The First Step to Success: Securing Funding For Your Small Business

by rgokli September 30 2008, 21:10

I. Introduction

Anyone who has considered starting a new business can attest to the excitement that comes along with being one's own boss, setting one's own hours, and turning a personal dream into reality. However, once the initial thrill wears off, the daunting task of ensuring enough preliminary funding and finding continued financing for the business can quickly turn this dream into a nightmare. This article will discuss the ways in which a small business can obtain initial funding and continued financing. First, it will stress the importance of creating a substantial business plan to which potential investors and sources of funding can look to learn about the business. Second, it will discuss debt options for funding and financing a business. Third, it will discuss equity options for funding and financing a business. Finally, it will conclude by summarizing the options for funding for a start-up business and continued financing of a new business.

II. Making a Business Plan

Solid business plans are resources that potential investors and lenders use to understand the business they are investing in and to feel secure that their investment has a high potential for success. [1]  Generally, a business plan outlines the type of business the entrepreneur wishes to start and gives financial projections for expenses and income for at least three years. [2] Additionally, if an entrepreneur can show that he or she is investing some of his or her own money in the business, investors and lenders will be satisfied that the entrepreneur has a financial stake in the business. [3] A good business plan "should show good profit potential in a short period of time." [4] However, small business owners should be aware that a even good business plan will not ensure funding if the business is based on unsteady ground. [5] Rather, a good business plan gives the investor a basis on which to invest in a company with the potential for success. [6]

Another way to make a new business appealing to potential investors and lenders is to show that the business fits a niche that no one else has filled. [7] For example, a firm became aware that surgical instruments were only sold in bulk to all medical institutions. [8] However, small medical institutions generally threw the instruments away after one use because they did not have the capability to sterilize the instruments. [9] After performing some research and speaking with various physicians and employees, the company began selling cheaper, but just as effective, disposable instruments to small medical organizations. [10] The key to finding a niche is to "try to find the right configuration of products, services, quality, and price that will ensure the least direct competition". [11]

III. Debt

Debt is defined as when a "business borrows the amount of money it needs, with an arrangement for repayment of the principal plus interest." [12] Debt can come from a variety of sources including credit cards, commercial banks, government lenders, including the Small Business Administration, and family and friends. [13]

Using credit cards may often seem like an easy fix for entrepreneurs who need more capital to start their business. [14] However, credit cards can quickly became black holes of indebtedness. "The trouble, experts say, is that few business owners take the time to read the fine print, so they don't understand the financing terms and fail to guard against rising rates."  [15] Additionally, entrepreneurs who use credits cards should be sure to diversify their line of credit so that if an unanticipated cost arises, he or she has alternative payment options rather than being "tapped out" of the one credit card they use. [16]

Commercial banks are the most common source of funding for small businesses. [17] However, contrary to popular belief, banks generally do not loan money to start businesses. [18] Rather, banks serve to provide funding once a company has a solid business foundation. [19] In rare instances, however, banks will lend to start-up companies without an established foundation. [20] "[For] businesses that do not have substantial assets or healthy revenues, the bank may look at the creditworthiness of the owners. Many financial advisors counsel that you guard your personal credit as this may become handy in such cases." [21]

The Small Business Administration is a government organization that guarantees loans for small businesses. [22] The Small Business Administration guarantees loans for businesses that might not be able to qualify otherwise by allowing banks "to extend credit to companies that might not qualify conventionally . . . The loans typically have longer terms so you can stretch the payments and make them more affordable." [23]

In particular, the Small Business Association 504 program may appeal to small business owners. [24]  The 504 requires the business owner to put up some of his or her own money. [25] "To finance [a] purchase through a 504 the borrower must put down at least 10%, while an SBA-certified non-profit agency lends another 40% through a government-backed boding offering. Then, a commercial bank or other lender provides the remaining 50%." [26] Although the nature of a 504 loan requires many more parties and administrative steps, it may be a good option for entrepreneurs who are having a hard time getting a private loan. [27]

Another sources of funding that is commonly used is borrowing money from family or friends. [28] While this method may be the easiest from an administrative standpoint, it often causes problems if the business fails and money is lost. [29] While family and friends may have noble intentions, if they are not experienced investors, "they don't fully understand how much risk there is . . . [M]ake sure that you understand how easily this money can be lost, and that you make them understand as well." [30] If individuals give money in exchange for a share of the business, this is considered equity, as well. [31]

IV. Equity

Equity is defined as "trading an ownership interest in the business for the funding needed by the business." [32] Equity can include private sources, venture capitalists, angels, and grants. [33]

Venture capitalists do not generally invest in start-up businesses unless there is "a rare combination of product opportunity, market opportunity, and proven management." [34] Venture capitalists invest in businesses with a high potential for capital- this means entrepreneurs will little or no experience will most likely need to look elsewhere for funding. [35] Business plans are a good way to show a venture capitalist that the firm has the necessary elements to succeed. [36]

Angels are another sources of equity for start-up businesses. [37] Angels are individuals with a substantial amount of money who invest in start-up businesses. [38] "They are stricter about screening but also more realistic about what they're buying . . . [T]hey're not asking for too much ownership of the companies or too many rights to impact decision making." [39] Angels are a good option for individuals who want to keep substantial control of their business but do not want debt. [40]

Grants, or "free money," are another option for entrepreneurs looking for equity. [41] Grants can be found by searching the Internet, inquiring to various business groups, and searching state and local government websites. [42]

V. Conclusion

All of the sources of funding discussed above come with risk for both the business owner and the source. However, by creating a solid business plan to present to potential investors and lenders, an entrepreneur will be on the right path to success. Depending on what the business owner would like to achieve, debt or equity offer many options. Additionally, all new business owners should remember to consult with an attorney for advice on the legal implications of their actions before committing to borrow or accepting money.

