Guide to Financing Your Business

by Fred Delibero

Adequate capitalization and cash-flow management are essential to the long-term success of any business. One of the greatest challenges an entrepreneur faces is obtaining sufficient capitalization to start or expand a business. Consider these sources of financing for your start-up specialty retail business.

Personal Savings

In most cases, your personal savings are your best source of start-up capital. Personal savings allow you, the owner, to maintain 100% ownership and control of your business. In addition, by financing your business with personal savings, you won't burden it with a debt load that requires you to make large monthly payments from cash flow. Instead, profits can be poured back into growing the business. Keep in mind, however, that using personal savings does "cost" you the equivalent of what you might have earned on those savings if you had invested them.

Retirement Savings

While tapping your retirement savings is a viable source of funding a start-up, it does come with risk. The greatest risk is that you will jeopardize a secure retirement. And by depleting your retirement fund balances, you forego the compounding of return on those assets over the course of the years before you retire. Many 401(k) retirement plans offer participants the ability to borrow from their investment balance. If you do, keep in mind your retirement funds will only earn the proscribed rate at which you borrowed the funds. If, for example, you're paying 9% on your loan and could realize an 18% investment gain had your account been fully invested in the broad markets, your true cost of funds is 18%. But if you had left your 401(k) account fully invested and found another source of funds at a rate of 12%, for example, you would be saving not only a great deal of money, but a secure retirement as well.

Angels

"Angel" investors are usually family or friends who are willing to invest in you and your business for the promise of a small return. Angels are not usually interested in a piece of the business; rather, they lend you the money because of your personal relationship. But as in any financing arrangement, there are negatives to using angel funds. The first consideration is that if the business fails and you are unable to pay the funds back, a great deal of strain will be placed on your relationship, and possibly on your relationship within the entire family if the angel is a relative. A second consideration is that an angel may insist on telling you how to run your business, also causing a strain on the relationship. Still, next to personal funds, angels are a great source of financing. In structuring this type of arrangement, always create and execute an agreement that defines the interest and repayment terms.

Credit Cards

It is not unusual for entrepreneurs to finance all or part of a small start-up business with credit cards. Credit cards are, in effect, loans that require no collateral. Today, people with good credit have access to a seemingly limitless pool of credit card opportunities offering high spending limits with low introductory rates. Further, credit card issuers have been eager to offer easy cash advances simply by attaching blank checks to their customer's monthly statement. In addition to access to cash, credit cards offer the ability to purchase inventory on credit and float the payment for 30 or even 45 days until the credit card bill is due. And with so-called "cash rebate" credit cards, business owners are enjoying a one- or two-percent cash rebate on their purchases at the end of each year. While credit cards offer advantages—easy, accessible, non-collateralized funds, and the ability to float payments on purchases—they are not without drawbacks. Expect to pay high interest rates and even higher cash-advance fees if you don't pay the full balance due each month.

Home Equity Line

Many people find that their home is relatively easy to tap as a source of start-up financing. Almost anyone with good credit and 10 percent or more equity in their home can access relatively inexpensive capital through either a home equity loan or home equity line of credit. (And in some cases, the interest may be tax-deductible; check with your financial advisor). While a home equity loan may carry a lower interest rate than a home equity line of credit, the loan usually has higher closing costs. So if you need to access your home equity for short periods of time, a line of credit may be better, since you borrow amounts against it as you need them, instead of one lump sum. Some lenders make loans of up to 125% of the value of the home. In any case, keep in mind that you are using your home as collateral, and you are risking its security if your business venture doesn't work out and you have no other means to make the payments. Be even more careful if you finance an amount greater than your home value. If you ever sell the home, you'll be required to pay off the entire loan balance, which is often greater than the proceeds from the sale.

Bank Loan

A traditional bank loan is more difficult to obtain today than in the past, especially for the small business start-up. In evaluating loan requests, banks look for historical data that demonstrate the borrower's ability to repay. With a start-up, it is difficult to accurately quantify cash flows on a projection basis, let alone a historical one.

And in many cases, it can take weeks or even months to obtain bank financing. While banks can be a good source of funds used to expand an existing business, they are not always the best source of start-up funds. Even so, banks do make thousands of loans each year to entrepreneurs with a solid business plan and a sound track record of fiscal responsibility. If you fall into that category, by all means talk to your local banker. But keep in mind that bank loans, like home equity loans, almost always require collateral, such as business assets, inventory or even your home, to back the loan.

Small Business Administration

The Small Business Administration (SBA) is essentially a federal agency that guarantees the loans banks make to entrepreneurs. The SBA is an excellent source of expansion financing for small to midsize businesses. They also guarantee loans for start-ups, although the requirements to do so are quite stringent. Using a prescribed application format, borrowers approach an SBA lender (your local bank and a non-profit intermediary) to apply for a loan, not to the SBA directly. Perhaps the biggest drawback of an SBA loan had been the time-consuming, often complicated process of applying for one. However, the SBA recently launched a new program that significantly shortened and simplified the application process. Also on the plus side, interest rates and repayment terms are often favorable. For more information, visit the SBA.

Secondary Financing Markets

Secondary lenders offer loans at a higher interest rate to individuals at greater risk of defaulting. In addition, there are specialized lenders that focus on specific types of financing, such as franchising. In fact, many successful franchise companies have pre-arranged financing available through specialized lenders. In either case, secondary financing sources carry higher interest rates and sometimes severe penalties for late payments and defaults.

Trade Credit

Trade credit, or payment terms negotiated with suppliers, can provide a 10- to 90-day float on money. In many cases, manufacturers of retail goods offer special payment terms as long as 90 days, allowing you to order merchandise, stock shelves and sell a portion of the product at retail before the payment is due—in effect, floating on the supplier's money. Start-ups often have difficulty establishing sufficient trade credit to meet their needs. However, there are no regulations governing trade credit (e.g., federal regulations governing bank loans), so savvy business people are often able to negotiate with vendors for a small starting line of credit. Then as the account is paid successfully, credit limits can be raised. But keep in mind that if your sales are not sufficient to pay off the debt when it is due, you'll have to make up the difference out of your own pocket.

Equity Investors

If all else fails, search for an equity investor. If this is your game plan, it is important that you carefully plan and prepare your business model for presentation to potential investors. In it, you should clearly define the percentage of the business you are willing to "give up" to attract investment capital along with the projected return on the investment. One way to attract investors in your inner circle is to offer them a personal balloon note with a defined interest rate that can either be called at the end of the term or converted into ownership in the company. This way, if the company is floundering, the investor can call the note, having earned a fair amount of interest on their money. On the other hand, if the business is flourishing, the investor can convert the note to an equity stake of a successful, growing company.

Sale of Assets

If all else fails, try selling some of your assets to finance your start-up business. Review what you own and decide what you can live without. Can you sell your car and get a smaller one? What about selling that fishing boat or personal watercraft? Or even selling your home and buying a smaller one? Many people are surprised at the value of their assets when they take stock of what they own.

There are many sources of financing for your start-up business. Decide which is best for you, and pursue your dream to start a new business with determination, dedication—and adequate financing.