Loans for Start Up Business

Complete Guide to Obtain a Loan or Investment for your Start-Up Business

Loans

Loans are a time-tested way of raising capital for your business. Unfortunately is not as easy as going to the bank and asking for money. The following steps should give you an idea on how to raise the right amount of capital to get your business going.

Step 1: Decide how much money you need.

This is an obvious statement but often overlooked. Entrepreneurs, particularly start-ups, when budgeting for their business often focus on the amount that is absolutely necessary to start their business without accounting for working capital or cash for contingencies. This is dangerous because lack of working capital can mean the death knell for the business.

On the other hand, some entrepreneurs, again start-ups, drastically overestimate their costs. This will make lenders not only question the entrepreneurs’ assumptions, but also question whether they know what they are doing.

Assuming that you did your research and decided on an amount, lets focus on the lender that is right for you.

a) If you are a start-up:

Loan amounts below $25,000 are considered smaller, micro-loans. Not all banks will be interested in doing a SBA guaranteed loan for small amounts (more below). Micro-lenders and Alternative-lenders are better equipped to handle this type of loans. These lenders usually make smaller loans and have a community focus. Look to credit unions, local development corporations and other non-profit lenders.

Small Business Administration (SBA) guaranteed loan is a guarantee to the lender. If the borrower defaults, the lender is guaranteed repayment of a portion of the loan by the SBA. You are still liable for the loan, so your obligation does not go away. From my experience, an amount of $50,000 and above is the usual range for SBA loans. The higher the amount requested the more the lender would look for collateral to secure the loans. Start-ups and existing businesses can apply for SBA guaranteed loans.

b) If you are an existing business:

If you own a company that has documented sales (you will need to show previous years’ tax statements) then you can apply for conventional bank loans. These loans are usually easier to apply, and may have lower interest rates. Normally for a conventional bank loan, you will need to be in operations for at least 18 months.

c) Set your expectations:

The bank does not want to own your business. It is highly unlikely that you will get a loan for a 100% percent of the project cost. You will need to put down a co-payment. Although the minimum co-payment varies by industry and lender, expect to invest at least 20%-40% of the project cost.

Step 2: Find out your credit score.

You should check your credit score and look over your credit report to make sure there are no problems. A credit score of above 650-680 is considered “Good”, but it does not mean you will get a loan. A credit score in the 700-800’s is very good and increases your chance of getting approved.

You can request your credit report from one of the reporting agencies, or use one of the many online services available to check your score.

Step 3: Start researching your options.

Start weighing all your options. Think of ways to strengthen your loan application. Can you find a co-signer? Bring in a partner with good credit or experience? Invest more cash into the business? If you think that you are not a strong candidate for a business loan, you can present the lender with options to increase your chances.

Step 4: Start writing the business plan and create the financial projections.

The business plan is more than a plan—it is a tool that helps you evaluate your business concept, your product or service, and explains how to implement your ideas. A business plan is also a tool to obtain investors, lenders, and strategic partners. You can find many resources and opinions on the Internet as well as your local bookstore on how to build an effective business plan. A lender will usually require a comprehensive business plan as well as a projected 1-year cash flow projection (month-by-month), 3 years income statements, a balance sheet, a statement of sources and uses of funds, and a loan amortization schedule. One mistake that borrowers are usually at fault for is the figures on the Business Plan not matching the numbers on the financial projection. Double-check your work before sending it to the bank.

Step 5: Find a lender

Finding the right lender is not easy; each lender has its own criteria for lending. However you can use the list below to get an idea of what type of institution is a better fit for your needs.

a) Commercial Banks

Banks are one of the largest small business lenders but their approach to lending varies. Commercial Banks decisions are based on your strength as a borrower (a good credit score, personal financial statements, experience and collateral) the banks goals for the period and their lending philosophy. Banks may be looking to expand their small business loan consumer base; others may focus on larger loans or a specific industry.

You will need a high credit score if you are applying for a bank loan (with or without the SBA guarantee). Although, this is not an absolute rule for all banks, we found that a credit score over 700 is a better predictor on the success of a loan application. The bank may look for collateral (home equity, saving, etc) if you are applying for amounts over $50,000.

