Financing a small business the ABC from star to fincne

Debt FinancingDisadvantages Debt Financing Disadvantages: • Interest Costs Expensive • Risk of profits not covering repayment • Easy to abuse & overuse • Must share financial information

BUS 202 Financing a SB Spring 2006 copyri ght sjh

Financing a Small Business

The ABC’s from Start to

Finance…

Why Worry about Financing?

 The key to a successful business often

depends on the ability to have sound

management, financing & cash flow to fund the

operations

 Inadequate financing is one of the major

causes of business failure

 To avoid this pitfall, small business owners

need enough money and need to know how to

manage it to STAY in Business!

What Financial Resources are available

for my business?

The most common resources:

• Personal Savings

• Friends & Relatives

• Venture Capital Firms

• Government Loans

• Commercial Loans

Knowing Who, When and Where to ask for financing can be a key to your success!

Debt or Equity?

• DEBT is borrowed

money…it becomes a liability on

your balance statement (long

Equity vs Debt Financing

AdvantagesDebt Financing

Advantages:

• Relatively Easy & Quick

• Maintain control &

ownership

• Interest & other costs tax

deductible

Equity FinancingAdvantages:

• Unsecured (not required

Equity vs Debt Financing

Disadvantages

Debt Financing

Disadvantages:

• Interest Costs Expensive

• Risk of profits not

covering repayment

• Easy to abuse & overuse

• Must share financial

information

• Lender Restrictions &

Limitations

Equity FinancingDisadvantages:

• Risk of destroying personal relationships

• Give up part of profits

• Give up part of ownership

of business

• Give up some control of business

• Legal restrictions

Debt: A Loan by any other name

 Debt Financing is most frequently used when

there are minimal risks and the investment

return is acceptable to the lender

 Businesses that rely on debt financing are

those in earlier stages of business

development (primary & secondary levels of business

growth)

There are two specific types of debt financing

1) Conventional Loan Programs

2) Government Guaranty Loan Programs

Needs for Capital

Capital to Open the

• Working capital to cover growth

expenditures normally a “line of credit”

Common Uses for Financing

• Start-up Capital

• Working Capital

• Permanent Working Capital

• Growth Capital

• Equity Transfer Capital

• Debt- refinancing (more difficult to get a

business loan)

Conventional Bank Loans

• Short-term

• Demand loans

• Seasonal lines of credit

• Single-purpose loans for machinery and equipment.

• Banks generally are reluctant to offer term loans to smaller firms

long-A Guaranteed Loan?

• SBA and State Guarantee Programs

are loans made by private lenders

and guaranteed up to 85% by the

federal or state government

• The government is not a “direct”

lender, but acts as a co-signer

• This takes the risk off the lender.

Business + Lender + Loan guaranty from federal or state programs =

AN Approved Loan

What’s a Lender to Do????

Lender’s can:

• Approve your Loan Request

• Seek a guarantee from SBA to support their loan to you

• Decline your application all together

US Small Business

Administration

The SBA guaranteed lending

program encourages banks and non-bank lenders to make long-

term loans to small firms by

reducing their risk and leveraging the funds they have available.

SBA & State Loan Eligibility

• Independently owned &

operated; not dominate in field

• Press & real estate not eligible

SBA Loan Guarantee

Programs

• SBA 7(a) Program

• Term loans for various

purposes

• SBA will guarantee up

to 85% of the bank’s

loan

• The SBA guarantee

helps shoulder the

risk for the bank

• SBA 504 Program

• Real Estate, Construction, Long- Term Asset purchases

• 50% Bank loan, 40% SBA financing

through CDC, 10% down payment

SBA 7(a) Loans

Loan Proceeds can

SBA & State Guarantee Loans

Small Business Administration

•7a Loan

•Low-doc/Women & Minority Pre-qualification

•504 Loan

•SBA Micro loan

•SBA Community Express SOHO Micro Loan

State Administered Loan Programs

• Nor-CAL FDC State Guarantee

•Clean Loan Program (pollution & waste reduction)

•Safe-Bidco State Guarantee

•State Rural Loans- Agriculture & Industrial

• Normally $25,000 or under

• Unsecured!

