How to Finance a Business

25 Ways to Finance a Business 
 

How much money do you need for your business? If you're like most first time business owners, you probably do not have the funds needed to cover all proposed business start-up costs.  On the other end of the continuum, seasoned entrepreneurs generally require external financing in order to expand or grow their business ventures.

Many businesses fail because their owners have not secured sufficient funds in order to operate and maintain their enterprise. If you don't have money, you can't purchase inventory, buy advertising space, pay rent, pay your staff, or pay the many other expenses associated with owning and operating a business endeavor.

We started this section by asking "How much money do you need for your business?"  This is the first step in the process of financing your business. If you don't know how much money you need, chances are you haven't developed your Forecasted Cash Flow Statements.  Moreover, a Forecasted Cash Flow Statement, not only forces you to think of all the expenses that may occur, but it helps you estimate how much money you will need and when you will need it. 
 

Contents of this Section:

Below discusses 25 methods and approaches to financing a business start-up or expansion.  Be sure to evaluate each source and select the methods that can best acheive your financing goals.   

 

Personal Saving Start a Small Scale Business
Partnerships Customers
Personal Credit Cards Employees
Families and Friends Home Equity Loans
Working Outside of the Business Insurance Policies
Trading Products and Services Finance Companies
Trade Credit The Internet for Financing
Angels Investment Conferences
Banks Credit Unions
Venture Capitalists Leasing
Franchising The Government
Silent Partners Factoring
Cutting Costs  

PERSONAL SAVINGS:

Most entrepreneurs will use money from their personal savings to assist them in financing their business start-up or expansion. The larger your personal investment, the greater chance you'll have at acquiring external financing. In other words, your personal investment will be viewed by potential investors/banks/government agencies as an indication of your dedication and commitment toward the venture.  Furthermore, the more money an owner has committed to the enterprise, the less chance he or she will abandon it, should the business ever experience financial problems.

You may also decide to invest other personal assets into the business such as; your computer, automobile, fax machine, photocopier, printer, furniture, etc.. These asset investments will certainly reduce the amount of financing required. 

 

PARTNERSHIPS

Finding a "qualified" partner can not only benefit your business financially, but it may provide the venture with needed experience. In return for a partner's investment, you may relinquish an ownership percentage of the company. In addition, depending on your arrangement, the partner may share in the duties, responsibilities, and decisions of the company.

Pooling of financial and human resources has lead to many great success stories as well as many catastrophes. Before you decide to accept a partner, be sure to carefully determine the partner's reason(s) for wanting to invest. Differences in goals, as they relate to the enterprise, could eventually lead to the demise of the endeavor. If you decide to form a partnership, be sure to have a partnership agreement developed by a professional lawyer or accountant.

 

PERSONAL CREDIT CARDS

Believe it or not, credit cards are becoming a common use in financing a business. Credit cards provide fast cash that is generally used to get a business through the tough times. Depending on your credit rating, your credit card could serve as a major funding tool. Many business owners, having a "good" credit rating, generally request an increase in their maximum limit. Other entrepreneurs order two or three additional credit cards. The down side to this type of financing is, off course, the high interest rate. Careful consideration should be given to this type of financing.

 

FAMILY & FRIENDS

Cash investments made by family and friends is another common way for entrepreneurs to obtain the financing needed to open and operate their business. Family and friends can be a good source for obtaining a small investment since they are usually more trusting in your abilities, they generally don't "stick" you with heavy interest payments, and they tend to be more understanding with late payments. Unless, you are willing to give a part of the business to the family member or friend, you will be required to pay back the investment; even if the business fails. To avoid any disagreements or "lose" of a family member/friend, it is wise to have a professional agreement developed and signed by each party involved.

 

WORKING OUTSIDE THE BUSINESS

Many successful entrepreneurs have funded their business, in the early stages, by working outside the business. In most cases, the entrepreneur operates his/her business during the day and works for someone else at night. The money earned in the business can stay within the enterprise, while the money made during an evening job is generally used to pay personal obligations. One scenario might see the entrepreneur leave their evening job when the business becomes "stable" enough to pay the owner a reasonable wage. 

 

TRADING PRODUCTS OR SERVICES

In order to save money, many entrepreneurs will sometimes trade products or services with other businesses. For example, an owner of a newspaper publication may trade its products with an owner of a retail computer store. The newspaper publication may require computer equipment while the computer store may need additional advertising. As you can see, money doesn't change hands, only needed products and services are exchanged, thus reducing the amount of financing required.