The borrower’s personal financial situation is key for the application. The bank’s underwriter will analyze the person’s net worth; as well as look at her previous earnings, length of credit history, among other factors.

For lower amounts the bank may not require a business plan. However, if there is a particular weakness in the loan application, the loan officer may ask the borrower to submit a business plan and financial projections.

b) Non-Bank lenders

These institutions do not conduct consumer banking but offer business services and business loans. Lenders’ requirements vary depending on the institution, and some prefer lending to specific industries. The Non-bank lender may take longer to process your loan application than a regular bank, but they can approve loans that banks find too risky.

Non-Bank lenders usually require a business plan and ample documentation with the loan application. Compared to banks these lenders have more flexibility working with lower credit scores as long as the borrower has the necessary experience and collateral.

c) Region specific Lenders

There are neighborhood specific for-profit/non-profit lenders that have more flexible lending terms. For example: Credit Unions and Community Development Organizations may lend to specific neighborhoods. The nature of your business and the reason why you are requesting the loan should fit with the organizations’ goals.

d) Micro and Alternative lenders

Micro and Alternative Lenders lend to riskier borrowers. These borrowers usually have low credit scores or they are just building credit, also they don’t have a strong financial history and have little or no collateral. These institutions lend lower amounts and charge higher interest rates.

Step 6: Prepare the loan application package

A “Loan Package” is the paperwork you submit to the bank in order to apply for a loan. The Loan Package includes the following:

• Business Plan
• Business Financial Projections
• Personal Financial Information
• Personal Tax Statements
• Information about business, location, sales contracts, etc.
• Business Owners’ Resumes

Step 7: Waiting

Loan applications are approved or declined much quicker than people think. A lender can approve an SBA express loan within 36 hours. Regular commercial loans have similar processing times. You should expect to get an answer within 2 weeks, and hopefully close the loan (get access to the money) within another 2 weeks. However, if the institution needs more documentation, or if the loan is for a larger amount, then it might take longer to process the loan, especially SBA loans.

Loans Overview

In this article, we will explain some of the different types of financing available to you. Some banks have streamlined the application process to make it easy for you to access capital. The requirements for each bank are different, but in general, you can abide by the following (the below is true for SBA and non-SBA loans):

• Good Credit Score, This is a very important factor in the consideration for a loan, but not the only one. If your score is not good right now, work on improving it. There are for non-profit organizations ready to help you improve your credit score by helping you manage your expenses, providing you with credit management education and even by making available a small business loan to help you re-build your credit history.
• Collateral, (security for loan) In some cases a good credit score and down payment are enough to secure a loan. However depending on the amount of the loan, you may also have to offer collateral. You can use your house, retirement plan, or any other major possession as collateral if the bank requires security in the event you cannot pay back the loan.
• The relevant experience of the business owner is also an important factor for the loan package. Banks feel more confident in giving out a loan to business owners who have relevant experience in the business that they are starting, such as a dentist opening a private practice.
• Owner’s Investment, if you are forming a new business be prepared to invest a certain portion of the start-up costs personally. Lenders rarely finance 100% of the business. They will expect you to raise 20 to 40% of the investment yourself. The higher your personal investment in the business, the better the application looks to the lender.
• Good Business Concept or Plan, A good business concept that is believable and relatively conservative.
• Capacity to Manage and Pay, The business should be able to generate enough cash to pay back the loan installments.
• Collateral and Guarantees, The lender will look at how the loan can be secured. He or she will give importance to the individual’s personal financial statement and see if the loan can be secured against personal and business assets.

When applying for a loan and writing a business plan, make sure your financial projections are correct. Do your research. Know your business. It is surprising to see the number of entrepreneurs who do not pay enough attention to the financial aspect of the business. Even though it may not be much fun, paying close attention to the financial details will determine whether your business will survive.

Note: Although most banks want to help entrepreneurs fund and expand their businesses, their primary responsibility is to make money from the loans and minimize their risk. Just because you have a great idea and are motivated to see it through, you may not get a loan. In fact, banks are very careful with innovation; they are conservative institutions that lend to tried-and-true businesses. Whenever you submit your business proposal, always ask yourself, “What would make this a good deal for the bank? What assurances (aside from my good credit and great idea) can I give to the bank so it will get its money back plus interest?”