• Can go as low as $5,000

• Used for start-up businesses

• Interest rates normally higher than conventional loans ( 3-6%) above

prime

• Relaxed criteria

• May have qualification restrictions

Local City & Redevelopment Loans

•Local City Redevelopment Loans

•“Gap” Financing to assist businesses in

What the Bank and SBA Look

For in Analyzing a Loan

Application

1 ABILITY TO REPAY

2 CREDIT HISTORY

3 EQUITY INVESTMENT

4 SECONDARY SOURCE OF REPAYMENT

5 EXPERIENCE/ABILITY TO MANAGE BUSINESS

6 PERSONAL OBLIGATIONS

#1 Ability to Repay!!!

• Financial Statements

• P & L’s

• CASH FLOW –

remember, bills are

paid with CASH, not

profits!

• NEW BUSINESSES –

Bus Plan is KEY

• Detailed information explaining credit

issues

3 Equity

• MUST be enough equity in the business

to leverage the loan

• General Rule – Debt

to Equity no higher than 4

• Start-up Businesses – expect 25%

4 Collateral

• Secondary Source of

Repayment

• Personal and

Business Assets that

can be sold to pay

back the loan in the

event of default

• Co-Signers can

pledge collateral

COLLATERAL VALUE

Mortgage Bal MktVal x 80% - Mortgage Bal

RECEIVABLES 75% “Under 90” 50% “Under 90”

6 Personal Obligations

• Outside sources of income to support personal living

expenses a PLUS+

• Low Personal Debt

a PLUS+

• Excess Outside Income can offset lack of collateral

Build a Banking Relationship

• Banks LIKE lending to

Checklist for getting it all

together!

Every bank or organization will have a slightly

different list of everything that is needed

Here is a basic list:

 Applicant Information Sheet

 Current Personal Financial Statement (for all partners)

 Schedule of Real Estate Owned

 Personal Tax Returns- 3 years (or business if in business)

 Signed Credit Authorization

 Current Financial Statement

 Business Debt Schedule

 If new business, business plan and projections for first 12 months

 If purchasing, Purchase agreement

 If franchising, Franchise agreement

Key Questions to Consider Before

Buying a Business

• Is the right type of business for sale in the market in which you want to operate?

• What experience do you have in this

particular business and the industry in

which it operates?

• How critical is experience in the business

to your ultimate success?

• What price and payment method are

reasonable for you and acceptable to the seller?

More KEY Questions

• Should you start the business and

build it from the ground up rather

than buy an existing one?

• What changes will you have to make

– and how extensive will they have to

be – to realize the business’s full

potential?

• Will the company generate sufficient

cash flow to pay for itself and leave

you with a suitable return on your

investment?

Advantages of Buying A Business

• Established good will and customer base

• It may already have the best location

• Employees and suppliers are established

• Equipment is already installed

• Inventory is in place and trade credit is

established You can “hit the ground running”

• You can use the previous owner’s experience

• Seller may finance or carry

Disadvantages of Buying A Business

• “It’s a loser”

• Bad reputation is hard to change

• “Inherited” employees may be

Locating a Business

• Business Brokers

• “Hidden market”

• How to Buy a Business Workshop

• California Businesses For Sale Website

www.bizben.com

Kwik-Mart

Five Critical Areas for Analyzing

an Existing Business

1 Why does the owner want to sell the real reason?

2 What is the physical condition of the business?

3 What is the potential for the company's products or

services?

• Customer characteristics and composition.

4 What legal aspects must I consider?

5 Is the business financially sound?

Valuing of a Business

• Balance Sheet Approach

– Adjusted Balance Sheet Technique

Planning For Your Capital Needs

Having the appropriate business plan is critical!

Financing Plan - must support ability to repay This plan

must have realistic projections and justification

Investment Plan - illustrates the strengths & potential of

the business in order to capture market share

Describes the “equity investment” and structure

(who is contributing and in what proportions)

Composite (existing) - often used by existing businesses

for on-going financing or for growth stage This

plan is often an “updated” business plan of a first

stage business

More Business Plans

• Start-up (“projected”)- details the

projected strengths and needs of a

new business The plan MUST BE

able to support the assumptions…

both the marketing and the

financials

• Other types of business plans (non-

financial)- Strategic (Action Plan),

Marketing & Operational

Outline of a Typical Small Business

Financing Business Plan

I Cover Page

II Cover Letter & Statement of Purpose

III Table of Contents

IV Executive Summary

Ten Most Common Mistakes Found

in Financial Business Plans

• Too Long

• No Competition Indicated

• Unreasonable Expectations &

Projections

• Unreasonable Financial Projections

• Unrealistic Profitability for Investors

• Management Skills not demonstrated

• Unrealistic projections of products &