Starting a business is a difficult decision, and a critical part is determining how you’re going to pay for this venture.
It is important to have a financing roadmap that outlines whether funds are needed to operate your business or funding is needed after you start, what will you need and/or consider prior to speaking with a lender — and what financing options are available.
First, let’s look at what a lender is going to examine to secure any financing and determine the viability of your venture.
You should start with the 5 C’s: Credit; capacity, capital, collateral, conditions and character. Capacity to repay a loan is the most critical. Lenders will want to know exactly how you intend to repay the loan and assure there is enough cash flow in the business to repay the loan.
Capital is the money you invest in the business and an indication of how much you have at risk should the business fail. Collateral is a form of security you provide to the bank. You are pledging an asset you own, such as your home, to the bank with an agreement that it will be the repayment source in case you cannot repay the loan.
Conditions has two meanings, the first refers to the conditions or the intended purpose of the loan. Conditions also refer to economic conditions, locally and within your industry which could affect your business and ability to repay the loan.
The final factor is character, your willingness to pay back the loan. Character traits banks consider are your experience in the industry, personal credit history, your integrity and good standing.
Once you have decided it’s time to speak with a financial institution, your lender will be looking for you to provide some key information. It is important for you to have a solid business plan that would include a profit plan that will show how the loan proceeds will be used to increase sales and profitability.
Your business plan should be a detailed document that gives insights into the business operations and include existing or projected financials. It is important for you to know what you can afford by calculating the amount of funds you will need along with the ability to pay the loan amount.
As a business owner, you should have a solid understanding of your financial statements, which would provide an accurate picture of how the business has succeeded or how you intend to make it succeed.
Additional things to consider is knowing your credit score, have some collateral options in mind and have your equity contribution already secured.
Now that you have a better understanding on what a lender will need to know, there are key items you will need to gather for the meeting. It is important to bring your business plan that describes your business along with the anticipated costs and your management and sales strategies that will drive growth along with realistic financial projections.
A detailed personal financial statement to show your assets, liabilities and net worth. You should bring at least three years of personal filed tax returns, your equity source and your additional collateral options should more be needed.
For most small businesses, operations can be financed in three ways (not including investment or loans from family and friends).
The first is personal lines of credit, such as credit cards (either an owner’s personal card or a business card guaranteed by the owner) or a home equity line of credit. While it is not standard practice to use a credit card to fund a startup business, there are many benefits once there is cash flow to ensure the business can support the debt exposure.
Using a small business credit card for your payables allows you to pay vendors early and extend your accounts payable cycle without negatively impacting your cash flow.
Another option for financing is a business line of credit; this permits a business to borrow up to a certain dollar amount and repay it in installments with interest during the course of a year. Typically, this type of financing works well for seasonal industries or for short-term financing needs.
The third way is through a business term loan, which is a set dollar amount to be repaid in installments during an established timeframe. This method is typical in regards to funding business equipment and is usually secured by the asset that is purchased.
There are many different financing structures available so it is important to have the identified materials as this will guide the lender in providing you with the best possible option to fund your business.
So, you have done all your homework, gathered the information required to have a meeting with a lender, discussed the opportunity and now it is in the hands of the lender.
He or she will review your credit score as this will show that you have a history of how you managed debt. A strong equity contribution will show a lender that you have a commitment to the project and the ability to earn, save and manage money.
Finally, the lender will look at the loan to value ratios. Depending on the purpose of the funds, this percentage can differ between real estate or equipment.
Starting a business can be very exciting, but with this excitement can come anxiety, which is usually related to the finances. By meeting with a lender early in your business strategy, it can help navigate the pieces of the puzzle while serving as a strategic partner when starting your business.