Small Business Advice: The Importance Of Financing

Financing is the lifeblood of capitalism - and its most carefully controlled resource - arm yourself with information and prepare to do battle!

There are several reasons you might be looking for financing:

- You are starting a new business;

- You want to expand your existing business; or

- You are looking for short-term financing for a crisis.

Following are the most likely sources of financing for each situation, depending on the scale and profile of your business.


The hardest time to raise money for your business is before you have one. With a typical failure rate of 70% for new businesses within their first two years, you'll be facing a wall of skepticism. To surmount that, you'll need a business plan that identifies your niche, your strategy and your budget and explains why you will be in the 30% that do succeed. As you write your business plan, you'll want to know whom you are pitching it to, so determining the most likely source of funding is a good first step.

VENTURE CAPITAL - This is the least likely source of funding. Venture capitalists usually have a narrow focus, such as software or technology. If you think your idea might be eligible and you expect sales of over five million annually, check industry publications to see who has financed similar startups; network at tradeshows; and ask for suggestions from successful entrepreneurs, their accountants and lawyers. A venture capitalist is usually not risking their own money, but rather acting as a front man or woman representing a pool of investors. They have a specific mandate - to take a position in company that offers a very high rate of return.

BANK LOANS - It will take more than a dream to get a bank to put their capital at risk. If you already own a small business with a successful track record of at least three years duration, or have a substantial personal net worth and a proven management team, a bank may be willing to finance a new venture, as long as the loan is secured by appropriate collateral. The right bank is usually one you already bank with, but shop around as well - some banks are actively looking to finance small businesses of a certain size or type. You can prepare with the following steps:

1) Identify your own investment. This can be cash or assets such as real estate or equipment (i.e., the van you will use for your catering venture). Do not expect to borrow more than what you are investing yourself or receiving from other investors.

2) Assemble your records. The bank will want financials for an existing business, for the last three years, preferably reviewed by an accountant, along with business tax returns. Be prepared to explain the history of any drastic variations in income or profitability. Stability, low debt to equity ratios and healthy cash flow are positives.

3) Prepare your personal records. Unless you have a long history with a commercial bank, your personal guarantee will be required on the loan. This means filling out information including banking, investments and of course providing copies of your income tax returns. This also applies to other equity investors if their assets will be considered collateral for the loan.

4) Polish your business plan. You will need to provide detailed sales and cash flow projections for the new business. Do not underestimate your capital needs and make sure you include a salary or some form of compensation for your own time. Make sure you account for seasonal variations in your financial projections. Prepare yourself to back up the numbers.

5) Build relationships. If you have a mentor or can attract a partner who already has an established business and a relationship with a bank, this can be a very good way to get past the catch-22 of needing to have a track record before you even start.

SMALL BUSINESS ADMISTRATION - Don't forget to take a look at the Small Business Administration's web site. This government agency's stated mission is to "aid, counsel, assist and protect" small businesses, particularly those that historically have had trouble getting financing, such as minority businesses or community-based micro businesses. A bank still lends you the money, but the government guarantees a portion of the loan. It's not a handout, just a helping hand. Remember that if you have any personal tax arrears, your business will not qualify for an SBA loan.

EQUITY INVESTORS -If a bank won't bite or you need more capital before you apply, think about private investors. You'll need a written agreement identifying the role of the equity investors, whether as "silent partner," expecting only basic financial updates, or actively involved in major business decisions. Other issues include whether they will have voting rights, signatory rights, whether there will be additional cash calls, or equity dilution, and how they will be bought out in the event of a dissolution of the business. You will likely need a lawyer to draft or at least polish the agreement. Even if your business starts very small, it might expand rapidly, so make sure you are not giving away the store merely to secure financing. The ideal equity investor is a mentor, particularly in a related but non-competing area, able to help you in countless ways that are well worth the payout.

There are two sources of equity investors:

1) Outside Investors - Look for business associations, web bulletin boards and other places where people with an interest in your industry congregate. You can either advertise if there is an appropriate venue, or try to build relationships. Don't try and solicit investors directly in a discussion group, but you can ask for advice on how to find investors, for example. Best of all is to turn cyber relationships into face-to-face meetings where you can better gauge the seriousness of any interest before you turn over your business plan to a stranger.

