Small Business Services

Guidance to Get Financing

Types of Capital

Start-up Capital
Start-up capital is the money you need to spend before the business opens. The amount varies widely depending on the type of business. Some examples include:

1. Seed Money - Research and planning
2. Security deposits for lease, utilities, etc.
3. Construction, leasehold improvements, signs, etc.
4. Equipment, tools, office equipment, etc.
5. Inventory
6. Labor - Hiring and training before opening business
7. Legal and accounting
8. Licenses and registration fees

Working Capital
Working capital is the money needed for day-to-day business expenses. The number one reason businesses fail is the lack of sufficient working capital. You need to be sure you have enough working capital to sustain the business until you have established a positive cash flow. Once you have established a positive cash flow, then the business will be able to generate enough cash to pay the bills without having to rely on other sources of capital.

Working capital is not only important for start-up businesses, but also for businesses that may be seasonal. There may be some months when your business has positive cash flow and other months you have a negative cash flow. You should have access to enough capital to sustain your business through the negative cash flow periods.

Types of Capital

1. Debt Financing
Debt financing does not give the lender ownership control, but the loan must be repaid with interest. Length of the loan, interest rates, security, and other terms depend on what the loan is being used for.
    a. Short-term: Loans for short periods (less than one year) are
        usually made to cover temporary or seasonal needs for working
        capital. Short-term loans are common for established
        businesses, but are unusual for new businesses.
    b. Medium to Long term: These loans may be repaid over a period
        of one to 20 years, depending on the use of the funds. The
       source of repayment is the cash flow of the business. Medium
       to long term loans are typically used to finance equipment or
       other fixed asset purchases.
    c. Real estate financing: Real estate is typically financed over a
        long term period, usually 10 - 25 years depending on the type
       of real estate and the lender. Expect a down payment of
        10 - 20%.
    d. Accounts receivable financing: Also called asset lending, this
        is money loaned against your accounts receivables, or in some
       cases inventory. Expect to pay much higher interest rates
       compared to more conventional lenders.

2. Equity Financing
Equity is money put into a business by the owner, private investors, and/or venture capitalists. Equity gives the investor ownership and possibly some control of the business. This is considered a stock purchase in a corporation.
    a. Your own savings: It is nearly impossible to start a business
        without using some of your personal funds. It is hard to
       convince someone to take a risk on your idea if you are not
       willing to put in your own cash.
    b. Friends, relatives, business associates, etc.: Many small
        businesses get started with loans not from traditional lenders,
       but from their friends or relatives. This group may either provide
       you with all your financing, or assist in your down payment.
    c. Venture capitalists: Groupd invest in a new firm looking for a
        high retuen on investment. Minimum investments are from
       several hundred thousands to millions of dollars. If a venture
       capital firm invests in your business, expect them to either want
       controlling interest, or a major voice on how the company is
       run.

3. Internal Financing
This is when you finance your business internally. This form of financing includes, but is not limited to:
    a. Trade credit: Once you have obtained a good reputation with
        your suppliers, your vendors may provide you extended terms
        of 30 to even 90 days or more. In these instances, you would
       be able to order, receive and even sell the goods before
       payment is due to the vendor.
    b. Profit: If your business is generating enough profit then many
        times you will be able to finance purchases with your own
       cash.

4. Leasing
Leasing is simply another form of financing. Leasing reduces the cash needed up front, but like a loan you are still obligated to make payments over a period of time. Some lease contracts give you ownership of the leased item at the end of the term for a specified amount, and in some cases as little as $1. Under certain leases you will be able to deduct the entire amount of the leas payment as an expense. In others, such as a capital lease, you will still be required to follow standard depreciation rules. Many leases will require you to pay state sales tax on the lease amount. If your purchases are normally exempt, then this could be an additional expense over a standard loan. Before signing any lease you should check with your accountant to see how the lease will affect your business.

Leasing is sometimes a good option if you are purchasing equipment directly from a manufacturer that may be offering an incentive, reduced price, or favorable credit conditions. Under many leases expect to pay a higher interest rate than under a typical loan, and check closely for any hidden charges.

Other articles:

Establishing a Banking Relationship

What Lenders Really Need to Grant Small Business Loans

Writing a Business Loan Proposal

The 8 C's of Credit