Types of Loans

Small Business Administration (SBA) Loans

As a new entrepreneur looking for capital, one of your firsts options will be the SBA, or to be exact, asking for an SBA-backed loan. SBA loan applications are made through a bank. In broad terms, the SBA guarantees a loan to the bank, so in case the borrower defaults, the bank is guaranteed a portion of the loan by the SBA. (You are still liable for the loan, so your obligation does not go away.) This makes it easier for banks to lend to budding entrepreneurs, but it does not mean that the bank can just lend indiscriminately. The bank will analyze the application to protect its interest as well as the SBA’s.

How to obtain an SBA-backed loan?

For loans under 50,000 it can be as “simple” as filing out an application, no business plan or financial projections required. However, lenders will look at you, your credit, your assets, and your idea carefully before approving a loan, so it makes sense to provide the banker with a business plan and financial projections with your application.

On the other hand, if you feel that you have a good idea, good credit score (over 700), a co-investment into the business, don’t have a lot of personal or business debt, and may provide collateral if needed, then you can apply with just the paper application.

For loans over 50,000 you will need a business plan and financial projections, in addition to the aforementioned criteria. As a rule of thumb, your business plan should be more detailed if you are requesting a higher loan amount.

Popular SBA Loan Programs

SBA Express and 7(a) Loan Program

These are the most common loans offered to small businesses. These programs are available through qualified lenders. Most banks and non-bank lenders offer these types of loans, but some are much better than others with SBA loans. Remember that if the institution does not want to extend this offer to the client (even if the client qualifies for the loan under the SBA standard) the SBA cannot force the lender to give the loan to the customer.

Eligibility Criteria

The SBA has very broad requirements, so most small businesses can apply for a loan under this program. Remember, however, that the lenders have their own criteria that will be the decisive factor whether a business receives funding.

Personal Guarantee

If you own 20% or more of the business, you must provide a personal guarantee for an SBA loan. If your business does not work, even if you are a corporation, you will be personally liable for the repayment of the loan.

Size Standards

To qualify, the business will have to be independently owned and operated and not dominate its field. You can find the size standards table from the SBA Web Site. In general, the standard is up to 500 employees for Manufacturing Industries and up to $6 million dollars in annual receipts for non-manufacturing industries.

Note: If the applicant business is affiliated with other companies, the applicant as well as the affiliated companies will have to comply with SBA size standards.

Type of Businesses

Businesses have to be for-profit, do business in the United States or its territories, and the owners must invest personal equity into the business.

Certified Development Company (CDC) 504 Loan Program

The 504 Loan Program provides financing for long-term major fixed assets at a fixed rate. It is offered through a Certified Development Company (CDC). A CDC is a non-profit corporation that works with the SBA and private lenders to provide capital for small entrepreneurs. The deals have the following structure: a private lender with a senior lien on the property funds 50%; the CDC (backed by the SBA) funds 40% with a junior lien, and the entrepreneur funds 10%.

You can use the funds for purchasing land or facilities, and improvements on existing facilities. You cannot use the loan proceeds for, working capital, inventory, consolidating debt or refinancing debt.

Eligibility Requirements

Under the CDC 504 loan program, the business qualifies if It is a for profit business, the net worth of the business is under $7 million, and the average net income is under $2.5 million after taxes for the last two years.

Types of Loans (with or without the SBA Guarantee)

Term Loans (Long-Term and Short-Term Loans)

Term loans have a fixed interest rate (although some loans offer a variable rate). A personal guarantee from the borrower and/or collateral (business, personal, or both) is usually required to secure the loan. If the loan has collateral attached to it, then it is considered a “secured loan”. If the loan is solely based on the reputation and creditworthiness of the borrower, then it is an “unsecured loan.” (Now you know why your credit score is so important.) These loans carry a monthly or quarterly repayment schedule and have a pre-determined maturity date.

