Small Business Finance Guide – Part II

  • Key factors to consider when financing your business

    • Credit and financial history. Your credit and your business credit can be considered separately. For instance if you have poor personal credit you can focus on building business credit which uses a different system.  Some lenders, particularly those working with SBA guaranteed loans, will insist on viewing personal as well as business credit history. Depending on your situation you may want to steer clear of those lenders.
    • Experience and expertise. You work history,  management experience and education will be examined when a lender assesses your business, particularly with a startup. If you have key managers or partners, lenders will look at their experience as well. You can strengthen your position by taking small business management courses.
    • Ability to repay the loan. This metric assesses how well the cash flow from operations covers the loan payment.  As with any loan you will want to have the lowest interest rate possible, so define your needs and shop around for rates.
    • Insurance. Use insurance prudently to guard against catastrophic events and frivolous lawsuits.
    • Incorporation. I discuss the benefits of other forms of organization elsewhere.
    • Contingency Plans. Succession or exit plans are a solid piece of any business or financial plan. If your business does very well everyone will want a piece of it, if it does poorly  your investors and lenders may work with you to develop plans to pay your debts.
    • Personal  Assets: Starting or growing a business with your own money is the best way to maintain control. Using your own money allows you to avoid taking on additional debt, and more importantly you don’t give up equity in the business.
    • Sales/Revenue: In an existing business, the easiest way to grow your business is to use customer sales revenue. It has the same benefits of using your personal funds without depleting your savings account. By not taking on additional debt or give up equity, and you won’t have to pay back a loan or accrue interest. Growth may be slower, but you will have greater peace of mind without a repaying a loan.
    • Credit Cards: Many businesses have started using credit cards, although high interest rates and too much debt make you risk damaging your personal credit. Typically using a credit card is an easier solution than getting a traditional loan. As an example you could use a credit card to cover short-term cash flow problems when you are guaranteed income soon. A good rule of thumb is only use a credit card that can be paid off each month. If you can’t pay off the credit card monthly, you will incur even more charges in interest and late fees. If your payments are late, you may also incur even higher interest rates. Using personal credit cards like this also promotes the mingling of funds and interest expenses which are difficult to account for.
    • Friends and Family: If money is given to buy ownership, then you need to determine how that arrangement will work. Will they be silent partners or active? Regardless of their role, one needs to be cautious with this sort of arrangement. If you decide to go forward with this type of financing, make sure you clearly define investment, ownership, and repayment terms.
    • Banks: There is a misconception that banks will lend to a start up business. In certain circumstances they will, for instance if the loan is fully collateralized with an easily salable asset. If you have had an existing business, you have a better chance of receiving a loan from a bank. The Small Business Administration (SBA) and community reinvestment programs provide loan guarantees to banks to encourage them to make small business loans. This means if you default on the loan, the bank will be repaid. These loans require a lot more preparation and paperwork and time to prepare. However, the business owner is still responsible for repayment of the full loan. As an existing business, you should establish a line of credit with a bank as your business grows to help manage your cash flow.
    • Angel Investors:  Angel investors are wealthy individuals or groups who invest in new or early stage businesses. They differ from venture capitalist firms in the typical size of their investment. If you use angel investors, be aware they will expect to participate in the equity in the form of stock or stock-buyback when the business purchases outstanding stock.
    • Peer-to-Peer Lending: This method of lending is also called online lending and it’s cheaper and easier than getting a loan through banks. These loans are considered individual loans or personal debt and will show up on your personal credit report. One needs a good personal credit score to qualify for a peer-to-peer loan, usually 640 or more, and loans are usually capped around $25,000.
    • Unsecured Business Loans: By definition unsecured loans do not require collateral. They are also called a line of credit loan. These loans are riskier for lenders due to lack of collateral as a repayment guarantee.  These loan amounts are smaller, and the interest rates are higher.
    • Small Business Loans: Small business loans are for businesses with relatively few assets which generate modest annual revenue. A small business designation is determined by asset value, type of assets owned, revenue and earnings, number of employees, and years in operation.
    • Minority Business Loans: To be eligible for minority status a business must be primarily or exclusively owned by minorities. These loans are generally made through non-profits that advance and support minority entrepreneurs and local programs like the Urban League.
    • Federal Grants for Small Business: Check here for federal guidelines for grants. (
    • State and Local Grants: When searching for small business grants, start by looking at the state where your business is located. Many states have agencies designed to offer grants and other types of business assistance in order to encourage small business growth and development in their area.

    Types of Financing

    Most states have a Small Business Development Center (SBDC) as part of the junior college system. SBDC’s are a nationwide network of sites, typically housed at colleges and universities, which provide training and advice to small businesses on all aspects of starting, financing, and managing a business.

    • Vendor Finance: If you have established a good relationship with a vendor, the vendor may be willing to finance part of your business by extending their terms of payment for a predetermined length of time. You can approach vendors and show them your business plan and the orders you’ve already received. If the vendor is convinced that your business will be successful and one of their better customers in the future, they may be willing to offer extended payment terms. Establishing supplier exclusivity for a documented amount of time may also be exchanged for longer credit terms. Your business may be required to pay a higher price for this arrangement.
    • Prepay Financing: If you have successfully demonstrated to your customers that you deliver your merchandise on time and as ordered, you may be able to persuade one or more of them to put a deposit on their future orders, perhaps as much as 50%. You can add an incentive by decreasing your price a bit in exchange for the deposit. Or, you can offer a bonus: if they’ve ordered 100 items, they get 10 at no charge. New customers can also be asked for a deposit, especially if it’s a large or custom order.
    • Factoring: If your business has some receivables and needs short term cash, factoring may be a good way to go. This involves selling your receivables at a discount, you get the cash now when you need it, however this will reduce your profitability.

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