collateral?
- Ease of transfer of title
- Low cost/no cost to maintain/service
- Increasing in value
- A ready and liquid market
3. Capacity to repay
- How much profit will your company generate?
- Will your cash flow provide you with enough money on a regular basis to cover the repayment of the loan?
- Are your projections for sales and profits realistic when compared to other firms in the same industry?
- What are the economic, demographic and regulatory trends which impact your business?
- What terms can be negotiated to allow the bank to evaluate the risk/reward considerations?
- What is your track record- personal and professional- in managing finances and paying credit obligations?
- Who are the key managers in your business; do they have the experience and ability to run this business successfully?
How Will Lenders Evaluate Your Proposal?
The lender expects the borrower(s) to have already invested from 10 to 30 percent of the loan amount. If your business has existed for less than 3 years, plan for 30 percent.
2. Debt-to-worth ratio
This is usually most critical on the first day after loan approval and at the end of the first year of operation. This ratio is calculated from balance sheet dates which the lender will predetermine.
Lenders require sufficient collateral to protect assets which reflect the following liquidity:
- Certificate of deposit 100%
- Real estate 75-80%
- Stock (publicly traded) 75%
- Vehicles 75-85%
- Equipment 50-75%
- Accounts receivable 50-75%
- Inventory 0-50%
4. Ability to carry debt service
The cash flow projections normally reflect this.
5. A secondary source of repayment
Important especially in start-up venture (e.g. spouse has a full-time position).
6. Personal guarantees
All parties to the loan request must be willing to pledge guarantees. Personal guarantees state that the borrowers truly believe in their venture.
Tips for getting and using small business credit
- Be straightforward and honest in dealing with lenders. Stress your strengths, but admit your weaknesses. If you’ve had credit trouble in the past, be open about discussing what went wrong and how you corrected the problems.
- Be prepared with a business plan. A business plan is your best representative for communicating your plans and expertise to a loan officer.
- Understand what you are getting into. Make sure that you clearly understand the repayment terms and the cost of the credit you’ve chosen.
- Be patient. Not everyone will get a loan the first time out. If you don’t, make sure you understand why you did not qualify and what you need to do in order to be approved in the future.
- Understand the risk associated with borrowing. You will be expected to provide security for your loan which means putting your personal assets at risk.
Source: SBTDC Business and Start-up Resource Guide