 

TRADE CREDIT WITH SUPPLIERS

Most suppliers of inventory provide credit terms which generally allow a business to postpone payment by 30 days.  Many suppliers, however, may agree to provide even longer pay back periods such as 60 days, 90 days, or 120 days.  Acquiring credit from your supplies basically gives you additional time to sell more inventory and helps your business hold onto its money longer. Some suppliers may even agree to accept an equity position in your business in return for the inventory you buy from them.

Another method of saving dollars when buying inventory is to negotiate purchase discounts.  A purchase discount is simply a reduction in price on goods and services.  Such discounts are used by suppliers to encourage businesses to pay early.  Purchase discounts may range anywhere from 1% to 5% of the total amount owed by the business.  This strategy is generally exercised by businesses with surplus cash.

 

ANGELS

Angels, as they are called, are private investors such as lawyers, bankers, doctors, accountants, and so on, who may be interested in investing in your business. Angels have usually had success in their fields and want to support other individuals in their quest for success. You can usually find an angel by approaching organizations such as your local chamber of commerce, local development agencies, and/or business related associations. It is important, however, that you learn as much as possible about the angel before allowing him/her to invest in your business. (I.E. What is their motivation for investing into your business? Is the angel really an "angel" within the community? Does the angel have credibility and integrity? Is he/she well respected by the community? Why do they want to invest into your particular enterprise? and so on). 

 

BANKS

Due to the emphasize placed on entrepreneurship and the many benefits of lending to a well structured business, an increasing number of banks are starting to become more comfortable financing small business ventures.  Banks generally provide two types of financing; namely, short-term loans and long-term loans. 
 

SHORT-TERM LOANS: 
Short-term loans such as operating loans and lines of credit are used to supply businesses with working capital. These loans are used to finance short-term assets such as accounts receivable and inventory. Banks generally require the company to pledge its accounts receivable as collateral against short-term loans. Short-term loans are generally reviewed on an annual basis, however, the financial institutions granting such loans, may demand FULL repayment at any time (I.E. demand loans). Usually full repayment of short-term loans is requested when a banker feels the company's financial position has seriously diminished. 
 

LONG-TERM LOANS: 
Long-term loans generally present themselves in two forms; namely, term loans and mortgage loans. Term Loans usually mature in five years (or less) and are used to purchase assets such as office equipment, automobiles, office furniture, etc. Interest rates may be fixed or at a floating rate and are usually higher than the interest paid on an operating loan or line of credit.

Mortgage Loans, on the other hand, generally mature between five (5) and twenty (20) years. This type of loan is used to finance assets having long useful lives such as land, buildings, parking lots, production equipment, machinery, etc. The interest rate on mortgage loans is usually fixed at a negotiated rate and is generally re-negotiated several times during the life of the loan.

Before you apply for a bank loan (short-term or long-term), be sure to spend adequate time preparing your material. This may involve developing a comprehensive business plan along with the answers to these questions:

-    nature of your business, 
-    how much financing you'll need, 
-    the various types of financing you anticipate to receive
-    the terms of any required bank loan (short-term or long-term financing), 
-    why you need borrowed money, 
-    what the money will be used for, 
-    when you plan to repay all borrowed money, 
-    how you plan to repay the money, 
-    the assets you have to pledge as collateral against any required loan, 
-    how much you are willing to personally invest into the business, 
-    and so on. 
 

Being fully prepared shows the banker that you have the ability to manage and operate the business.  In addition, proper preparation shows that you have researched the businesses' viability and have set a clear direction or path in which to strive for (goals and objectives).  Remember, a bank or any other investor for that matter does NOT invest money into a business, instead, they invest money into a business owner. The better prepared you are, the more creditability you will have in the eyes of a banker. In addition, the more assets you can take to the bargaining "table", the better your chances are of receiving a bank loan (short-term or long-term).

 

VENTURE CAPITAL

Venture capitalists usually are groups of investors who pool their money together to invest in high risk businesses. If you have been "turned down" by traditional financial institutions such as a bank, you may decide to approach a venture capitalist. Remember venture capitalists usually request a higher return on their investments compared to traditional financial organizations. These returns may present themselves in the form of higher interest rates (debt financing) or a percentage of your business (equity financing), or both.

NOTE:  Many venture capitalists impose their own demands and requirements on the businesses they invest into. This may present problems for those business owners whose objectives are dissimilar to those of the venture capitalist.

