Financing Your Business

Securing the funding necessary to start and grow a business is one of the biggest challenges to launching a successful startup. Careful planning and an understanding of the ﬁnancial options available will improve the chances of securing ﬁnancing.

Preparation is critical. No one just walks into a bank with a great idea and walks out with a loan. Research, planning, and preparation are key to making the best impression you can when you ﬁnally meet with a lender.

To ensure you are successful in obtaining ﬁnancing, understand:

What type of funding best ﬁts your needs
What lenders consider
Critical questions you need to be able to answer
Loan package components

Types of Funding

It is important to explore all of your ﬁnancing options before making a decision about which option that is best for you. Several sources of ﬁnancing to consider are:

Personal Savings

The primary source of capital for most new businesses comes from savings and other personal resources. While credit cards are often used to ﬁnance business needs, there are usually better options available, as the interest rates on credit cards can be very high.

Friends and Relatives

Many entrepreneurs rely upon private sources of capital 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. It is important, however, to put the terms of the loans in writing to avoid any misunderstandings that could harm your personal relationships.

Banks and Credit Unions

The most common sources of funding, banks and credit unions, will provide a loan if you can show that your business proposal is sound. For startup companies, however, the burden of proof is much higher than for an existing business seeking a loan to expand current operations. Conservative projections and careful attention to the assumptions that underlie these projections are critical to increasing the chances of receiving startup funding.

SBA Programs

There are programs targeted to help startup businesses secure ﬁnancing by reducing the risk to traditional lenders who make loans to small businesses. These programs, run by the SBA on the federal level, do not make any direct loans to business owners. Yet, as a business owner, be sure your lender is aware of these programs that aim to make lending to small businesses more attractive to improve your chances of securing funds. Again, the SBA programs are administered through traditional lenders such as banks.

What Lenders Consider

Your bank is in business to make money and keeping that in mind will help you understand what your lender is looking for when deciding whether or not to make a loan. The bank must consider the following “5 C’s of Credit Analysis” prior to making a loan.

Capacity to repay is the most critical of the ﬁve factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash ﬂow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships—personal and commercial—is considered an indicator of future payment performance. Prospective lenders also will want to know about contingent sources of repayment.
Capital is the money personally invested in the business and is an indication of how much you will lose should the business fail. Prospective lenders and investors will expect you to contribute your own assets and to undertake personal ﬁnancial risk to establish the business before asking them to commit any funding. If you have a signiﬁcant personal investment in the business, you are more likely to do everything in your power to make the business successful.
Collateral or guarantees are additional forms of security that can be provided to the lender. If the business cannot repay its loan, the bank wants to know that there is a second source of repayment. Assets such as equipment, buildings, accounts receivable, and in some cases, inventory, are considered possible sources of repayment if they are sold by the bank for cash. Both business and personal assets can be sources of collateral for a loan. A guarantee, on the other hand, is just that – someone else signs a guarantee document promising to repay the loan if you cannot. Some lenders may require such a guarantee in addition to collateral as security for a loan.
Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender will also consider the local economic climate and conditions both within your industry and in other industries that could affect your business.
Character is the personal impression you make on the potential lender or investor. The lender decides subjectively whether you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience of your employees will also be considered.

Critical Questions

Before you meet with a bank or credit union, it is a good idea to call and ask a few questions about their business lending history. After you have chosen a few banks to meet with, call and ask questions like:

What types of business loans do you offer?
Do you only make business loans of a certain size?
What is your application and review process?
How long does it generally take to fund a loan?
What is your approval rate for business loans?

Use the answers to prepare the best loan package for each bank. When preparing to meet with a lender, keep some critical questions in mind to increase your chances of successfully obtaining a loan. Any materials prepared should answer the following questions:

How much are you looking for?
What will the money be used for?
How will the loan beneﬁt your business?
When will you pay back the loan?
How will you generate sufficient cash ﬂow to repay the loan?
Are you a good credit risk?
What happens if your business fails and you cannot repay the loan?

Most of these answers should be readily available, particularly if you have carefully prepared a business plan and a ﬁnancial loan package, but it is always best to make sure the answers are clear in the materials you present.

Loan Proposal

Different lenders may require or prefer various pieces of information when reviewing loan proposals, so it is always best to call ahead and inquire about each bank’s application and review process to be sure that you put together a loan proposal that meets their expectations. Generally, a loan proposal will include the following information:

I. Cover

Name of business
Your name and contact information
Date
Name of lending institution (“Prepared for xxxx”)

II. Executive Summary

Brief description of your business
How the proposed loan will be used
How and when the loan will be paid back

III. Business Description

Brief overview of company history
Description of products
Strengths and accomplishments

IV. Industry/Market Analysis

Research on the industry
Analysis of competition
Target consumer base
Sales and marketing plan

V. Top Management Proﬁles

Summary of experience, qualiﬁcations, and credentials of top management
Resumes
Professional and ﬁnancial references

VI. Financials (View samples in SCORE’s Financial Statements Template Gallery)

Projected Balance Sheet
Projected Cash Flow
Projected Proﬁt and Loss
Twelve-month Sales Forecast
Personal Financial Statements
Tax Returns
Credit Reports (Equifax, Experian, and TransUnion are the three major credit bureaus and each has a process for requesting and obtaining a copy of your credit report.)

VII. Summary of Loan Package

Reiterate exactly how much you need and what you will do with it
Summarize reasons why you should get the loan

VIII. Appendices

Letters of reference, letters of intent, supplier agreements, etc.