2) Friends and Family - Think long and hard about this one. You are putting relationships at risk as well as capital, sometimes even by simply asking for money. Even if your business succeeds, what if a niece or nephew falls seriously ill and your brother suddenly wants to withdraw all his capital? A carefully drafted written agreement, along with a contingency plan is doubly important here. Be sure to include a reasonable rate of interest, or your agreement might be seen with a jaundiced eye by a court of law.

YOUR OWN SAVINGS - If you don't have a track record, or there are some credit issues in your past, you may have to look to your own savings and investments (some life insurance policies will allow you to borrow). You may simply want to save all the return on your business for yourself, or you find the process of seeking investors too daunting. It's critical to ask the following questions:

1) Is your business venture going to deliver a better or at least equal rate of return to your current investments? Make sure you don't drain your savings to the point where you are unprepared for personal emergencies.

2) Consider the emotional impact on your spouse, family or other interested persons. You will need to put on paper a plan that imposes limits on the amounts of money you will put at risk, and train everyone to think in a business-like way about the risk you are taking. Otherwise an emotional crisis could derail your business at a critical moment.

UNSECURED DEBT - Starting a business using credit cards can have a very high price tag, including personal bankruptcy if the business fails. You will be paying a very high rate of interest and the only one to show a net profit from your efforts will be the credit card company. Also, the ease of access of credit cards can tempt you into not preparing an adequate business plan. If you have already started your business this way, look at ways to refinance that credit card debt at a lower rate of interest.


So you have a business, things are ticking along, but there are opportunities you simply can't seize because you don't have the cash to expand. Before you start looking around for money sources, you need to define whether your needs are seasonal (short term) or growth related (long term). IF your needs are seasonal, a bank credit line, credit cards or factoring are options; if long term, you will need to apply for a bank loan or seek equity investors (covered above).

CREDIT LINE FROM YOUR BANK - if your business has excellent fundamentals, this is the cheapest short-term cash. The catch is that you have to have planned ahead -- the time to apply is when your business is in good shape. Banks apply the following criteria:

1) The Debt-to-Equity ratio. Review your balance sheet. The amount of debt should be less than half your equity (assets minus liabilities). If it isn't, consider how you can reduce your debt to an acceptable level at least temporarily. It is important to note that different countries have different debt-to-equity ratios that are acceptable. In countries like Singapore where sme loans are the norm, individuals starting businesses are able to find low interest rate loans due to the government of Singapore encouraging low interest rate loans to increase entrepreneurship. These low interest rate loans are less risky to take out than those with higher interest rates, and often times have longer payback periods.

2) Additionally, the bank will look to see if your receivables and cash on hand meet or exceed your current liabilities. Note that they will not include receivables over 60 days in this formula. You are better off putting dramatically past due receivables in collections than to have them be too high a percentage of your receivables.

CREDIT CARDS - The advantage of unsecured debt is that no questions are asked. However, don't use your personal credit cards to make a loan to your company without documenting it properly and paying yourself back any interest you have incurred.

FACTORING AND COLLECTIONS - One source of cash is often your own receivables. In certain industries, a factoring firm will buy your accounts receivable at a discount, based on their risk assessment, and the amount of monthly billings (generally over $10-15 thousand a month). Of course you lose some of your income as they take a percentage. Another option is take your collections to the next level yourself, even if it is your most dreaded task. If you are persistent and consistent in your efforts you can dramatically improve payment schedules for the future as well.


If your business is at least three years old, has shown a steady rate of growth and is ready to graduate from a local to a regional or national market, it may be interesting to a venture capitalist. It is critical that the management team appears capable of making the transition to the next level. Brush up as best you can on skills and presentation or expect to relinquish substantial control of the company in order to acquire the resources to expand. Because venture capitalists are looking to take a strong position in the companies they finance, if you are overleveraged, it will be tough to get additional funding without giving up significant control of the company. If you are in a weak position, equity financing can become a takeover situation very easily. See the section on venture capitalists above.


If your business has been a victim of some kind of natural disaster, such as a hurricane or flood, and your premises or equipment has been damaged, or a military reserve unit calls up an essential employee, a first line of defense is often the SBA. Where you might be eligible for a loan at a very low rate of interest. Read the parameters carefully at the SBA website to see if you qualify for such a loan.


If all this sounds like a cautionary tale, it is - remember that 70% failure rate? Overall, a long-term strategy is essential to getting and keeping financing. It's a lot of work to get financing, but if you put your small business on a sound financial footing by adequately capitalizing, you'll be able to reap the rewards of your hard work much sooner and with less stress.

© High Speed Ventures 2011