 

FRANCHISING

A franchise is a company that uses a common name, reputation, and/or process for achieving an overall success. Franchising is a growing source for funding businesses worldwide. The franchiser (the company owning the rights to the franchise) obtains funds from the franchisee (the individual obtaining the permission to use the franchise name) to help expand the company while the franchisee gets to use the franchiser's buying power, distribution methods, reputation, processes and, in some cases, financing to start the franchise.

To use the franchise name, the franchisee is usually required to pay a front end fee to the franchiser. In addition, a franchisee may be required to pay royalties for using a franchiser's privileges. Most franchisers have established policies and regulations and discourages or disallows any franchisee from deviating from such regulations. 
 

 

SILENT PARTNERS

Another financing method many entrepreneurs use is to acquire one or more "silent" partners. Silent partners are investors who invest in a business and generally remain silent about their actual role.

These types of partners may or may not have any affiliation with the organization's operational functions. This will certainly depend upon the arrangements between you and the investor. In addition, a silent partner usually is not personally liable for any of the company's debt nor do they share any control in the decision making process.

 

CUTTING COSTS

If you operate an existing business, you can use cost cutting techniques to improve cashflow or to finance other required functions of the enterprise. Many entrepreneurs reduce their costs and use those savings in other areas where more efficient utilization can be seen.

Cost cutting techniques can also be used by individuals planning to open a business venture. When you are developing budgets, be sure all your forecasted costs are necessary and provide full overall financial benefit to the operation. If you have budgeted costs that will not provide economic benefit, consider omitting them from your financial forecasts.

Whether you are planning to open a business or already operating one, it is important to carefully evaluate the effects of each cost cutting item. Once again, be sure the cost reduction will prove beneficial and therefore improve the overall cashflow and bottom line. For example, it may not be a good idea to lower your advertising expense by $2,000 if sales of $10,000 will be lost as a result.

 

STARTING A SMALLER SCALE BUSINESS

Many entrepreneurs have raised the necessary money for their "dream" business by starting a smaller scale venture such as a mail-order business or a network marketing business. The startup capital essential for these types of businesses is generally small while the return can to be high (depending upon several factors of course). Be careful, however, when buying into a multilevel marketing or network marketing enterprise - do your homework.  These days, a better approach would be to start an internet business.

 

CUSTOMERS

Depending on your positioning strategy and the industry's credit granting policy, customers may assist your financing needs. You may decide to use practices such as:
 

  •   Offer credit to increase overall sales and therefore future cashflow;
  •   Grant discounts to customers for early payment (on credit purchases);
  •   Require a deposit on lay-a-ways;
  •   Request a Deposit on purchases made on credit;
  •   Cash only policies;
  •   Prepaid orders;
  •   Enlist the use of credit cards, debit cards, etc. (if not currently used). 
     

It is very important to note that changing your credit granting practices may not improve your cashflow nor assist your financial needs. On the flipside, a company not offering credit to its customers, in an industry where credit is encouraged, will most likely experience loss of sales to competitors. Be sure to carefully evaluate the industry standards as they relate to customer payments.

Finally, enabling customers to pay by way of credit card and debit card is a must these days.  Research indicates corporate sales will be much higher when customers can pay with "plastic" opposed to a cash only policy.  Furthermore, the average dollar value of a consumer purchase is much higher when the customer is given the option to pay with a credit card or debit card.  Think about it... who carries around large amounts of cash these days?  Very few people!

 

EMPLOYEES

Employees can be viewed as possible sources of financing. For example, you may design a program allowing employees the option to buy a small portion of your company. A standard deduction from their weekly pay check may provide employees with a modest equity share of the business. This approach obviously reduces your overall ownership of the company, but it also reduces the amount of cash (financing) needed to pay employees. Such a program may increase the company's overall profitability by motivating employees to work harder and more efficiently. In other words, many employees will, indeed, work harder if they see the apparent benefits (I.E. the more profitable the company, the greater the employee will benefit).

 

HOME EQUITY LOANS

If you own a home and have the desire to start or expand a business but lack the necessary funds, you may elect to use the equity in your home as collateral. (only the ownership value of your home; not the remaining mortgage). The bank, if they approve your loan, will lend against the value it feels it would get for the house on the open market (maybe 60% of the market value). Banks generally "like" lending loans against homes as they are almost certain to get their investment back in one way or another.

The down side is that your home can be foreclosed if you default on payments. This being the case, you should research thoroughly the long-term viability of your business before using this source for funding.

One final note on home equity loans.  Many lenders will not allow you to use the equity portion of your home as a means to acquire financing for a business start-up or expansion.  To combat this challange, most creative entrepreneurs site the loan is required for personal reasons such as home renovations or consolidation of existing debt, for exmaple.

