One key to a successful business start-up and expansion is your ability to obtain and secure appropriate financing. Raising capital is the most basic of all business activities. But as many new entrepreneurs quickly discover, raising capital may not be easy. It can be a complex and frustrating process. However, if you are informed and have planned effectively, raising money for your business will not be a painful experience.
Finding the Money You Need
There are several sources to consider when looking for financing. It is important to explore all of your options before making a decision.
Personal savings: Most new businesses are started with the primary source of capital coming from savings and other forms of personal resources.
Friends and relatives: Many entrepreneurs look to private sources such as friends and family when starting out in a business venture. Often, money is loaned interest free, or at a low interest rate, which can be beneficial when getting started.
Banks and credit unions: The most common source of funding, banks and credit unions, may provide a loan if you can show that your business proposal is sound.
Venture capital firms: These firms help expanding companies grow in exchange for equity or partial ownership.
Banks make money by lending money. However, the inexperience of small business owners in financial matters often prompts many banks to deny loan requests. You must know exactly how much money you need, why you need it and how you can pay it back. You must be able to convince your lender that you are a good credit risk. Requesting a loan when you are not properly prepared sends a signal to your lender. That message is ... "High Risk!" Seek assistance from the Small Business Development Center before you visit a bank.
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. Remember, 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. A good loan proposal will contain the following key elements:
- General Information
- Business name, names of principals, social security number for each principal, and the business address.
- Purpose of the loan: State exactly what the loan will be used for and why it is needed.
- Amount required: Request the exact amount you need to achieve your purpose.
- Business Description
- History and nature of business: Give details of your business's age, number of employees and current business assets.
- Ownership structure: Provide details on your company's legal structure.
- Management Profile
- Develop a short statement on each principal in your business; provide background, education, experience, skills and accomplishments.
- Market Information
- Clearly define your company's products as well as your markets. Identify your competition and explain how your business competes in the marketplace.
- Financial Information
- Financial statements: Provide balance sheets and income statements for the past three years. If you are just starting out, provide a projected cash flow and income statement.
- Personal financial statement: Prepare a personal financial statement on yourself and other principal owners of the business.
- Collateral: List collateral you would be willing to pledge as security for the loan.
Short-term loans are paid back in less than one year. Types of short-term loans are:
- Working-capital loans;
- Accounts-receivable loans; and
- Lines of credit.
Long-term loans have maturities greater than one year, but usually less than seven years. Real estate and equipment loans, however, can go up to 25 years. Long-term loans are used for major business expansions, purchases of real property, acquisitions and, in some instances, start-up costs. Types of long-term loans include:
- Commercial mortgages;
- Furniture and fixtures; and
How Your Loan Will Be Reviewed
When reviewing a loan request, the bank official 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. Therefore, you should 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% of the loan you are requesting? (Remember, a lender or investor will not finance 100 percent of your business.)
- Do you have a sound record of credit worthiness as indicated by your credit report, work history and letters of recommendation? This is very important.
- 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 monthly payments on the amount of the loan request?
To be successful in obtaining a loan, you must be prepared and organized.