Basic Business Cents
Homework for Starting a Business
Part III-Where Will the Money Come From?
by Lou Schultz, SCORE counselor
Original publish date 08/2010 (#43)
In the previous two articles, you have thought through whether the new business is good for you, whether the product/service and market is real, and taken a good look at the financial projections for the first year by month and next two years by quarter to make sure the effort is worth it. You probably found you will need some cash input to carry you through to where the operation is making money and can support principle and interest payments on the infusion of investment by others. The key question now is where is the best source of these funds.
SCORE defines the Six Cs of Credit as character, capacity, capital, collateral, communication, and conditions. Potential lenders will look at the character of the borrower and if your word is good. They will look up your personal credit score and check with Dunn and Bradstreet and Better Business Bureau. They will look for a well-written and complete business plan. Repayment terms supported by the ability to pay as defined in the financial projections and condition of the economy are also factors in obtaining loans.
Prospective lenders will require a sizeable investment by the borrower, usually from 20-35% to prove your commitment and backed with a personal guarantee with pledged collateral for the remainder. They will want to understand the sources of your investment such as savings or credit cards. A bit of a red flag is credit card debt because the high interest rates can quickly put you in trouble if used for more than a very short term. It is also not advisable to tap into 401k investments.
Banks want to see realistic, well thought out financial projections to provide them with some comfort that they will get their money back and will be looking for an ongoing relationship. The bank can help you with a conventional loan or with a Small Business Administration guaranteed loan. The SBA backed loan makes it less risky for the lender.
Other sources of capital are available but generally less desirable. Grants are seldom available to for-profit companies. They are generally for specific purposes, not for operational expenses. Other sources of funding can be the government and private foundations but they are very competitive and require substantial reporting. More information can be found at www.grants.gov.
Venture Capitalists will make investments in start-up companies but look for a high return in a short period of time. They will usually want control of the Board.
And then, there are the triple F investors-family, friends, and fools. These loans can be dangerous to long-term relationships with family and friends.
To do your homework before you apply for a loan, you will want to understand the players and their motivation
- Banks and investors want to make money
- Know your credit score. The better your score, the less risk to the lender or investor
- Start with your own bank, but shop around – not all lenders are the same
When approaching a lender, first have (and understand) a good business plan. Stress your industry experience and management skills. Address your succession plan and exit strategy, it may be more important to define your “get outta” than “get intta”. Do your homework in researching relationships with lender or agent and be professional in your attire and demeanor. This may be the biggest sale in your new business venture.