 

CASHING IN AN INSURANCE POLICY

Many entrepreneurs have used their insurance policies as a source of obtaining financing. Some decide to cash the full amount of their insurance policy while others simply borrow against the policy. With its increase in acceptance and popularity, more and more insurance companies are making this option available to their clients.

 

FINANCE COMPANIES

Finance companies specialize in lending to high risk borrowers. Many of their clients include entrepreneurs who have fully exhausted all other means of obtaining funding. They are sometimes referred to as "last resort financial institutions". Before deciding on a finance company be sure to review their collateral requirements and rates of interest. These financial institutions generally require you to have sufficient collateral as security. By shopping around, however, you will be surprised at the variation in requirements.  Also refer to mortgage brokers for your financing needs.

 

USE THE INTERNET TO FINANCE THE FUTURE

You can use the internet to generate money now for business expansion and growth.  As you are aware, using the internet can amazingly increase sales and profits to unbelievable levels.  If fact, the internet has turned regular people into multi-millionaires in a very short period of time.  For many of you, however, we can use the internet in the short term to greatly increase sales to finance new developments or expansion plans. 

 

INVESTMENT CONFERENCES

Investment conferences are organized events that bring investors and investees together. Most entrepreneurs have found these events to be an extremely beneficial means of acquiring needed capital. In essence, these events eliminate the task of finding someone who may have an interest in investing into businesses. Since investors frequent these conference, your task is to convince them of your businesses' merit.Your local chamber of commerce may provide you with information regarding possible dates for such events. If no investment conference is scheduled, ask your local chamber of commerce to consider sponsoring one.

 

CREDIT UNIONS

Credit Unions have served as lenders and supporters for many local business startups and expansions. In most cases, the loan manager is well aware of the structure of your community and will see how your business can strengthen it. Credit Unions usually have less stringent collateral requirements but request higher interest rates compared to traditional banks.  

 

LEASING

Another way your business can save on large cash outflows and thus reduce your total financing needs is through leasing. By leasing capital equipment (computers, production equipment, photocopiers, etc.), opposed to purchasing, you ultimately free up cash thus reducing the amount of capital needed.

For example, instead of paying a lump sum of $5,000 plus taxes for an office computer, you may decide to lease the same computer and make small monthly payments until the full amount is paid. In short, you pay for what you use, when you use it.

What a lot of people fail to understand is that the leasing option can be used for almost any type of asset purchase.  Examples include - corporate automobile, production equipment, office furniture, office equipment, buildings, and land to name only a few.  

Before you decide to lease any piece of equipment, be sure to discuss your options with the leaser and possibly other entrepreneurs who have used leasing in the past.

 

THE GOVERNMENT

As we have seen in Part 1, governments can be a good source for obtaining financing. Many federal, state/provincial governments provide financial assistance to businesses in an attempt to improve the economic and social welfare of society.  Each government program will have specific criteria in which a business must meet.  Below lists a number of areas generally viewed as important to governments.  

  •   Businesses creating new technology;
  •   Businesses engaging in export;
  •   Businesses creating or increasing employment; and
  •   Businesses producing a product to eliminate the need for importing.


Government funded programs usually carry a lower interest rate compared to commercial loans and other types of financing through traditional lenders such as banks. In addition, government programs geared towards assisting business startups and growth tend to be more flexible in granting assistance.   

 

 

 

 

FACTORING

If your business offers credit terms, chances are you'll have customers who owe you money for purchases placed on credit (accounts receivable). If your business needs cash fast, you may decide to sell your accounts receivable to a factoring company. Moreover, factoring companies buy outstanding accounts receivable from businesses for less than their value.  The factoring company will then proceed to collect the full amount owed by customers.

For example, suppose your business had total accounts receivable valued at $10,000 and needed money quickly. You might decide to sign over these receivables to a factoring company. The factoring company will look at the average length of time in which the accounts receivable have been outstanding (not paid) to determine their fee. Lets assume the company quotes a fee of $4,000. This means your business will receive $6,000 for the total amount of accounts receivable ($10,000).

As you can see, selling accounts receivable can be extremely expensive, however, if your business requires fast cash, you may have no other choice. Before you decide to sell your receivables, be sure you examine all other alternatives.

Another way to obtain funding from a factoring company involves by borrowing against the value of your accounts receivable. In this case, the factoring company lends money to your business based on the value of your accounts receivable. Your business will promise to pay back the borrowed money when you have collected on the outstanding accounts.

In summary, this type of financing is generally used only when money is needed quickly and all other financing options have been exhausted.

Categories: Financial