Debt Financing For The Small Business
When it is necessary to look to someone other than yourself or a close friend or relative for business funds, it helps to be aware of other sources.
Banks are financial institutions that accept deposits and make loans. They fall into several categories, such as savings and loans, thrift institutions and commercial banks. Knowing the category in which they include themselves can tell you a lot about the kinds of loans these banks are interested in making.
Savings banks are more experienced in dealing with consumer loans, such as home mortgages and automobile loans. Commercial banks have more experience and interest in business loans. This doesn’t mean that you can’t go to a savings bank for a business loan. It may be a good choice. Just be sure to consider that bank’s primary focus and level of experience with your type of request. Probably the most important point to keep in mind when dealing with a bank is that bankers don’t like risk. Their primary concern is always the safety of their funds.
How do they operate?Banks may be one of the first sources that come to mind when you begin searching for additional business capital. Certainly, they will meet your most basic condition: they have money available to lend. However, it may be difficult for a new business to borrow from a bank since lenders usually prefer to lend to established businesses. Keep in mind, the first responsibility of a bank is to protect its depositors. As a result, bankers tend to be very cautious about lending money.
Banks come in all shapes and sizes and there are some real differences among them. Small community banks with two or three branches may operate quite differently from large commercial banks with hundreds of loan offices. You will want to carefully review the differences among banks before you select a particular one. Each type offers certain advantages. A commercial bank may be more experienced and familiar with a business loan request, but a community bank may know you personally and have more confidence in your ability to repay your debt.
Where can you get more information? Chances are you’re already familiar with several banks in your area. It’s extremely helpful to approach a bank with which you already have a savings or checking account or a personal loan. For banks outside your area, you may want to consult a banking directory, such as Rand McNally’s Bankers Directory or Polk’s World Bank Directory. Most libraries have copies. Directories list the name, location, assets, liabilities and officers of banks.
Credit unions are financial institutions developed by the members or employees of a company, labor union or other group. Their overall goal is service to their members, as opposed to profit making. As a result, their interest rates and other terms may be more favorable than those offered by a bank. Credit unions are regulated by the National Credit Union Administration.
What are the advantages of a credit union? The company for which you or another family member works may have a credit union. If you decide to start your business while you are still working for a large company, you may be able to borrow some of the capital you will need from the credit union. As your business becomes more profitable and better able to support you financially, you may decide to concentrate all your energies and time on your business.
Credit union interest rates are often lower than the rates charged by other lenders. The amount you will be able to borrow from a credit union may not be large, but this source of funds may be helpful in making initial purchases for your business. Also, a loan application through a credit union may be more likely to be approved as you may be known to the individual evaluating your loan request.
Where can you get more information? If you’re employed, ask the human resources department of the company where you work about your eligibility to join a credit union. There are directories available at your local library listing all of the credit unions in the United States.
Consumer Finance Companies
Consumer finance companies make small personal loans secured by collateral. Unlike banks, they do not accept deposits and they lend under the jurisdiction of each state’s small loan regulations. Consumer finance companies will often consider loans with 100 percent financing because the loans are secured by an asset.
How do they operate? Consumer finance companies charge higher interest rates and processing fees than banks and credit unions but can be more flexible about approving requests. Loans from this source are more expensive because they are considered to be more risky. In some cases, the interest rate you will be charged will be the highest allowed by law for your state.
Consumer finance companies are often approached by people who have poor credit ratings. Certainly, if you want to start a business and your credit rating is questionable, you will find consumer finance companies a more likely source of funds.
However, this does not mean that you should only borrow from a consumer finance company if you have credit problems.
You should be aware that loans from this source will usually not exceed several thousand dollars. Also, keep in mind that if you can’t repay your debt, the item that you purchased with the funds will be seized.
Where can you get more information? The classified advertising section of your telephone directory lists consumer finance companies under the heading of Loans. Call and request a meeting, or ask them to send you written information.
Commercial Finance Companies
The primary purpose of a commercial finance company is to provide loans to purchase inventory and equipment. This can be a useful resource, particularly if your business will manufacture a product or act as a wholesaler. Commercial finance companies are similar to consumer finance companies but concentrate on business loans rather than consumer purchases.
How do they operate? Like consumer finance companies, commercial finance companies charge higher rates of interest than banks. They also may be more willing than banks to approve your loan request. Commercial finance companies will require your debt be collateralized. This means if you purchase a computer with the funds you have borrowed, they will have a direct claim on your computer. If you can’t make your monthly payments, the commercial finance company will be entitled to take your computer and sell it to recover its investment.
Where can you get more information? Check the telephone directory for a list of commercial finance companies in your area. You should research your rights when borrowing from a loan company by reading your state’s laws concerning debt repayment.
When a vendor allows you to buy a product and to delay paying for it, this is known as trade or vendor credit. Vendors offer this service to help make their products more attractive and to induce you to buy from them rather than elsewhere. Offering easy credit terms encourages sales. Keep in mind that the vendor is in business to make money. There may be a hidden cost for flexible credit terms in the form of slightly higher prices.
