Running a Business - Getting Money

Getting Money

Credit is the lifeblood of American business, especially for the smaller firm. It helps the entrepreneur get started, obtain equipment, build inventory, develop new lines of merchandise, or expand. In brief, credit makes the business grow.

The financing for small business comes largely from the nation's 14,500 commercial banks. Surveys have found that aside from personal savings, banks are the major source of capital for starting new firms. Even more striking, about 85 percent of loans to operating small businesses come from banks, according to a report by the National Federation of Independent Business.

In seeking a loan for your company, you are essentially asking a bank to become your business partner. Before entering the market for a loan, make sure you have done all of the ground work necessary:

(a) How much do you want and for what?
(b) What terms do you need for your loan?
(c) What kind of a business person are you?
(d) What shape is your business in?

Your preparation must also include doing the groundwork of a good consumer: Which banks in your area are known for small business loans? Which ones are the most reliable? Remember, loans are the products that banks sell. Look for the best combination of price, quality, and reputation of supplier. In the end, getting a loan depends upon your credit-worthiness.

1. Planning For A Loan
2. Types Of Loans
3. Selecting A Lender
4. Writing a Business Plan
5. The Review Process

1. Planning For A Loan
Before you step into a bank to borrow, you should ask yourself some basic questions. Thinking these through and having answers ready will lead to a more productive credit interview. The answers to questions such as these are central to the lending decision. And the information you provide--backed up by your financial statements--will help the banker make the decision as quickly as possible. Here are some examples:

1. How do you plan to use the money you will borrow?
2. How much do you need? (Be prepared to be as specific as you can about why you need the amount requested.)
3. How long will you need these funds?
4. How do you plan to generate sufficient cash flow to pay back the loan?

2. Types Of Loans
As a business person, you know that you may need to borrow to maintain or expand your business. But loans come in various forms and some are more appropriate than others for your needs are. The following are some types of loans available. Try to determine how your needs match them.

Short term loans
A line of credit allows you to borrow repeatedly up to a certain amount. You repay and re-borrow as often as you need. At the end of the year, the line of credit may be renewed. This is sometimes called a revolving line of credit because of the repeat borrowing and repayment provisions. These loans, which usually must be secured by collateral, allow you to maintain an even cash flow with which to operate your business. They may allow you to take advantage of special discounts offered by suppliers, or to gear up for a special sales effort. They can tide you over until a customer pays a big bill.

One type of line of credit bearing special mention is the seasonal line of credit. Many businesses have a strong seasonal nature. There may be a time when you need capital to prepare for a seasonal product. The period between its production and the income it produces may be lengthy. Cash flow may be diminished, but you need to keep operating. When applying for such a seasonal loan, determine how much you will need and, based on past experience, when you will be able to repay it. Don't borrow more than you need. Like most other types of lines of credit, this kind of loan is expected to be repaid within a year.

Intermediate term loans
These loans may run as long as three years. Consider such a loan for a business start-up, the purchase of new equipment, the expansion of a store or plant, or an increase in working capital. The intermediate term loan is usually repaid in monthly or quarterly payments from the business's profits. The loan will usually require collateral.

Long term loans
A long term loan typically runs for more than three years, is usually secured, and may be granted for business start-ups, purchasing major equipment, moving a plant or store, or for other purposes.

The long term loan is commonly repaid on a monthly or quarterly basis out of cash flow or profits. The loan agreement may contain provisions which limit your company's other debts, dividends, or principals' salaries or which require minimum equity or working capital levels. It may also require that a percentage of the firm's profits be used expressly to repay the loan. Collateral for a long term loan may be the assets you are purchasing, supplemented by your personal guarantee, stocks, bonds, certificates of deposit, or other business assets.

Commercial mortgages
You may need a commercial mortgage if you plan to buy, build, or enlarge a building, or to obtain needed land. Generally, the mortgage is made for 75 to 80 percent of the appraised value of the property and is amortized over a set period of ten to twenty years. The bank will probably require an independent appraisal at the customer's expense.

Should you need cash, property that your company now owns may be mortgaged. If the property, land or building is already mortgaged, you may be able to obtain a second mortgage. The interest rate on the first mortgage should not be affected by the second one. The interest on the second mortgage would be at prevailing rates--most likely higher than the rate of the first mortgage.

Letter of credit
Although not an actual loan, a letter of credit is used to facilitate certain business transactions. Therefore, a request for opening a letter of credit is similar to an application for a loan and is treated the same way.

In domestic use, a standby letter of credit substitutes the bank's credit for the firm's credit by providing the bank's guarantee of payment to a third party if the borrower fails to repay the loan. For example, a small firm manufacturing dresses might need to offer a standby letter of credit to a supplier of cloth to assure the supplier that the bank will provide payment for the cloth if the purchaser cannot.

