Starting Capital?

Every business needs capital to get started and to finance continued growth but credit is hard to get. Small businesses have always been at a disadvantage and the current credit crunch just makes matters worse. Fortunately there are additional sources of capital that are available although many are not well understood.

Small businesses get their capital from many sources depending on the characteristics of the business, such as the length of time it has been operating and the industry in which it operates, as well as the purpose for which the capital will be used. According to an annual survey conducted in April 2008 by the National Small Business Association (http://www.nsba.biz/docs/2008bizsurvey.pdf) small businesses use the following sources for financing:

• Credit cards – 44%
• Earnings from business – 36%
• Bank loans – 28% (all-time low)
• Friends & family – 19%
• Vendor credit – 15%
• SBA loans – 5%
• Leasing – 5%

Institutional investment (venture capital or angel investors) and asset based financing strategies such as factoring do not even show up on the list although many small businesses are able to take advantage of them.

Startup Capital

Startup businesses tend to rely on personal assets as well as investments from friends and family while building sales and a revenue stream. In addition, many businesses use credit cards as a source of financing. While these funds are readily available they can be costly if not well managed and over-use can have a negative effect on the business owner’s personal credit score.

Conventional wisdom suggests that financing for startups is readily available from banks (including SBA loans) or investors. The reality is quite different. Banks and institutional investors have very specific requirements concerning the businesses in which they will invest and few new businesses will qualify. Briefly,

• Banks look at the personal and business credit of potential borrowers and avoid certain high-risk industries. Collateral and cash flow are also factors.
• SBA guarantees loans made by banks so the bank’s normal criteria apply although there are some targeted programs that have special eligibility criteria.
• Investors focus on specific high-growth industries that have the potential to yield 30-50% annual returns in 3-5 years. An exit strategy is essential – this is not long-term financing. Investors often demand some degree of control over the company’s operations but their industry expertise can be very helpful.

Growth Capital

When a business is established and has revenue coming in more financing options become available. Ideally a business can finance its growth with cash from operations. Bank financing also becomes more available once the company is profitable and has a credit history. Even if bank financing is not an option and cash from operations is inadequate there are additional options, including

• Vendors of equipment often provide financing at competitive rates for the purchase or lease of their products since it helps them make sales.
• Leasing programs are also available from independent sources. Both new and used items can be leased.
• Receivables can be used as a flexible source of working capital to release the cash tied up in unpaid invoices through invoice factoring programs or loans using the receivables themselves as collateral. Because of the extra administration and risk involved these programs cost more than conventional bank loans but are comparable in terms of cost to credit card processing fees.
• Cash advances based on anticipated future credit card receipts are available for certain businesses that accept credit cards.

Don’t hesitate to shop around or ask your professional advisors for input when considering any source of capital. There can be substantial differences in fees, terms and customer service levels from different providers.