This is the second part of a 3 part series on “cash is king”. In the first part, I wrote as to why you need a business plan before you seek any funding for your business, and what the key elements are, that goes into a business plan. Before you go out and seek funding for your business, it important that you have a business plan. Please read my article “Cash is king – Plan! Plan! Plan! – An essential requirement before you seek funding for your small business!”
What are the different regular and alternate funding sources?
Most folks have heard of bank loans, credit cards, bank loans, friends and family, and venture funds, as possible sources of funding. However, there are many other alternate sources for funding that a small business owner can and should consider.
In these trying economic times, the traditional lending sources such as banks, venture funds and others have raised their bar, as to whom they would lend to. Therefore, it is essential for the small business owner, to know other alternate sources for funding for their start ups or for expansion of an existing business.
Before I discuss the various regular and alternate funding sources, there are a few essentials that a small business owner should follow, or put in place before you go about on your funding endeavors.
The 12 essentials
Here are my twelve (12) essentials that I would urge you to follow, before you start your small business funding endeavors.
- Business plan – Have a business plan!
- Credibility – Establish personal credibility and reputation in your community or social circle.
- Credit – Maintain a good credit rating
- Confidence – Be confident
- Perseverance – Be prepared for rejections – Don’t give up
- Passion – Show a sense of passion – after all, you are the Chief Believer!
- Pitch – Have an elevator pitch – A summarized pitch of your business to be articulated to potential funders in no more than 3 minutes
- Professional – Dress appropriately for the business that you are in.
- Punctual – Always be punctual for any meetings with potential funders.
- Preparedness – Rehearse your business plan presentation.
- Presentation – Have a professional looking and polished presentation summary of your business plan, as well as a detailed version of your business plan.
- Personal – You should personally articulate your vision, mission and commercial model – It is alright to have the consultants beside you, but you should make the critical part of the pitch yourself.
What are all the funding sources available to a start up or a small business?
There are many funding sources available to a start up or a small business. Some are the obvious ones, whilst there are others that you might have not heard about.
Funding your entire business with your personal savings is not the most prudent thing to do. As most start ups fail, it is not smart and fair to you that you have to put all your “eggs in one basket”.
However, if you can afford it, then using a portion of your personal savings is definitely a boost in your overall funding endeavor, as it will show your commitment and “skin in the game”, to other potential lenders and investors.
Keep in mind that the journey is going to be very tough, and therefore any personal investment from you should be sourced from the sale of an asset that you are not currently using – like an extra property or vehicle. If you do have a chunk of your own extra money sitting in a bank, by all means invest in your business of choice. A point to note is that, if you do have a chunk of money sitting idle in the bank, then you probably would not be reading an article on sources of funding.
A word of caution – Before you invest with your hard earned personal savings, please take a step back and consider seriously the impact it will have on your family and yourself. If you still feel that you must, then you are probably on to something that is worth the effort and the risk.
Family and friends
Most small businesses fund their start ups with money from their immediate family or friends. If your boot strapped company is in dire need of cash, and if you have a family member or friend willing to invest, it is a path that you should consider.
Unless you are in a bubble economy or have some unique technology patent, most friends and family are not investing in the business, but rather they are investing in you personally.
A word of caution – the $10,000 that Cousin John dished out might come at a high price – like requests for employment for all kith and kin and or unnecessary interference on your time and business.
Since most family and friends are investing in a person rather than a business, it is recommended that funding from friends and relatives be started off as a loan rather than an equity participation in your business. This loan should of course be structured with a formal agreement and repayment plan. This way, you can mitigate future unwarranted interference in your business.
Funding a start up or an ongoing business with personal credit cards is more common than you think it is. About 30 years ago, it was considered “non-passé” or “not credit worthy” or imprudent to use your credit card to fund your business. Today, it is not a practice that is not frowned upon, nor is it considered risky.
Before you start on a credit card splurge for your business, be aware of the high interest rates that credit cards charge. Also do keep in mind that cash advances on a credit card carries with it much higher interest rates.
Credit cards should only be used to fund emergencies in your business. Do not use credit cards to fully fund and mange your business. Credit cards should only be used as a mezzanine or stop gap measure for interim working capital or inventory management.
If you do use credit cards to fund your business, ensure that the pricing of your goods and services reflect the relatively higher interest rates that you are paying to fund your business, through the usage of credit cards.
Also, ensure that you choose the credit cards from providers offering interest free financing, for longer periods of time.
A word of caution – Do not max out your credit card limits by paying the minimum monthly payments. If you are prone to paying the minimum payment, then this important source of funding will just not be there, when you need it most!
The term “angel investors” originated from Broadway where wealthy folks who funded theatrical productions were called “angels”.
Angel investors are generally a group of successful folks who have extra money at hand to invest. Angel investors understand the risks they are taking and therefore expect a much higher return for the increased risks that they are taking.
As most start ups fail, the increased returns that they expect are fair because it is more likely than not, for them to lose the investments completely.
Before you approach a group of angel investors, it is important for you to know the objective of the angel investor. Of course, most of them are taking part in this high stakes game for the expected high returns. Also do keep in mind that since most of them are successful entrepreneurs or former business executives, there are other reasons why they fund start ups. These can range from their need to keep informed of the latest trends in technology, to networking to opening an avenue to share their business experience and networks. Therefore it is important that you position you company and yourself to match the angel investor’s objectives.