How does it work? Trade credit is one of the most readily available sources of financing for your business. In many situations, you will be able to purchase supplies and equipment directly from a vendor and spread your payments over several months or years. Often it is possible to make no or a minimal down payment and to avoid interest charges as well. Even suppliers who will not extend credit in the beginning of your relationship may be very willing to do so after you have placed several orders.
When you are trying to pay for equipment and/or supplies that your business needs, trade credit can be invaluable. Office furniture, computers, certain raw materials and manufacturing equipment are examples of products that can be purchased with trade credit.
Where can you get more information? Discuss payment terms with vendors with whom you deal or plan to deal. There may be dramatic differences in terms among different suppliers. Talk to several suppliers before making a decision. Remember to ask what types of credit they offer and if they grant a discount for prompt payment. Also, be sure to compare prices. Vendor financing is not desirable if you are being charged substantially more for the same product you can purchase elsewhere more cheaply with cash.
Insurance companies are a possible source of financing for your business because they make commercial loans as a means of investing unused portions of their income. Generally, insurance companies make term loans and mortgage loans.
How do they operate? If you borrow from an insurance company, you can expect terms and interest rates similar to those available from a commercial bank. Insurance companies can provide your business with a large amount of capital at market interest rates, but you must have assets sufficient to cover the debt, plus 20-30 percent extra. In effect, you mortgage your property to free cash for your business. This allows you to retain title to the property while freeing cash invested in it. Insurance companies usually have high loan limits; this makes them a good source of funds if you need a large supply of capital.
Where can you get more information? Speak with your insurance agent or ask friends to make recommendations. You may also wish to request information packets from insurance companies’ loan offices.
A factor company can be a useful source of funds if you are already in business and have made sales to customers. Factor companies purchase your accounts receivable at a discount, thereby freeing cash for you sooner than if you had to collect the money yourself. You transfer title of your accounts receivable to the factor company in exchange for a cash payment.
How do they operate? Factor companies provide two types of financing alternatives: recourse factoring and nonrecourse factoring.
In recourse factoring, you retain part of the risk for ultimately collecting the debts owed to you. The factor company assists you by speeding up the process. For example, the factor company purchases your receivables and advances you cash while the accounts are being collected. However, if your customers do not pay, you will be held responsible for repayment to the factor company.
In nonrecourse factoring, you sell all rights and obligations concerning your accounts receivable. The factor company purchases your receivables and collects the debts owed. If a customer does not pay, you will be under no obligation to the factor company.
Factor companies can be a useful source of funds for a new or existing business. They are not appropriate as a means of seed capital to start a business because they require that you have accounts receivable to sell.
Where can you get more information? Factor companies often advertise in the business sections of newspapers. Usually the advertisement will say We buy accounts receivable or something similar. Make sure you work with a reputable company that will not alienate your customers by harassing them for payment.
A leasing company is a business that rents various types of equipment to businesses and individuals. By renting rather than buying the equipment your business will need, you will be able to avoid many capital expenditures associated with the purchase of equipment.
How do they operate? Many leasing companies require a down payment or several months’ prepaid rent. Some, however, may allow you to lease equipment without requiring any prepayment. This depends upon the relative size or worth of the asset leased. The small amount of cash needed to secure the use of equipment for your business makes leasing very attractive to many business owners. However, since you do not actually own the equipment, the leasing company may repossess it if you miss a payment.
An advantage provided by leasing is that you will need little or no cash to secure equipment and you will be able to upgrade your equipment more easily than if you purchased it. If your industry experiences rapid changes in technology, leasing may help you to avoid the expense of purchasing quickly outdated equipment.
Obviously, you will not be able to meet all of the financing needs of your business by leasing. You will still need additional funds for ongoing expenses, such as employee salaries. Leasing, however, can allow you to hold on to the cash you may otherwise have spent on equipment, and this cash savings can be used in other, less easily financed, areas.
Where can you get more information? Many equipment suppliers offer leasing arrangements in addition to actual sales. Discuss with suppliers and vendors what types of items they lease and what terms they offer. A service contract can usually be purchased for an additional charge.
U.S. Small Business Administration (SBA)
The SBA may provide a loan guaranty that will help you borrow from a bank. Essentially, the SBA guarantees the lender that up to 90 percent of your debt will be repaid. This helps the lender feel more comfortable about making you a loan. Although the SBA primarily guarantees loans made by banks and other lenders, there is a limited SBA direct loan program, generally for Vietnam-era and disabled veterans, businesses located in areas of high unemployment and handicapped individuals. Funding for this program is subject to congressional appropriations.
Loans backed by the SBA usually offer reasonable interest rates and long repayment terms, making them very desirable. It is the SBA’s goal to assist those businesses unable to borrow successfully from conventional lenders without the assistance of the government. You can get additional information on SBA programs by contacting the SBA field office in your area.
Small Business Investment Companies (SBIC)/Specialized Small Business Investment Companies (S-SBIC)
The federal government may also be able to help you with financing through an SBIC or S-SBIC that makes direct loans to entrepreneurs for start-up and expansion as well as equity investments. SBICs and S-SBICs are licensed by the SBA and operate under its guidelines. They are privately owned organizations, chartered by the state in which they operate.
There are several conditions your business must meet in order to be considered for assistance from these sources. Typically, an SBIC or S-SBIC is less averse to risk than a bank.