In an international transaction, a commercial or import letter of credit refers to a specific transaction. It helps insure the buyer and seller, who may be separated by thousands of miles and operate under different legal, political and business practices, that they will both receive protection regarding the receipt of goods and payment for them. For example, a small U.S. tea manufacturer may wish to purchase tea leaves from a supplier in the Orient. The letter of credit would contain provisions guaranteeing that the seller would receive payment by a specified date if the buyer received the merchandise by a certain time and if the merchandise met pre-determined standards of quantity and quality.

Equity Financing
Previously, several types of debt financing have been described. However, another way you can obtain financing for your business is to share its ownership with others. Through this equity financing, additional individuals or firms provide capital for the company but may or may not take part in its operation.

General partners are those who normally contribute both capital and management time. They share in business responsibilities and liabilities. Limited partners are individuals who contribute capital to the business but who normally have neither management responsibilities nor liabilities. A sole proprietorship is a business where there is only one owner, and this person is responsible for all the company's debts.

If you establish a corporation, you can accommodate numerous equity investors in the business. Each investor is a stockholder and owns a part of the company. A privately held corporation may consist of an unlimited number of stockholders. Often they are friends, relatives, or employees. A publicly held corporation is one which seeks to offer ownership to the general public. Shares are sold by an investment banking or stock brokerage firm.

Since the objective is to raise money, the corporation can obtain equity financing through the issuance of a number of instruments:

• common stock is issued to friends, relatives, and investors.
• preferred stock represents ownership in the business, but requires that its holders be repaid first if the business should go bankrupt.
• convertible debentures are bonds which may be converted into common stock before being repaid to holders.
• debt warrants allow holders to buy a company's stock even after the debt has been repaid.

A business that is a corporation may enjoy certain advantages in obtaining funds. But bear in mind that corporations are more highly regulated than most other legal entities.

A Note on loan collateral: Banks will usually require the value of the collateral to be somewhat greater than the amount of the loan. One factor to be considered is the liquidity of the collateral. Another consideration is the expected economic life of the collateral. For example, items that rapidly lose value, such as seasonal inventory, are not normally acceptable as collateral for intermediate or long-term debt. When making loans to businesses with multiple owners, such as partnerships or corporations, banks may require a pledge of personal assets or a personal guarantee.

A Note on equity financing: Although some companies select equity financing, debt financing historically has been and currently is preferred by most small firms. The existing tax structure is one special reason for this. Interest paid for a loan is deductible as a valid business expense. It reduces the tax burden. Furthermore, the money obtained through borrowing is controlled by the owner of the business-control over the company is not diminished. Thus, where credit can be obtained at a favorable rate, debt financing is usually the better course for the small firm than equity financing,

3. Selecting A Lender
Choosing the bank for your loan should be a careful decision and not based on relatively superficial grounds, such as convenience of location. Money from one bank is every bit as good as money from another bank, so it pays to shop around.

Interest rate Obviously the cost of financing should be a factor in selecting a bank. Different financial institutions may offer different rates because of variations in their cost and availability of funds. Also, ask whether agreeing to maintain a minimum balance in the bank will result in a lower rate. At some financial institutions it will. Many banks may offer only variable rate financing or both variable and fixed rate loans. With variable rate loans, the interest rate will be tied to some economic index, and the rate on the loan will change to correspond with increases or decreases in the index.

Quality of Service Do additional research besides studying interest rates before selecting your bank. However, the number and quality of other small business services and the bank's commitment to long-term relationships are important, too. See if the bank is one that makes a specialty of lending to small business. If there is one with small business people on its board of directors, this may suggest a willingness to deal with small firms. Also, you may want to know whether the bank participates in programs of the U.S. Small Business Administration. Check with other small business owners in your industry or your region. They may know of banks which have a history of serving your kind of business and are therefore worth considering. If your colleagues have had good service from a bank, a fair rate, and good financial guidance, they should be quick to pass this on. Ask your accountant or lawyer for suggestions as well.

4. Writing the Business Plan

5. The Review Process
Every lender tries to understand the condition of the borrower's business as well as its prospects. That is the reason for asking you to submit several types of financial statements. They give the banker a chance to see how critical aspects of your business relate to each other.

The "seven C's" of credit are used as a framework to analyze a credit request. Each of the following is looked at in relation to the borrower, the business, and the market area. Identified risks need to be mitigated and strengths should be enhanced. Loan Considerations

7 C's of Lending
1. Credit
2. Character
3. Capacity
4. Capital
5. Condition
6. Capability
7. Collateral

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