Most angel investors know that you will need additional funds to scale your business. Therefore, one thing to keep in mind when you negotiate the term sheet is that you should alert the angel investor on your anticipated future funding needs. You should offer the angel investor the option to invest in subsequent rounds, as well as alert them of the high potential for dilution of their equity.
An important note on angel investors: If you have found an angel investor interested in your start up and one who does not want to invest his or her due to other commitments – One option is to leverage the angel investor’s asset base and reputation to guarantee a bank loan for your small or start up business.
Bank term loans
There are many forms for bank loans available for the small business. They include bank overdrafts to term loans. A bank overdraft is seldom given to a start ups with no established cash flows.
Term loans are the most common types of loans for small businesses. They are very simple in that the lender provides a specific amount of money, usually at a fixed rate of interest, and there is a schedule for repaying the loan (usually in monthly or quarterly payments) over a certain amount of time.
The big question that a bank wants answered is whether you have the necessary collateral. In these trying times, an unsecured loan is a rarity and is only offered to folks or businesses with an exceptional credit history.
There is big caveat on bank loans that you should be aware – most banks will seek full recourse to the individual owner or shareholders for full recovery of the loan just in case if things don’t turn out the way you expected it. It is imperative therefore that you ensure that the business risks are mitigated before you commit to a bank loan as the consequences of a failure will affect you personally.
The requirements for a term loan are arduous and time consuming. Banks normally require a significant amount of information before they approve the loan. These can range from:
- Your detailed business plan.
- A personal guarantee for short-term loans, a new business, or if the collateral is insufficient;
- Your credit report – very likely from Dun and Bradstreet
- The type of collateral you can provide;
- Company incorporation or trading licenses
- Your personal and financial commitment to the business
- Your business ’ Financial statements for at least three years;
- Tax returns (if and where applicable), for the past three years;
Term loans have benefits and drawbacks. The benefits include the ability to leverage the term loan to preserve your working capital. However, you need to watch out for those exorbitant fees
Venture Capital (VC)
Seeking funding from Venture capital companies (VCs) provides medium term committed share capital, to help companies grow and succeed.
The funding objectives from VCs are very different from funding sourced through bank loans. Banks charge interest for their loans and seek repayment of the capital, irrespective of whether the business succeeds or fails. VCs invest in exchange for an equity stake in your business. VCs expect significant returns when they exit the business. Exit from a business can occur in many ways, ranging from taking a start up to an IPO stage or selling it to other equity owners.
VCs invest in business that has unique intellectual property or in businesses that have a unique and sustainable commercial model. VCs also generally invest in companies which are managed by experienced and capable teams that have the requisite experience to take the business to the next level.
If you are confident of your technology or your commercial model, then seeking funding through VCs might be a good option to take your business to the next level, as they have the breadth of contacts that will come in handy in terms of new funding, customers or people that you might need for your business.
I have come across many small businesses that do not use leasing as a way to fund a portion of their capital requirement.
Most equipment leases rarely require down payments. Therefore, if you have vehicles, machinery and equipment that needs to be purchased, leasing is an option that you should seriously consider.
For many start ups, the reality is that leasing may be your only real option for acquiring needed business assets.
An advantage that is often overlooked is that leasing may improve certain financial indicators, such as your debt-to-equity and earnings-to-fixed-assets ratios. This is so because you are able to exclude your leased assets and their corresponding monthly rental obligations from your balance sheet but are able to include the revenue derived from the assets in your income statement.
Factoring is useful for companies suffering cash flow squeeze and or are facing slow payments from their customers. Small businesses can sell their invoices or accounts receivable to funding companies called factors. The factor advances most of the invoiced amount ranging from 75% to 95%, after verifying the credit worthiness of the small business’ customer. The factor charges a factoring fee and remits the balance back to the small business. The factoring firm handles the collections and therefore the small business can focus on running its business and does not have to spend time or money on its collection endeavors.
Once the credit worthiness of a small business customer is established, a small business is usually able to get the funds for invoices within 24 to 48 hours rather than waiting 30 to 90 days for the small business customer to pay.
Traditional lenders normally look at the business creditworthiness when evaluating a loan application, whilst factors evaluate mainly the financial standing of the small business’s customers. This is a tremendous boost for a small business’s funding endeavors, as they are able to fund their working capital through factors, even if they have little or no credit history.
One important point to note abut factoring is that it can be costly by several basis points above a traditional lender.
One other important consideration for small business before using a factor is that it will not be economical for a small business that sends out thousands of small value invoices, as the service fees that a factor charges might depend on each invoice.
Small businesses have many options to fund their working capital or long term funding requirements. The key to note is that the funding expense varies and that the resultant costs should be baked into the pricing of your goods or services.
Do not feel dejected if you funding applications are turned down. As a small business owner and risk taker, you are already special. Don’t let some high and mighty bureaucrat in some large corporation tell you that you stand no chance.
For inspiration, remember what Dale Carnegie said; “ Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no help at all.”
All rights reserved: John Lincoln, Brentwood, CA 94513