08/ 23/ 2004
by Jeffrey Moses
Running out of cash before becoming profitable is the most common cause of small-business failure. For this reason, adequate funding must be secured, both when starting a new business and during the initial phases of growth.
Bank financing is rarely an option for a new small company. Banks focus on a company's financial history, collateral and cash flow projections: none of which a small company can demonstrate with certainty. Similarly, venture capitalists are reluctant to put money into unproven start-up companies, and time spent wooing potential venture capitalist funding often is unfruitful.
Loans from the Small Business Association (SBA) have gotten thousands of small companies off the ground. Visit the SBA Web site for more information on how your company may qualify and receive seed funds.
Knowledge of alternative financing is necessary for small-business entrepreneurs. While not as glamorous as receiving funding from venture capitalists or as straightforward as a bank loan, the avenues of alternative financing may prove more accessible and practical.
The most common sources include:
1. Angel financing. An individual puts up most or all of the money required. Usually, "angels" will want to participate in business decisions and may demand a significantly higher return on their investment than would be expected in a bank loan. When using angel financing, consult with an experienced attorney to help guide you in negotiations and creating a contract.
2. Family members and friends. Those who believe in you and your business and who are willing to help fund your startup. It's important to establish and maintain a strict business approach to borrowing from family members and friends. The entire arrangement should be treated, in essence, as though you do not personally know the lenders. Don't base your agreement on a handshake. A detailed contract for funding should be created by an attorney. This will help avoid confusion and hard feelings down the road. Remember, you may be sitting beside "Uncle Charlie" at holiday dinners for the rest of your life. You don't want an unsatisfactory business relationship to haunt your relationship.
3. Loans based on contracts with customers. This is the best of all worlds. When you can secure a contract for providing work from a former employer or a company you have done business with in the past, most banks will lend money based on the projected income.
4. Funding by partners in your company. A financing partner may actively participate in the business or remain "silent" -- that is, provide funding but allow you and other partners to handle day-to-day operations. Many successful businesses have been created through this type of funding. The difference between partner financing and other types of financing previously mentioned is that a financing partner will retain long-term interest in the business, not merely receive a return on investment.
5. Leasing of equipment and vehicles. Leases are, in effect, loans, and in most cases are much easier to secure than bank loans. Usually, equipment and vehicle leasing agencies do not require the extensive business financial history that banks do. Leases can be a good way to fund key components of your start-up needs.
6. Credit cards. Ouch! Try to avoid putting the funding for your new company on plastic. Debts can spiral out of control, especially with the high interest rates charged by many card companies. Credit cards should be used by businesses only as a tool to facilitate purchases and should be paid off immediately. Don't fall into the trap of thinking that your company will become profitable immediately, and therefore the use of credit cards is justified. History has shown that many of the most successful small companies have had to weather financial ups-and-downs during start up.
7. Home equity lines of credit. This is a proven way to finance a new business, but it places your home in jeopardy. When considering a home-equity loan, do not put more at risk than you can continue to comfortably carry, as a second mortgage should your business not bring in adequate income.