Lines of Credit

With a line of credit, you can make use of monies up to a maximum amount set by the bank. You pay interest only on the amount that you use. The interest rates on these loans are variable. In addition, lines of credit have renewable periods from 90 days to several years; but for extended periods, the lender will ask for annual reviews.

Equipment Leasing

Leasing equipment helps you acquire the latest equipment that otherwise would be unaffordable if purchased. Banks and finance companies may lend you money to lease equipment, or the equipment manufacturer may facilitate the financing directly. The loan term is usually tied to the term of the lease.

Letters of Credit (LOC)

A letter of credit is a guarantee of payment upon proof that the contract terms have been met. This is commonly used in international trade transactions. In a letter of credit, your bank guarantees (for a fee) that it will pay the purchase price on behalf of the buyer upon completion of the contract. In most cases, you should have an established line of credit with your bank.

Other Financing Options

Remember that “finance” is a flexible term, as the loan terms can be adjusted to match your individual needs. The following are other forms of financing available to you:

Factoring

This term refers to getting a short-term loan based on the financial strength of your accounts receivable. This means that you sell the accounts receivable of your business to the factoring company at a discount in exchange for getting money now. Factoring is useful when you have to meet your business obligations, such as paying your bills, payroll, suppliers, and other business expenses while you wait for your customers’ payment for the products delivered or services supplied.

Purchase Order Financing

This is one of the most expensive and risky forms of financing. In this arrangement, you will assign your purchase orders to a third-party lender. The third party will be in charge of billing and collecting on the purchase orders. Usually this happens in cases where the company requires cash to manufacture orders.

Home Equity Line of Credit and Home Equity Loan

The Home Equity Line of Credit (HELOC) is an open-ended credit line secured by a second deed to your house. This allows you to borrow against the equity of your home. You can take out as much as is allowed on the credit line, which works just like a credit card. You can either pay it down or make the minimum payment; interest is calculated monthly.

A Home Equity Loan is a second mortgage against your house. In contrast with a HELOC, you receive the amount at once and pay interest on the entire amount.

Equity Capital Overview

Equity capital is an expensive form of financing because it requires a higher return on investment than the interest rate on a loan, and in some cases, the amount of ownership in the business that the entrepreneur risks to lose is greater. Following are the most popular equity financing options:

Venture Capital

Venture Capital is of the most talked-about forms of financing, and it was very popular in the dot-com boom. Venture capitalists raise money from investors in order to manage a portfolio of privately held companies. In short, they are intermediaries. Venture capitalists fund companies that are in early-stage development, expansion, or for special cases such as turnarounds or leverage buyouts.

According to the National Venture Capital Association www.nvca.org, venture capitalists look to:

• Invest in new companies or in companies that are experiencing rapid growth.
• Buy equity securities.
• Help companies develop products and services by contributing experience or capital.
• Advise a company’s management on business operations and strategy.
• Gain higher returns in exchange for taking a higher risk on their investments.

Venture capitalists tend to have a long-term outlook and take more risks than other types of financiers, such as banks. They manage that risk by investing in portfolios of young companies either by themselves or with other venture capital funds. Moreover, they actively work with the companies in their portfolio, assisting management with strategic decisions and business expertise gained by helping other companies with similar problems.

Is Venture Capital Right for Your Business?

If you are willing to report to a board of directors, bring partners into your company, share in governance and decision-making, then you might wish to consider venture capital. When considering such funding, know that you will lose some control and ownership over your company in exchange for financing, connections, and business experience from the venture capitalist.

Can you Deal with Not Being the CEO of Your Company?

Usually the CEO founder of the company does not have all the skills to take the company to the next level, whether it is a merger of acquisition or an initial public offering. Many founding CEOs are very skilled in some areas—perhaps technical or entrepreneurial—but lack in financial, sales, marketing, or other areas of experience. Venture capitalists usually have a network of people from many industries that can take the helm of a company. These people have risen through the ranks in other companies and have extensive experience in different areas of business management. Venture capitalists as well as entrepreneurs must clarify all contributions to the deal and skills brought to the table. It may be to everyone’s best interests for you—as the entrepreneur—to step down from the CEO position.

