How to Get Finance a New Business
Borrowing money from friends and family to finance a new
business is a terrific idea in theory.
Banks and other lenders will demand airtight business plans and financial
statements. But be aware of the potential drawbacks of so-called
"easy" money.First of all, if you ask family and friends for money, make sure
it's a loan, not an equity investment. If you allow too many friends and family
to own a legal stake in your business, then you're setting yourself up for
trouble.
Legally, you'll have to run every major business decision by them
first. And if you don't consider their opinion, they can sue. Talk about an awkward
family reunion.That said, private loans can offer significant advantages over
traditional loans. Interest rates if interest is even charged are generally
much lower than those offered by banks. Private loans are also an important
show of support (both financial and emotional) in the early stages of a new
business.
One crucial rule: Get everything in writing. It will make both
sides feel more secure about the transaction and rule out any potential legal
problems down the road. You can find free boilerplate loan documents online.
Credit Cards
There's something romantic (in an economic sense) about
financing a successful small business by maxing out your credit cards. We hear
exciting stories about this all the time. What we don't hear are the stories about
new business owners who maxed out their credit cards and then failed. So before
you turn to plastic for financing, consider the risk.
It's true that credit cards can be a fantastic source for large
amounts of capital. A credit card, after all, offers a line of credit with
limits as high as $10,000, $20,000 or even $50,000 for a small business card.
Since it's a line of credit, you don't need to fill out a loan application or
submit a business plan each time you need an infusion of cash. Just swipe away!A credit card allows you to carry a large balance as long as you
make timely minimum monthly payments. Conceivably, you can leverage a debt of
$50,000 with $50 monthly payments.
But the question is, do you really want to?The huge drawback of credit cards is that they carry very high
interest rates. At the time of this writing, the average interest rate for a
balance transfer credit card is 13.2 percent [source: Bankrate.com]. So if you
choose to use a credit card for start up capital, make sure you have a plan to
pay it back quickly. If not, that interest will add up fast.
Bank Loans
Bank loans are one of the most traditional and conservative ways
to finance a small business. Unfortunately, they're also some of the hardest
loans to get. Small business loans are small beans for banks because they make
a lot more money from big loans. But with the right attitude and the right
business plan, you might get lucky.
A typical commercial loan from a bank feels a lot like a
mortgage. There's a fixed interest rate, fixed monthly or quarterly payments
and a maturity date. The specific terms of the loan vary depending on whether
it's an intermediate-term loan (less than three years) or a long-term loan (up
to 20 years)
One reason why bank loans aren't ideal for new businesses is
that the bank will often require collateral or other existing business assets
that it could seize in the event of a default. New businesses typically don't
have a lot of collateral. That's why bank loans are better suited for
construction projects, buying new equipment or expanding an existing small
business.
Still, don't give up on banks. If you already have a strong
working relationship with a local bank, you might be able to convince them to
give you a small commercial loan. Remember to bring a solid business plan with
realistic financial projections. Of course, it wouldn't hurt if the loan
officer were a close family friend, too.
Social Lending
The Internet has added an interesting new wrinkle to the world
of new business financing. On so-called social lending Web sites, individuals
can apply for loans from other individuals. The two parties set their terms and
the Web site acts as the intermediary.One of the more popular social lending sites is called
Prosper.com. The site is designed around the auction model popularized by eBay.
As a borrower, you register at the Web site and post a loan request for a fixed
amount of money at a maximum interest rate. Interested lenders then bid on your
loan. When you find a lender that offers an attractive interest rate, you
proceed with the loan.All loans on social lending sites are three year unsecured
loans. Unsecured simply means that the loan is made without any collateral. A
credit card is another form of unsecured loan.
LendingClub.com is another social lending Web site, except it
uses a system based on your credit rating. When you register at
LendingClub.com, the site assigns you a credit rating (A, B, C, et cetera).
Different credit ratings qualify for different interest rates.
Once the loan is approved, the amount is deposited directly into
your bank account. Likewise, fixed monthly payments are automatically deducted
from your bank account for the life of the loan.(Another social lending:
Trade Credit
Trade credit is the lifeblood of most established businesses. It
works very simply. When you buy parts from a supplier, the supplier delivers
those parts with an invoice for the amount due. Because you have an established
relationship with the supplier, he doesn't ask you for cash on delivery (COD).
Instead, you have a period of time to pay him back without incurring any
interest or penalties. That's called trade credit.
Trade credit is based on trust. As a new business, you're at a
disadvantage, because you don't have an established track record of paying
invoices on time. If you want to win the confidence of suppliers, you'll need
to present them with the same credentials you might give a bank: a business
plan, collateral, financial statements and other proof that you have your act
together.
One of the greatest advantages of trade credit is that it's
interest-free for a fixed period of time, perhaps 30 or 60 days. Even better,
some businesses offer discounts if you pay the invoice within a very short
period of time, maybe a week or 10 days. As a new business, it might take a lot
of legwork and a little luck to secure trade credit, but it's worth it.
Customers
Now, this one might seem illogical at first. How can customers
help finance your new business if it isn't even a business yet? The trick is to use your business plan and your charm to
convince people to become your customer even before your business is off the
ground. Let's say, for example, that you want to start a company that builds
custom computers for video game enthusiasts. You build a prototype of your
computer, bring it to a videogame convention and a large computer retailer
wants to buy 1,000 units.
You don't have supplies to build 1,000 units and no bank is
going to give you a loan to cover the costs since you're working out of your
parents' basement. You can have the retailer sign a letter of credit saying it
will pay for the 1,000 units upon delivery [source: Entrepreneur]. With that
letter of credit, you can convince suppliers to offer trade credit until the
computers are delivered.
Here's another customer-based technique. Let's say you're a
hairdresser with a loyal clientele. If you decide to start your own beauty
salon, you might want to ask your longtime clients to become investors. Throw
in free haircuts for life, and you may have yourself a deal.
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