4.02 Sources used in financing a small business

Equity sources:

Capital sources that trade cash for some portion of ownership in the business.

Identify the entrepreneurial characteristics needed to obtain financing (six C's of credit):

Character, Capacity, Capital, Collateral Conditions, Coverage.

Lines of credit:

Agreements made by a bank to lend money at a stated interest rate whenever the owner needs it. A fee is charged for the privilege whether the money is used or not, and interest is charged on any money that is used.

The Economic Development Administration (EDA)

Division of the U. S. Department of Commerce; Lends money to businesses that operate in and benefit economically distressed parts of the country; Similar to SBA, but more restricted

Small Business Investment Companies (SBIC's):

Licensed by SBA; Provide equity and debt financing to young businesses; Invest about twice as often in startup ventures as do venture capitalists.(Privately owned)

Small Business Administration (SBA):

Uses a commercial bank to process and release the money and guarantees up to 90% of the loan if the business fails

Department of Housing and Urban Development (HUD):

Provides grants to cities to lend money to private developers to help improve impoverished areas.

Factors to consider when choosing a financial plan:

Risk, Control, Availability of funding.

Steps in getting a loan:

Select the bank carefully; Prepare financial statements and a business plan; Make an appointment; Prepare to answer questions.

Collateral:

Something of value that the lender can claim if the debt is not repaid.

Equity:

Sometimes called risk capital because the investor puts his/her money at risk. Since the investor acquires ownership in the business, no repayment of money with interest is required.

Local and municipal governments:

Sometimes make small loans of $10,000 or less

Debt sources:

Sources of funding that require the money borrowed to be paid back with interest.

State-sponsored venture capital funds:

Funds provided to entrepreneurs by the state in an effort to encourage economic development and creation of jobs.

Character:

The bank needs to believe in the character of the entrepreneur and the people with whom he or she is associated, including the management team of the business; Responsibility shown by paying bills in the past; Good credit rating; Good reputation

Conditions:

The bank will consider all of the environmental conditions such as competition, growth, location, and economic outlook in which the business will operate.

Coverage:

The bank will want to know what kind of insurance coverage the entrepreneur has.

Types of financing available to a small business:

1. Equity Sources 2. Debt Sources

Sources of equity funding

Personal Savings, Family and Friends (love $), Partnership, Private Investors (angels), Personal savings

Unsecured loan:

A loan that is not guaranteed by collateral; usually granted to a bank's most credit-worthy customers for a short period (less than a year) and for a specific purpose.

Sources of Debt Equity:

Banks, Short-term financing, Finance companies, Credit unions, Personal loan from family or close friend, Government agencies, SBA, MESBIC

Credit Unions:

Cooperatives formed by labor unions or employees for the benefit of the members.

Capital:

Demonstrated ability and willingness to invest personally in the business venture; Evidence of a good financial plan with little outstanding personal debt

Venture capitalists:

Individuals or firms that invest money professionally to make money, expect a large capital gain, and look for high growth potential (30-50% return on investment).

Minority Enterprise Small Business Investment Companies (MESBIC's):

Established by SBA to provide funding to businesses whose ownership is at least 51% minority, female, or disabled

Capacity:

Evidence of the ability to repay the debt; Legally eligible to enter into contracts

State governments:

Most states have economic development agencies and finance authorities that make or guarantee loans to small businesses.

Short-term loan:

Must be paid back within a year; may be used for the specific purpose of dealing with a cash flow problem.

Government agencies:

Operated by the government to provide technical assistance, counseling, grants, or other means of financial assistance in the form of low-interest loans.

Long-term loan:

Repayable over a period longer than one year; may be used to make improvements that will help increase profits.

Types of loans available:

Secured loans, Short-term loan, Long-term loan, Lines of Credit: A loan that is backed by collateral.