January 2007 The Good Seed Finding the financing to get your small business off the ground By Shayla Byrd
Small business owners beware. Those late-night infomercials that, for a fee, promise to help you secure free government grants to help you start your own business? They’re a complete fallacy, says Mark Taylor, a Memphis director of the Tennessee Small Business Development Center.
“That’s actually the number one complaint that I get from people,” he says, referring to the numerous calls he receives each month from people who have been scammed out of their money.
Government grants are for government agencies, institutions of higher learning and nonprofit organizations, Taylor says—and even they have to jump through several hoops to receive aid.
“It’s silly to think that you’re going to get no-strings attached money from anyone other than mom, dad or a family friend.”
So what’s an ambitious business owner to do?
It’s no secret that money—or the lack thereof—is the biggest hurdle for new businesses to surmount. In fact, according to the Small Business Administration, inadequate or ill-timed financing is second only to poor management as the most frequently cited reason many businesses fail.
But there are ways for small business owners to successfully secure financing for their companies—and they don’t include spending hundreds of dollars on seminars. All it takes is some good old-fashioned hard work.
The first step is knowing the difference between the two types of small business financing. There are two major types: equity and debt. Equity financing involves bringing in a third party venture capitalist who invests money in the company and in turn receives a percentage of its ownership. But these types of loans often go to more established businesses that are undergoing periods of expansion and growth. Most small businesses, and virtually all startup companies, depend on debt financing to get them off the ground. Banks are generally the source of this type of funding.
But don’t ask for that loan just yet. Several things need to be in order first. When making loan decisions, the two major things that lenders look at are the entrepreneur’s credit score and collateral.
“If you come in with poor credit, the odds are against you,” Taylor says. “If your score is below 600, you can forget it.”
Even though it may sound silly, according to Clint Smith, the Tennessee District Director of the Small Business Administration, one of the biggest mistakes people make is walking into a bank without having their credit in order. Unpaid student loans and back taxes are deal breakers when it comes to new financing.
Another mistake that people make is poor planning, i.e. they don’t have a solid business plan.
Not only does a business plan demonstrate a sense of foresight and professionalism to the potential lender, but it helps the entrepreneur decide exactly how much money he or she will need for a successful startup. Without a good cash flow analysis in the beginning stages, a small business that depends heavily on accounts receivable, such as a medical billing company, might fail to request enough money in the beginning and end up bottoming out before the business ever really has a chance.
Collateral and independent financing are also important. Very rarely will lenders finance 100% of the company, Smith says. “It’s unreasonable to expect the lender to take 100% of the risk.” A good rule of thumb, he says, is for entrepreneurs to be prepared to put up about 25% to 30% of the total opening cost.
One exception to that rule, however, is the Small Business Administration 504 Loan, a loan that helps small business owners acquire long-term financing for fixed assets, such as buildings or machinery. In those cases, the bank would finance 50% of the total operating cost, the SBA would finance 40% of the cost, while the entrepreneur would only be responsible for the remaining 10%.
The SBA can also be helpful in cases where lenders are concerned about the high risks associated with certain applicants.
“A business may not have the heavy cash flow that the bank thinks it needs in order to pay the loan back in a regular manner,” Smith says. “Sometimes people need a middle ground, and with a guaranteed loan from SBA, entrepreneurs can be approved, and often with longer repayment terms.”
SBA guaranteed loans are negotiated between the bank and the SBA. (Entrepreneurs can’t go directly to SBA to request the loan.) For those businesses that meet their criteria, the SBA will guarantee repayment of up to 85% of loans no larger than $150,000. For greater amounts—up to $2 million—the SBA has a guarantee rate of 75%.
This option does, however, cost a little more in the long run. A guarantee fee of about 2% is passed onto small businesses owners when they opt for an SBA loan. But that fee may just be worth it for those who otherwise wouldn’t be approved for the loan at all.
It’s also wise to speak with more than one bank, Taylor recommends. “Often, small community banks will look at other factors beyond strictly credit scores,” he says. “If they feel like your product or service is useful in the community and has the potential for a rapidly expanding area, they may be willing to take a chance on you,” something that larger banks might not do.
So the money is there, it just takes a little digging and a lot of preparation in order to secure it.
Groups like the Tennessee Small Business Development Center and Service Corporation of Retired Executives (SCORE), a group of retired business owners who volunteer their expertise, offer free consulting services to entrepreneurs who want to ensure that they get qualified for as much financing as they can the first time around.
And because securing financial support early is such a crucial part in a businesses success, it’s worth it to take that extra time on the front end. Otherwise, those grand dreams of small business ownership will be over before they ever really begin.
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