Early-Stage Financing

Venture capitalists can be general investors or they can concentrate in a particular industry, sector, or development stage of a company. Not all venture capitalists invest in start-ups; some of them invest in different stages of a company’s life cycle, such as early-stage financing or expansion financing. However, the focus of this document is for start-up and early stage companies looking for investments.

Early-Stage Financing

Seed Financing: Here, venture capitalists fund entrepreneurs in the idea stage, when a company has not yet produced a product or service and is building its management team. You should expect to receive capital under $50,000. In this stage, businesses should look for private investors. Outside investors may look to negotiate for a larger share of the company or require other people to join your management team. You will be sharing confidential information about your company with prospective investors, so research those people thoroughly before entering into negotiations.

Start-Up Financing: This capital is reserved for companies that are in the product-development stage. This funding includes the initial marketing for the product.

First-Stage Financing: This capital is earmarked for commercial development, production, and sales. It is for companies that have already developed a sellable product, proven their business concept, and have assembled a credible management team. At this point, your business is ready for the market and investors will take a passive role in comparison to either seed or start-up financiers.

Investors will look to your business plan for:

• An explanation on how you and your team will implement your company’s mission statement.
• Financial analysis identifying business costs, sources of revenue, and financial projections.
• Market research establishing the market size, growth potential, and any potential factors that may affect your estimates.
• Competitive analysis assessing the strengths and weaknesses of your competitors.

Although most of the venture capitalists in the United States invest in technology companies—and the industry gets a lot of attention for these investments—they also invest in business services, construction, industrial products, restaurants, retailing, and socially responsible companies.

Expected Returns

Venture capitalists consider it a success if they get a 40 to 60% return on their investment, which is not out of line considering the amount of risk they are taking. However, on average, they get returns ranging from 10 to 20%. They expect to net these returns after they “cash-out” of the company, if possible within a three- to five-year period. However, the cash-out period can be as long as ten years or more. Consider this when assessing your business potential return on an investment.

On another note, it is normal for venture capitalists in the earlier stages of financing to expect a tenfold return on their These investors expect to wait four to seven years for a return.

You will need to write a business plan and make sure that your financial statements and revenue projections are in order before you approach a venture capitalist.

Approaching Venture Capitalists

You can use two methods when approaching venture capitalists. You can randomly present your executive summary to venture capitalists or you can research your target to see if it matches your industry, region, development, and capital requirements. Venture capitalists and other professionals favor the targeted approach because it reduces the number of extraneous opportunities to a few manageable ones.

You can speak with lawyers, accountants, or specialized financial intermediaries who have relationships with venture capital companies. Usually intermediaries charge a standard fee plus commission, so make sure you are working with a reputable one. You can also get access to these financiers in venture capital seminars.

Exit Strategy

Venture capitalists want to cash out of an investment and receive a profit. Although an Initial Public Offering (IPO) is the most popular form of receiving capital, most venture capitalists exit the investment when they sell their partnership through successful mergers or acquisitions with larger corporations.

Things to Remember When Considering Venture Capital

• Determine whether you actually need venture capital. Can you run your business with other forms of financing such as loans, friends, or relatives?
• Prepare a business plan—a must for venture capital funding.
• Research your target venture capitalist. Find out what his or her investment criteria are.
• Network your way into an introduction with a venture capitalist. Lawyers, accountants, and other professionals that help venture capitalists are a good source.
• Use the Web to your advantage; some venture capital managers have Web sites where they write down their ideas. Read them to get a better idea of how these managers evaluate business opportunities. It will give you a better idea where to focus your efforts.
• Make sure that your plan endures due diligence. Ensure that you can support and explain any part of your plan and business projections.
• You will have to meet people and expand your Rolodex if you want to have an opportunity to meet a venture capitalist.

Other Points to Keep in Mind:

Equity financing is expensive. You need to compensate your investors for the risks they take in your company. If your business is successful, your company will end up paying more for the equity invested than it would have with a loan.

Develop your business strategy. Your executive summary must clearly state what your business does and how you expect to make money. Investors will question your revenue projections and how you plan to achieve them, particularly in relationship to the current market environment, costs, distribution, and supply.

Strengthen your management team. Venture capitalists invest in a company’s management as well as the product or service. Think on any weaknesses that your team may have and look for people to join or mentor your company.

