Show Me the Money
Business capital doesn’t grow on trees, but it’s out there. Figure out your needs, options and goals, and then seek these mainstream—and not-so-mainstream—sources of money to start or grow your company.
A survey last year by MultiFunding, a consulting firm that helps small businesses obtain financing, found that 73 percent of entrepreneurs who needed loans were not even applying for them. Of those who did apply, 42 percent received only partial funding or were rejected altogether.
Not much has changed, nor will it for the foreseeable future, says Ami Kassar, MultiFunding’s founder and CEO. In fact, it may get worse. While big banks have plenty of money to lend at low interest rates, they require collateral that small-business owners—whose home and equipment values have dropped—don’t have.
But there is a silver lining. The other 58 percent of entrepreneurs in MultiFunding’s survey who applied for loans did get approved—and so can you. The secret is in your approach.
Plan of Attack
Whether you seek financing for a startup or an existing business, you need specifics: exactly how much money you need, what you will do with it and how it will benefit your business in measurable dollar terms.
“Understand what the money is going to cost you and how it will improve your business,” Kassar says. “Say you are in a situation where, if you don’t get financing, you’ll make $100,000 next year. If a loan that costs you $20,000 will guarantee you’ll earn $150,000 instead, it’s worth it.”
Once you know what you want, explore your options. Community banks may be more receptive than big banks. According to a survey by loan broker Biz2Credit.com, small-business loan approvals by small banks and nonbank lenders reached 46.3 percent late last year. In contrast, the approval rate at big banks was just 9.3 percent.
If you can’t qualify for a traditional commercial bank loan, consider a Small Business Administration guaranteed loan, which encourages banks to lend by guaranteeing a certain amount of the loan. Because of the guarantee, Kassar explains, businesses seeking SBA loans face higher interest rates and additional layers of complexity.
Despite those drawbacks, more business owners are turning to the SBA. In 2011, SBA lending reached a record $30.5 billion, thanks to the Small Business Jobs Act, which temporarily raised loan guarantees to 90 percent of loan amounts and waived fees for some loans.
The SBA has two new programs—Community Advantage and Small Loan Advantage—with streamlined application processes and is expanding its CAPLines program, which provides small-business lines of credit.
Community Advantage, which began in February 2011, expands small businesses’ access to capital in previously underserved areas; through small, community-based, mission-focused financial institutions, the SBA will lend a business owner as much as $250,000. Small Loan Advantage involves existing SBA lenders and encourages them to make loans of smaller amounts than they did previously ($250,000 and under). CAPLines helps small businesses meet short-term and cyclical needs for working capital of up to $200,000.
If you can’t qualify for a commercial or SBA-guaranteed loan, enter the world of alternative financing. Kassar ticks off these options:
- Equipment leasing. Instead of borrowing to finance equipment or software, consider leasing, which lowers upfront costs.
- Asset-based lending. Nonbank lenders offer loans against inventory, equipment and accounts receivable, but usually at higher interest rates than banks charge.
- Factoring. A purchaser called a “factor” buys your accounts receivable invoices for a percentage of their face value. This provides you with ready cash, and, of course, the buyer will profit by collecting a higher percentage of the receivables than the purchase amount.
“I have seen [factoring] become mainstream in the last several years,” says David Worrell, founding partner of Rock Solid Finance, which provides strategy and finance help for entrepreneurs. In addition to traditional factoring, Worrell says big financial services companies such as Citigroup and Bank of America have cash management accounts that serve similar functions. They have everything from lockboxes to short-term credit based on invoices, he says. Talk to your banker about your options.
- Merchant cash advance. If you have a merchant account with a credit-card company, you may be able to obtain a loan from these third-party lenders against future credit card purchases made by your customers.
- Purchase-order financing. Purchase-order finance companies extend short-term financing to pay suppliers. Find these companies online by searching on the term or ask other business owners for referrals of companies they’ve done business with. You can also go to websites (one is SmallBusinessLoans.com) that match lenders with small businesses. Often used by distributors, wholesalers or manufacturers, this option works when you have a purchase order to fulfill but can’t pay suppliers upfront.
