Q: As I budget for our second year of business, I realize we will need additional money, but am not sure what form of financing to seek. Could you give some guidance to a neophyte borrower who does not want unnecessary debt?
A: There are only three types of financing available to a small business owner: debt financing, equity financing, or a combination of the two.
Debt financing comes from banks, government loan programs, or anyone you can convince to lend you money, to be repaid over a period of time with interest. Equity financing is the money you or an investor places into the business, representing an ownership position in the venture.
Investors are generally repaid through dividends taken from profits, or from selling a successful business.
Start by considering where you can qualify for money at the cheapest rate. Generally, retained earnings or trade credit are the cheapest sources, followed by debt financing from banks, government loan programs or non-bank lenders, followed by equity options that require you to share ownership and profits with outside investors.
Your budget projections will tell you how much money you need. Whether you can qualify for a loan depends on whether you can demonstrate to lenders that your company can meet their underwriting requirements. They will include managerial capability, proof that you will have the money to repay the loan, good credit, adequate equity and investment, and collateral.
If you cannot meet these requirements you will have to consider attracting equity money from investors.
Once you know how much the loan will cost, make sure the money can be used profitably. For example, one of the Small Business Development Center’s clients had to pay 13 percent interest to buy computer gear that allowed her to track her inventory. But the equipment allowed her to save cash through better inventory control, returning 23 percent on her investment. That’s putting money to use profitably.
You should also make sure you use the type of financing you need. Short term financing, is repaid within a year from the money you obtain selling inventory or getting paid for your accounts receivable.
* Holloran is executive director of the Small Business Development Center of Hampton Roads. Write to him c/o The Daily Press, P.O. Box 746, Newport News 23607.