Your company should generate cash flow. You will have an easier time finding financing if you start your company without outside capital. Although this sounds counterintuitive, venture capitalists constantly receive business plans and projects to invest in, many from entrepreneurs who have not yet launched a business. Why would you expect somebody else to take the risk and invest in your company if you are not willing to do the same? You will be in a better position to seek financing if you have already started your business. You will have a better chance to find capital if you start your business with money from loans, personal investment, family and friends, or sweat equity and then look for outside investors.

Work on your business plan and financial projections. Your business model should be clear to you and your investor. The model should communicate the value of your company to all the stakeholders. You can use an Annual Statement Studies® from the Risk Management Association www.rmahq.org to verify that the financial ratios in your projections match the ones from a company in your industry and your size. Provide explanations if you project more aggressive numbers. For more figures to help your research, you can check the U.S. Census www.census.gov or the SBA Web site www.sba.gov for further statistical data.

Consider your market. Venture capitalists are looking for large markets with high compound rates of return and low penetration. If your business has an obscure market, the venture capitalist might not be able to predict the success of your business idea and will not feel comfortable investing.

Angel Investors

Another source of capital are angel investors. These are high-net-worth individuals who invest in early-stage companies. They are usually former entrepreneurs who are now looking to invest as well as provide their expertise. Venture capitalists and angels are similar in many ways, with the notable exception that the latter has disposable capital and available resources. Expect to raise capital from an angel investor of anywhere from $20,000 to $250,000.

Good angels have the following traits: they have funded companies before and they have good contacts and industry and entrepreneurial experience. It is easier to work with a seasoned angel investor than with a novice. You can find these angels through networking, business groups, and investors’ associations.

Family members and friends can also be angel investors. Your dentist, doctor, financial advisor, or friends are all possible angel investors who might be interested in investing in your business.

With certain types of angel investors, it is important that your business is impressive. A wealthy, amateur investor may be more interested in investing in a high-end restaurant than in a medical claims office or other less-impressive business but more profitable businesses because, for an angel, it is not always about making more money but about the prestige of owning part of an interesting business.

In order to secure early-stage financing, you may be asked to relinquish some control or ownership of your company. Furthermore, as with venture capitalists, you need to provide these early-stage investors with a viable exit strategy.

Use of Angel Funds

• Early-stage financing
• Bridge Financing
• Establishing a marketing program for an existing product or service
• Increasing working capital (due to incrementing sales)

Analyzing the Deal

When investors evaluate the opportunity you present, they will look at the following factors:

• The people who will manage the company; this includes your management team and your advisors.
• The concept value. This is the opportunity you present to them. It includes many of the following: What need does your business satisfy? What is your business model? What is the size of the market? Who are your potential or actual customers? What external problems (economy, industry, regulatory, or technological) may affect your estimates?
• The price that you put on the deal. How much equity is the angel going to receive for the investment? What are the terms of the investment? This will include operational information such as salaries, costs, ownership control, or other information that may affect the return on investment.
• Deal Structure. What are the terms of the investment? Are the investors going to provide debt or ask for equity? Are the angels going to be active or passive investors?
• Exit Strategy. How are investors going to cash-out of this opportunity? Will they receive dividends? Will these dividends be through a partial sell to management or another party (shareholder or outsider)? Do you plan to sell the business to another company? Are you planning to take your company public?

Issues with Angel Financing

Capital investment from angels is expensive. The investor may require 10% to more than 50% of the company’s equity. The amount of equity handed over to the investor will depend on negotiations. Investors may charge monthly management fees on top of the equity in the form of a retainer. Angels do not usually invest as a group and will demand different terms for their investments, making negotiations difficult.

Where to Find Angels

Government or state agencies, New York State Small Business Development Center www.nyssbdc.org, the Small Business Administration www.sba.org, and regional economic development agencies may direct you to interested angel investors. You can also look for these investors at Angel Investor organizations www.angelcapitalassociation.org, Business Incubators, these are organizations that offer young companies a plat form to grow by providing information, rental space and infrastructure www.nbia.org, or government sponsored organizations www.activecapital.org.

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