- Credit card financing. “I’m seeing more [entrepreneurs] relying on credit cards,” says Worrell, who thinks they have become an essential tool for growing a business. “Just be careful, and keep it paid off.”
- Other nonbank lenders. These include community development financial institutions, microlenders or community organizations that support specific types of businesses. “Know that every nonbank lender has an agenda,” Worrell cautions. “You’ve got to know that agenda and show that you fit their investment criteria.” For instance, if the lender focuses on creating local jobs, you must prove your business will do so. Worrell recommends the Opportunity Finance Network website as a place to seek such lenders.
For Startups Only
Entrepreneurs also may borrow from 401(k) or other retirement plans. “We’re seeing more and more people doing that,” Kassar says. The downside is needing to repay the money, with interest and on a deadline (or you will owe income tax on the amount withdrawn), and removing an important emergency cushion from your assets. If you lose or quit your job, full repayment of the loan from your 401(k) is usually due in 30 or 60 days.
Many financial managers say this should be your last resort, so make sure you understand the consequences of taking these risks. If it is truly your only option, once your business starts making money, set up a new retirement plan as soon as possible.
While many startup entrepreneurs flinch at the high cost of borrowing, Kassar believes getting a loan—even at a higher initial cost—is always preferable to giving investors equity in the business. “Lenders eventually go away; investors never do,” he says.
Worrell agrees and urges startups to bootstrap their businesses if possible. “Be a lean startup,” Worrell says. Modify and massage your original idea until you find the formula that performs well, he adds, because “everyone wants to put money into something that works.”
Another startup option is financing from friends and family. Friends and family financing “has further-reaching impact than just getting money,” Worrell points out. “It’s a reference point [for other lenders and investors]. If you don’t have money from friends and family, there’s no reason strangers should trust you.”
If loans aren’t available or don’t provide enough money, consider equity financing, in which investors receive ownership (equity) in the business. Investors can be friends and family, or “angels”—wealthy people who may invest individually or form angel groups to invest in small businesses and often offer expertise along with their money.
Worrell sees more angels stepping into the financing gap, and the Angel Market Trends survey from the University of New Hampshire’s Center for Venture Research bears him out. After bottoming out in 2009, the report says, the angel market is slowly recovering, with increased investments last year. In the most recent survey, from 2011, 15 percent of companies that sought angel investors succeeded, landing an average of $338,400.
Search for angels in your community, says Worrell, who notes the ideal angel investor probably lives within 30 to 50 miles of you and is already in your network (i.e., “Someone you could find on LinkedIn”). Your accountant and attorney may have recommendations.
Despite the hype about online angel matching sites, Worrell is lukewarm. “I’ve only seen a couple that work. One is Gust [formerly Angelsoft].” Because angel sites skew to high-tech communities, he adds, entrepreneurs who aren’t in Silicon Valley or New York City may not find a match.
One online option Worrell finds promising is crowdfunding, which enables businesses to solicit small donations from individuals via websites such as IndieGoGo and PeerBackers. “This isn’t free money with no strings. Crowdfunding websites are highly regulated,” he says.
Worrell says crowdfunding works especially well for product-oriented startups; participants essentially “vote” on the viability of the product with their dollars and become a presold market for the item.
Money Is Available
The lesson for entrepreneurs: There is money to be had.
Worrell points out, however, that it’s critical to match the source of money with the way you’ll use it. “Where does the money come from, and how are you going to pay it back?” For example, he says credit cards should be used for short-term expenses such as inventory, not to pay salaries or rent.
Also know that the search for financing is not a one-time effort. “Loan markets change and businesses change,” Kassar says. “Your business financing needs—and what you’re eligible for—will change. Do an annual debt review and check [to see what’s available] to get your business to the next level.”