Generally, there are two ways to capitalize your business. You can borrow money (debt) or, if you don't mind sharing ownership, find investors willing to provide the funds you need in exchange for a "piece of the pie" (equity). Debt must be repaid. Equity, however, generally does not; it is simply exchanged for an ownership interest in your business. Which method, or combination thereof, is right for your business depends upon (among other things) how much money you need, your financial situation, the type of business you intend to begin, and how much control over the business you are willing to surrender to others. Before soliciting funds from outside sources, you should consult with your legal advisor to ensure compliance with all federal and state securities laws.
When you think of debt, you think of loans. Generally, a loan is money temporarily lent to a borrower for some specified use. The money eventually has to be repaid (with interest). You or your business, if it is an independent entity, can borrow funds. If you personally borrow the funds, you become the debtor and are personally liable for repayment. You can then either turn around and invest these funds in your business (equity) or turn around and loan the same funds to the business. If, instead, your business borrows from a third-party lender, your business is the debtor, not you. In practice, however, even if your business is the borrower, a lender may request you to personally guarantee the loan, in which case you would be personally liable for its repayment.
- What should you look for? You should shop around for two things: the right lender and the lowest interest rate. Which lender is right for you depends upon many things, including the lending practices as well as the size, type, and financing needs of your business. Generally, however, you should look for a lender with the following attributes:
- Aggressive lending policies
- An interest in businesses of your type and size
- An interest in serving--and the ability to so serve--your business's various credit and noncredit (e.g., payroll and checking accounts) needs, current and future
- Financial stability
The second thing to look for is a low interest rate. The lower the interest rate, the more money you'll have for your business expenses.
- What will debt investors (lenders) look for? A lender primarily looks for two things: your ability to repay and collateral. A lender will let you borrow if he or she believes you are capable of repaying the debt. The lender will make a decision after carefully reviewing the following things:
- Your credit history
- The risk of failure of your type of business (new businesses are considered riskier than established businesses)
- Your personal and business income, both current and projected
- Your business/managerial experience
- Your equity in the business (the amount you contributed to the business)
Lenders also look for collateral--assets that the lender can keep if you fail to repay your loan. Few people can obtain loans without it. There are many forms of collateral, including, but not limited to, real estate, inventory, equipment, and accounts receivable (what people owe you). Unfortunately, if you have little or no collateral, you will likely encounter much difficulty when seeking a loan.
- What are the advantages and disadvantages of debt? With debt, you do not have to share ownership and control. When you repay the debt in its entirety, the creditor has no interest left in your business. Conversely, loans are difficult to obtain, and once acquired, the loan will saddle you with monthly payments. In addition, you will likely repay an amount much larger than what you borrowed because of the interest charges. If you ever fail to repay, you will be assessed penalty fees, given a bad credit rating, or have the loan "called" (requiring you to pay it immediately in its entirety), which may cause you to lose the business.
- What are the different types of loans? A loan can be an installment loan or a line of credit, secured or unsecured, and short- or long-term:
- Installment loan/credit line. An installment loan is money provided in one lump sum that must be repaid in installments (i.e., monthly). A line of credit, on the other hand, permits the borrowing of funds as they are needed; the funds usually have to be repaid within the year.
- Short-/long-term. A loan is considered long-term if its term is longer than one year. Conversely, a short-term loan must typically be repaid within a year.
- Secured/unsecured. A loan is secured when the lender is given an alternate form of payment in case of default (you fail to pay). When a loan is secured, the lender is given a security--an alternate form of payment (e.g., a mortgage on a home). The asset that constitutes the alternate form of payment (the home, for example) is called "collateral."
Equity is all the nonborrowed funds contributed to your business. In other words, all the money invested in your business that you do not have to pay back is equity. You, your friends or family, or strangers interested in a new opportunity can contribute such funds. These funds are exchanged for an ownership interest in the business.
- What should you look for? Generally, you should look for investors who are experienced with, or at least understanding of, your type of business. In addition, you should seek out investors with whom you are compatible. There's nothing worse than sharing ownership of your business with someone you dislike!
- What will equity investors look for? An equity investor looks for a high return on investment profits. An equity investor is giving you money in exchange for the right to share in the ownership and future profits (and losses) of the business. Essentially, you are selling a piece of your business. Naturally, such an investor is not going to risk his or her money unless you can prove that the business has the potential to be successful and profitable.
- What are the advantages and disadvantages of equity? Unlike debt, equity investments do not have to be repaid. Because equity investors are eager to make a profit, they might be more willing to take risks than debt investors, who worry about getting their money back. On the other hand, your equity investor will require you to surrender some control over the use of his or her money. This means that you have to consider the opinions of others as to how the business should be run, regardless of how disagreeable they may be. Finally, equity financing is relatively complicated. Paperwork needs to be prepared and filed, and various regulations adhered to (e.g., laws regulating the sale of stock and other securities).
Primary Financing Sources
There are many sources of financing available to you. You should consider each carefully before making any decisions. Among the Debt Sources you could look into an SBA Loan Program. Continental Nationak Bank is a permier SBA provider. The SBA is a federal program that provides technical assistance (in the form of management counseling and informative seminars), and financial assistance (direct loans, loan guarantees, and tax relief). Though the SBA offers direct loans in specific circumstances, the SBA primarily acts as a guarantor of long-term loans for qualified business owners. In this capacity, the SBA usually guarantees 70 to 90 percent of a loan, typically for those in business for more than one year.
For more information on these and other loan programs contact our Small Business Department at 305.643.8240 or fill out the form below.
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