Small business owners may need outside funding when running their company. Many small businesses face numerous difficulties generating positive cash flows during the early months and years of operations. External funding is used to offset the slow cash flows resulting from these situations. Business owners may not be able to secure traditional small business funding through bank loans or equity investments. In the absence of traditional funding options, small business owners may look to alternative funding sources for securing business capital. Venture Capitalists
Venture capitalists represent private investors who give small business owners funding in exchange for a business ownership stake. These investors often require small businesses to provide them a substantial financial return in addition to ownership. Venture capitalists often have experience in the business industries where they invest money and may provide small business owners with experience or expertise in particular business functions. These individuals may also be interested in growing the small business and taking it public to cash out their invested capital.
Angel Investors Angel investors are individuals who use personal funds to finance small business ventures. These individuals are often more patient with business owners and may not require a substantial return on investment. Small business owners may also be able to borrow funds from angel investors in varying amounts for short- or long-term time periods. Although angel investors often allow favorable terms regarding invested capital, they may also require an ownership stake in the company.
This ownership stake allows the investor to ensure the small business owner makes the best decisions and the business venture will be able to repay the investor’s capital with interest. Credit Cards Small business owners may use business credit cards for funding different purchases in their company. Credit cards allow business owners to have an open line of credit for making purchases quickly and easily. Using credit cards can also help business owners establish a credit history for their business, which may increase the company’s ability to secure traditional ank financing. Small business owners can also use business credit cards that offer special perks, such as travel miles or cash back benefits, that business owners can use for business or personal use. Factoring Factoring is the process of selling accounts receivable balances to a company in exchange for cash. For example, small businesses may get 80 cents to 90 cents on the dollar for each approved accounts receivable balance. Factoring allows small business owners to receive an influx of cash rather than waiting for clients to pay their outstanding balance to the company.
Creating a business relationship with a factoring company may also allow small businesses to factor future accounts receivable balances and generate a positive income stream from this process. * small Business Administration The Small Business Administration (SBA) was started in 1953 to encourage small businesses and entrepreneurs to start their own businesses. Under the SBA, there are two types of loans that can help borrowers to get the capital they need to start their business: a 7(a) guarantee small business loan and the 504 fixed asset small business finance program.
The 7(a) guarantee loans for small business are more common for small businesses and can be applied for at banks participating in the SBA loan process. “Both programs look for businesses not in the startup phase,” said Chuck Evans, managing director at the South Eastern Economic Development Company of Pennsylvania. “They look for businesses two years into business cycle that are generating cash flow. ” Advantages “The advantage to the borrower is they have more access to capital,” said Evans of the 7(a) guarantee loan. When borrowing with a loan, collateral or purpose often dictates the terms. If you look at real estate, you are looking at a 20- to 25-year term. If you are financing equipment, you look at the useful life and may finance it for five years. If you look at permanent working capital, you may only want to loan them for three years. With a guarantee from the SBA, banks can go up to 10 years for working capital, 10 years for equipment and 25 years for real estate. It gives the borrower longer terms and improved cash flow. Additionally, banks may also be more willing to give these loans out as the SBA guarantees 75 percent of the loan. “At a point, if that business goes under in the future and you have liquidated all of your collateral, acted like a prudent lender and done everything you are supposed to do, the loss is split,” said Evans. “Let’s say on a million-dollar loan, if you sell a building from the business for $600,000, that leaves a loss of $400,000. With a 75 percent guarantee from the SBA, they will give $300,000 and the bank will take a hit of $100,000.
Disadvantages “Because the loans are sold in the secondary market, they tend to structure a lot of those loans on a variable basis,” said Evans. “If you are getting a 25-year fully amortizing loan at prime plus 2. 75 percent today, interest is going to be at 6 percent because prime is currently 3. 25 percent. Three years from now it might be nine percent. The interest rate risk is greater on the 7(a) program. ” Additionally, borrowers must make a smart choice when choosing the bank to borrow from, Evans said. If you take 100 banks in the state of Pennsylvania, maybe only 20 banks made more than 10 SBA loans last year,” said Evans. “If you deal with that few loans a year, you are not going to be able to understand the nuances of a program that is constantly changing, so it can turn into a slow and cumbersome process. If you go to a bank that does it well and does it on a regular basis, you stand a much better chance of a more simplified process because they understand it. Traditional lenders A lender who is not affiliated with a bank or traditional lender, and who may or may not normally be in the business of providing loans. Private lenders are not as constrained by regulations as traditional lenders are and can approve ventures that traditional lenders cannot. Private lenders and financiers often charge higher interest rates and fees than traditional lenders due to the higher level of risk they expose themselves to. Also known as “private financing. “