[1] Tim Berry, Funding Tips for Small Business, http://articles.bplans.com/index.php/business-articles/financing-a-business/funding-tips-for-small-business (last visited Sep. 29, 2008).

[2] From the 'Lectric Law Library's Stacks: Business Basics, http://www.lectlaw.com/filesh/qfl10.htm (last visited Sep. 29, 2008).

[3] Berry, supra note 1.

[4] Id.

[5] Berry, How to Get Your Business Funded, http://articles.bplans.com/index.php/business-articles/starting-a-business/how-to-get-your-business-funded (last visited Sept. 29, 2008).

[6] Id.

[7] Write a Business Plan, Small Business Administration, http://www.sba.gov/smallbusinessplanner/plan/writeabusinessplan/SERV_NICHE.html (last visited Sept. 29, 2008).

[8] Id.

[9] Id.

[10] Id.

[11] Id.

[12] Henry Ongeri, Show me the Money: Funding your Small Business, <!-- /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:""; margin:0in; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:"Times New Roman"; mso-fareast-font-family:"Times New Roman";} h1 {mso-style-next:Normal; margin-top:12.0pt; margin-right:0in; margin-bottom:3.0pt; margin-left:0in; mso-pagination:widow-orphan; page-break-after:avoid; mso-outline-level:1; font-size:16.0pt; font-family:Arial; mso-font-kerning:16.0pt;} @page Section1 {size:8.5in 11.0in; margin:1.0in 1.25in 1.0in 1.25in; mso-header-margin:.5in; mso-footer-margin:.5in; mso-paper-source:0;} div.Section1 {page:Section1;} --> Mshale, Jan. 6, 2008, http://www.mshale.com/article.cfm?articleID=1659.

[13] Id. <!-- /* Font Definitions */ @font-face {font-family:Tahoma; panose-1:2 11 6 4 3 5 4 4 2 4; mso-font-charset:0; mso-generic-font-family:swiss; mso-font-pitch:variable; mso-font-signature:1627421319 -2147483648 8 0 66047 0;} @font-face {font-family:Gautami; mso-font-charset:0; mso-generic-font-family:auto; mso-font-pitch:variable; mso-font-signature:2097155 0 0 0 1 0;} /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:""; margin:0in; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:"Times New Roman"; mso-fareast-font-family:"Times New Roman";} @page Section1 {size:8.5in 11.0in; margin:1.0in 1.25in 1.0in 1.25in; mso-header-margin:.5in; mso-footer-margin:.5in; mso-paper-source:0;} div.Section1 {page:Section1;} -->

[14] Colleen DeBaise, The Six Best Places to Find Funding for Small Businesses, <!-- /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:""; margin:0in; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:"Times New Roman"; mso-fareast-font-family:"Times New Roman";} h1 {mso-style-next:Normal; margin-top:12.0pt; margin-right:0in; margin-bottom:3.0pt; margin-left:0in; mso-pagination:widow-orphan; page-break-after:avoid; mso-outline-level:1; font-size:16.0pt; font-family:Arial; mso-font-kerning:16.0pt;} @page Section1 {size:8.5in 11.0in; margin:1.0in 1.25in 1.0in 1.25in; mso-header-margin:.5in; mso-footer-margin:.5in; mso-paper-source:0;} div.Section1 {page:Section1;} --> SmallBiz, Feb 16, 2007, http://www.smsmallbiz.com/capital/The_Six_Best_Places_to_Find_Funding_for_Small_Businesses.html.

[15] Id.

[16] Id.

[17] Finding Startup Capital for Your Small Business, All Business, http://www.allbusiness.com/business-finance/business-loans/662-1.html (last visited Sep. 29, 2008).

[18] Berry, supra note 5.

[19] Ongeri, supra note 12.

[20] Id.

[21] Id.

[22] Debaise, supra note 14.

[23] Id.

[24] Colleen Debaise, Businesses Find Cheap Capital in SBA Mortgages, Aol Small Business, http://smallbusiness.aol.com/article/_a/businesses-find-cheap-capital-in-sba/20080731134009990001. <!-- /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:""; margin:0in; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:"Times New Roman"; mso-fareast-font-family:"Times New Roman";} @page Section1 {size:8.5in 11.0in; margin:1.0in 1.25in 1.0in 1.25in; mso-header-margin:.5in; mso-footer-margin:.5in; mso-paper-source:0;} div.Section1 {page:Section1;

[25] Id.

[26] Id.

[27] Id.

[28] Berry, supra note 5.

[29] Id.

[30] Id.

[31] Ongeri, supra note 12.

[32] Id.

[33] Id.

[34] Berry, supra note 5.

[35] Mark Henricks, The State of Small-Business Funding, July 2006, http://www.entrepreneur.com/money/financing/article159798.html.

[36] Id.

[37] Id.

[38] Berry, supra note 5.

[39] Henricks, supra note 35.

[40] Id. See also Sharpening your skills: Starting a Business, Feb. 25, 2008, Harvard Business School: Working Knowledge, http://hbswk.hbs.edu/item/5841.html.

[41] Debaise, supra note 14.

[42] Id.

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