Oakland County Business Services (MI-SBTDC) -- Financing

What Kind of Financing is Best for Your Company?

Once you have answers to the following key questions:

How much money do I need?
What do I need it for?
When do I need it?
How will I pay it back?

You must decide which type of financing best suits your situation. With equity financing a portion of your business is sold to raise the money you need. With debt financing you borrow the needed funds. Both options have advantages as well as disadvantages.

Equity Financing: You and the other owners invest in the business without stipulating repayment terms but expect to receive an income when the business profits. All investors usually share the risk and the control of the business, and understand that if the business fails they will lose their investment.

Debt Financing: You and possibly a family co-signer borrow dollars which you must pay back. The loan payments are due whether the business shows a profit or loss, and are usually secured with collateral.

Collateral: Collateral is property pledged to a lender as security for the loan. If you do not repay the loan, according to the terms of the loan agreement, the lender can seize the property as repayment. Collateral may be all business assets, your home, insurance policies, stocks and bonds, or anything of value that is acceptable to the lender. Inventory or furnishings are not generally accepted as collateral.

Generally, banks and government agencies will not lend based on the sales projected in your business plan. Rather than looking into the future, they will probably look at your current personal financial situation and ask two questions.

If the answers to these two questions are yes, then you have a reasonable chance of borrowing from a bank or government agency. The first question is "Is there enough income, outside the business, to make payments?" Lenders will not rely on repayment from projected profits. A new business will not be profitable in the beginning. The second question is "Is there enough collateral, outside the business, to secure the loan?" Lenders must consider the risk to their depositors' funds.

But what happens if the answer to one of these is no? You might consider finding someone to "co-sign" a loan for you. The co-signer promises to make payments or provide collateral for you.

Sources of Financing

Friends or Relatives: A friend or relative may buy a portion of the business or loan you the needed money. In order to prevent misunderstandings down the road, have the terms of the agreement in writing, reviewed by an attorney, and signed by you and the investor. They might also co-sign a loan.

Government: There are several government loan programs available. However, a survey of sources of starting capital showed that only "one-tenth of one percent" of new business receive start-up capital from government sources. Most programs require outside income and collateral, usually cost at least as much as a bank loan and require more paperwork.

Small Business Administration (SBA): (313-226-6075) People frequently think of the SBA when they think of government loans. Some assume if a bank turns them down for a business loan, they will automatically receive an SBA loan. This is incorrect.

If you are interested in a guaranteed loan, talk to your banker. Your application must be submitted to the SBA by the banker.

Capital Access Program (CAP): This is a state-sponsored loan guarantee program. Its major advantages are that it does not require a lot of extra paperwork and it is available to any banker for any type of business. Its major disadvantage is that it is somewhat more expensive than a regular bank loan. A banker may use this program to complete your loan.

Life Insurance or Pension Plans: Do you have life insurance or a pension plan you can borrow against? Check with your agent or employer.

Credit Cards: If you have credit cards, can you use them to make the purchases you need or can you get a cash advance? Credit cards provide immediate access to money, but the total amount you can get is fairly small and the cost is relatively high.

Equipment leases: Leasing equipment may be more viable than securing a loan and may require a smaller down payment. Ask the person selling you the equipment if they have a lease plan or if they can direct you to a leasing company.

Suppliers: Your major suppliers might be willing to extend credit to you, freeing up your cash. It is common practice in many types of businesses.

Customers: Another source of funding might be your customers. If you provide them with something special, that they cannot get elsewhere -- for example, a unique product, better service, or a lower price -- your customer may be willing to advance deposit money on future purchases. Identify your best customers and talk to them!

Conclusion

As you can see, there are many financing options available. However, most people will not qualify for any type of loan unless they have outside income to repay the loan, and outside collateral to secure the loan. If you do not qualify for a loan, reduce your start-up and operating costs to reduce funds required, raise more capital, or postpone your plans until you have the needed funds.

Financing / Grants