Sources Small Business Capital

Sources of Small Business Capital - With your new business plan, financial projections and financing knowledge, you are now ready to secure outside capital for your new venture. The following 10 types of financing sources are ranked according to amount of preparation required and ease of securing the outside capital. Less preparation to secure a loan does not mean it is the best source, nor the least expensive source of capital. Of course, there will be exceptions to these general statements about each financial source.

1. Trade Credit or Supplier Credit - Payment terms offered by your suppliers are a potential source of credit. Study the discounts for early payment and the penalty for late payment to determine the true cost of the credit. While some suppliers will extend credit only to well-established, proven firms, many will extend limited credit to new businesses to encourage another outlet for their merchandise. Planning for use of trade credit is essential. To establish good trade credit, a new business must make timely payments as agreed. Trade credit is effectively used by large businesses to buy products at lower cost than small firms. Do not depend too much on trade credit from one supplier. If repayment problems arise, you may find your major source for supplies cut off when you need it the most.

2. Life Insurance Policies - A standard feature of most life insurance policies (except term insurance) is the owner’s ability to borrow against the cash value of the policy. The money can be used for any business or personal need. It normally takes two years for a policy to accumulate sufficient cash value. You may borrow up to 95 percent of the cash value of the policy for an indefinite period of time. As long as you continue to pay the insurance premiums, the interest can frequently be deferred indefinitely. The policy loan will reduce the dollar value of the policy and, in case of death, the loan is repaid first and then the beneficiaries receive the remainder. Some older life insurance policies guarantee very favorable interest rates.

3. Friends and Relatives - It is best not to borrow from friends and relatives, but many people do. If you must borrow from a friend or relative, do it on a business basis by putting the agreement in writing. Check with a lawyer if you want a binding, legal agreement. You may also get a sample business loan contract form from a bank or lending institution. Use it as a basis for a written agreement that both parties find acceptable. Unrealistic and/or naive investment expectations have ruined many friendships and family relationships.

4. Customers - When customers pay for work in installments as it is completed or provide some of the materials, they are, in effect, financing the business. For example, a carpenter reduces capital requirements when the customer purchases the building materials for a remodeling project. In addition, it is not uncommon to request a deposit from customers when ordering items, particularly special items.

5. Leasing Companies - Leasing business equipment is another way to reduce capital needs. Everything from office furniture to food processing equipment can be obtained from leasing companies or commercial finance companies. Leasing is generally more expensive than bank financing and is limited to items that have a long serviceable life, widespread use, and are easily repossessed in the event of default. In many cases, you have the option to buy the equipment for an agreed upon amount at the end of the lease period.

6. Commercial Finance Companies - Commercial finance companies are generally seen as the place to go when you are unable to secure financing from a bank. Commercial finance companies, like banks, are concerned with your ability to repay the loan; however, they are more willing to rely on the quality of the collateral rather than your track record or profit projections. If you do not have substantial personal assets or collateral, a commercial finance company may not be the best place to secure start-up capital for a business. Commercial finance company capital is usually several percentage points higher than bank financing.

7. Commercial Banks - Commercial banks are by far the most visible lenders and make the greatest number and variety of loans. However, banks are generally conservative lenders. Although they accept collateral for business loans, loan approval rests on your ability to repay the loan as shown by your profit projections, management skills and your personal record. Strive to establish and keep a good working relationship with your banker. It may help to involve the banker in the planning process for your new business. Avoiding the banker until you need money may make a loan harder to get because the banker is unfamiliar with the business and its history.

8. Small Business Administration - The Small Business Administration (SBA) is an independent government agency formed in 1953 to help small businesses. The SBA provides loan guarantees, participates with bank loans, and, if funds are available, makes a limited number of direct loans. To receive financial help from SBA, a business must be unable to secure reasonable financing from other sources. A business must also fit the SBA’s generalized criteria for a small business, which vary for different types of businesses.

SBA loan interest rates vary from year to year based on the cost of money to the government. Also, the maturity of a SBA loan is limited to 10 years, except for the purchase or construction of buildings that may have a maturity of 20 years. A loan proposal for the SBA is generally more complex and more documented than one for banks. Unlike commercial lenders, the SBA will sometimes ignore a losing track record if a business shows signs of improvement with a healthy future.

9. Small Business Investment Companies - Small Business Investment Companies (SBIC) are privately owned companies that are licensed and regulated by the SBA. SBICs were created to supply equity capital, long-term loan funds and management help to small businesses. There are investment companies in Maine that are ready to help businesses with excellent potential. Most investment companies prefer to lend to established companies or finance purchases of existing businesses.

Summary - There are many sources of capital for the small business with good potential. However, there is no substitute for putting your financial assets on the line in starting your own business. Securing capital for any new business will require well-developed business plans, financial projections and knowledge of sources of financial support. However, like any small business person, commercial lenders are also in business for profit.