|
OBTAINING BUSINESS FINANCING
Funding for a business results from two primary sources; equity or debt. Equity is the owner's or stockholder's original investment and, as such, represents the owner's cash contribution to the business. This funding can be obtained from various sources, including the business owner's friends, family, and in limited instances, venture capitalists. Equity funding is dollars which remain in the business and have no set repayment schedule for disbursement to investors.
Equity is critical to a business in need of obtaining a loan to fund start-up or expansion. As a general rule-of-thumb, equity requirements for a new business fall in the range of twenty-five to fifty percent of the total projected cost of the business start-up. This means that owners may be required to provide up to one-half of the funds needed to open the business.
A loan or debt is the other funding source common to business financing. This source becomes necessary when an owner's equity investment is insufficient to finance the company's start-up or expansion. These are funds obtained from a third party source, generally a commercial bank, having a defined repayment schedule which stipulates both principal (that portion of a loan repayment representing retirement of the original loan amount) and interest (the portion of repayment which represents the business' cost of obtaining third party financing) requirements. Loans can either be unsecured or secured. Unsecured loans are based solely on the borrower's financial strength, without pledging of assets (collateral); while secured loans, also based on financial strength, require pledging assets as collateral for the loan. Secured loans are the common method used by third party financing sources.
Commercial banks offer loans with varying interest rates and repayment terms. Interest rates are generally based on the New York banks' prime interest rate given to their most creditworthy customers, with a percentage add-on for the perceived degree of risk of each individual lending situation (i.e. prime plus 2%). Repayment terms will vary with the useful life of the asset financed. As a rule-of-thumb, working capital loans (used to finance inventory and accounts receivable) range from three to five years, equipment loans five to seven years, and fixed assets (land and buildings) twelve to fifteen years.
Third party financing sources, such as commercial bank or governmental loan programs, will require a variety of information on the business and borrower. These include such items as a comprehensive business plan, collateral description, tax returns, projections, resumes and personal financial statements. Additional information may be required depending on specific loan source requirements.
There are a number of governmental loan programs available to finance a start-up or expansion. These are, however, predicated upon a business being able to meet the necessary requirements of the particular loan fund being considered. These loan pools represent federal, state and local funds designed to spur local private investment and aid local development efforts. Governmental loan programs are not sole source financing options. They require the involvement of a private lending institution, such as a commercial bank. It is imperative that a commercial bank or some other private third party lender be committed to financing a portion of the project prior to contacting any of the governmental loan programs.
Governmental loan programs fall into two types; guarantee programs and direct loan programs. Under loan guarantee programs, all loans are provided to the business owner by a local commercial bank. The governmental program provides to the bank a loan loss guarantee (similar to a co-signor). The borrower deals primarily with the local commercial bank, which sets the general terms of the loan. The guarantee insures the bank against loss from default by the borrower up to a certain specified percentage, generally eighty to ninety percent.
The direct loans are either group specific, such as handicapped or veteran loan pools, or are limited in their scope of participation. This limit is generally set in the range of thirty-three to forty percent of a project's total cost and further requires job creation criteria as part of the loan consideration. The majority of direct governmental loan programs require the creation of one full-time permanent job for each $10,000 - $20,000 of loan funds sought under that program. Direct loans also generally have a minimum dollar amount the loan pool will consider, which usually ranges from $50,000 to $100,000. Thus, using the forty percent maximum participation amount; the minimum $50,000 loan amount; and the job creation criteria of one job for each $10,000 borrowed; the minimum project cost would generally be in the $125,000 range with the creation of a minimum of five (5) full-time permanent jobs.
For a more detailed discussion of financing and loan programs, please call and schedule an appointment to speak with one of our SBDC counselors.
|
