Whether people are preparing to launch a start-up or wanting to grow a business, they will need money. Borrowing money or selling ownership interests to equity investors are typical options for small businesses. However, given the current economic climate, neither of these options may come through easily.
So how can small businesses looking to grow secure financing? Leslie Weiss of Barnes & Thornburg LLP offers these suggestions:
Be Prepared: It’s crucial for small businesses to prepare budgets and financial projections ahead of time to determine capital needs. Once determined, businesses need to figure out how and where they can acquire the capital they need to grow. Developing this financial plan can help small businesses highlight their growth potential to interested investors or convince debt- financing sources that they’re a reputable candidate for a loan.
Go for Equity: If a small business has a lot of growth potential and sophistication, acquiring equity is an ideal game plan. The following are considerations for going down the equity path:
- Find a Guardian Angel: “Angel investors–wealthy persons who frequently invest in start-up companies and are often seasoned entrepreneurs themselves–are a good source of equity capital for expanding small businesses,” Weiss says. “To attract angel investors, a business should offer a compelling growth plan (see point one) that convinces the potential investor…the business will increase in value and the…investment in the business is worth the risk. Entrepreneurs need to network to find these angel investors.”
- Put the Best Foot Forward: Another source of equity financing for small businesses is venture-capital funds. Venture investors are very sophisticated and review business plans from many companies seeking funding. The entrepreneur needs to make his/her business stand out and clearly show why investing in the business will give the venture fund a good rate of return. “Venture investors evaluate the exit when they are investing,” Weiss says. “Is there potential to go public? Can the company be sold for a favorable price? Venture funds generally have a five- to seven-year window for their investments to show return. Demonstrating value to the venture community is a significant project, but can be worth the time and effort if a business has enough staying power to show a return on investment.”
- Get By With a Little Help From Friends: While some businesses obtain initial capital from friends and family to start a business, most businesses cannot depend on this funding source for growth.
- Offer an Exclusive: For technology companies or companies developing product, potential purchasers that are larger [and] seasoned…may finance the development of the companies’ products in exchange for exclusive or other types of preferred arrangements after the products are developed. Joint development projects are a good way for small companies to fund development with third-party monies. Small companies need to figure out their target markets and meet with those potential customers to convince them of the value of paying for such development.
Debt-Financing Considerations: For a start-up or a small business unable to get equity-support financing to grow, debt financing may be the way to go. Many of these sources request collateral or offer high interest rates and fees before lending money. While there are many lenders to consider, some debt-financing options may make more sense than others, depending on the type of business.
According to MultiFunding LLC, a start-up that helps small companies locate financing and submit loan applications:
q Less than a third of small-business owners qualify for traditional or Small Business Administration-backed loans, which cost roughly 3% to 8% in interest and fees.
q More than half, or 57%, of small businesses would need to seek financing through alternative means, such as factoring, merchant cash-advances or unsecured lines of credit, which can cost upwards of 20%.
q The remaining 15% wouldn’t be eligible for any type of financing.
Weiss outlines these debt-financing options:
- Collateral Is King: “Banks are a good debt-financing source; however, banks require strong collateral before they lend money,” Weiss says. “When considering a bank, a small business should ask itself: does my business own valuable assets, such as capital equipment, it can pledge to the bank? If not, it is unlikely any bank will finance the business.”
- Capitalize on Assets: Another category of lender is the asset-based lender. Again, a collateral pledge is required, such as receivables, to obtain financing from an asset-based lender. Asset-based lenders generally charge fairly high interest rates as well. Service businesses and small technology companies are unlikely to have assets to pledge to obtain debt financing.
- If the Business Is On Its Way; Consider SBA: Small businesses that have been in the market for a few years and need extra support to give their business a boost may consider an SBA loan. The Obama administration and Congress made SBA loans more attractive to borrowers and lenders in the 2009 economic-stimulus bill by offering cheap capital to community banks for use in making small-business loans. As of May of this year, the SBA had approved nearly $13.7 billion in 7(a) loans, which is three times the SBA’s lending two years ago. Many small businesses think it’s easy to get SBA loans; however they must offer real collateral in order to get these loans (e.g., are they willing to put up their house to obtain an SBA loan?).
The Small-Business Optimism Index calculated by the National Federation of Independent Businesses is showing month-to-month declines,” Weiss says. “However, there are blue skies out there for small businesses that meet a true market need and looking for sources of either debt or equity to stay afloat and even grow during these uncertain economic times.”