Help Growing Businesses Get Financing

Transcription

1 A Guide to Help Growing Businesses Get Financing WHAT S INSIDE: Financing Options: Finding the Best Fit for Your Business Preparing to Seek Funding Financing Terms You Should Know

2 Learning about Lending Most businesses borrow money at some point in their lifetime to expand, fuel an innovation, or weather a cash flow crunch. In fact, according to Capital One Spark Business survey, one-quarter of business owners received some kind of funding just in the past year. In this guide, you can weigh the pros and cons of the wide array of financing options currently available. After you figure out which financing solution is best for your business, read on for tips to present the most compelling case possible to convince potential lenders. Finally, review the glossary of financing terms to ensure you are well on your way to cash in on new opportunities for your company. 1

3 Financing Options: Finding the Best Fit for Your Business Selecting the right funding source is important since terms, interest rates, and flexibility can vary dramatically across options. The best match for your needs may change over time, but this guide covers multiple options to help you hone in on what works best for you today. Here s a quick glance at the funding avenues available to you: Term loans Lines of credit SBA loans Microloans Credit cards Asset-based lending Alternative lenders Peer-to-peer lending Equity financing Crowdfunding Financing Options: Finding the Best Fit for Your Business 2

4 Term Loans Three in five small companies that received funding in the past year got it from a bank, according to the Spark Business survey. Term loans are often used when a business needs to purchase equipment or other capital goods. Collateral essentially, a pledge of business or personal assets that can be converted into cash in the event of a default secures the loan. Interest rates normally remain unchanged for the life of the loan; the length of the loan often depends on the loan s purpose. Pros: Term loans generally have lower interest rates than other financing options. Rates are often fixed, which helps make payments predictable. Cons: Term loans often have more stringent approval requirements than other forms of financing. Lines of Credit Lines of credit (LOC) are often used to cover short-term cash flow needs like funding for inventory, payroll or seasonal expenses. Slightly more than 7 in 10 business owners who have a line of credit use it for these purposes, according to the Spark Business survey. Unlike a term loan, which provides a lump sum up front and requires regular payments, a line of credit allows businesses to withdraw funds as needed. Pros: No payments are required, and no interest accumulates until funds are tapped. Cons: Lines of credit may come with up-front fees and maintenance fees. Interest rates are often variable, which can make payments harder to predict. Financing Options: Finding the Best Fit for Your Business 3

5 SBA Loans The U.S. Small Business Administration, or SBA, offers programs to help businesses that may not meet conventional lending requirements. Though the SBA provides the financing, the loans are offered and administered through banks. Additionally, funding may come through financial institutions affiliated with certified development companies, or CDCs, which are nonprofits certified by the SBA. The two most popular SBA loan programs are: 7(a) loans: Proceeds from 7(a) loans can be used for a wide range of purposes CDC/504 loans: Proceeds are often used specifically to purchase real estate or long-term assets like equipment The maximum amount of an SBA 7(a) loan is $5 million. CDC/504 loans have no maximum amount, though the SBA s maximum contribution is $5 million to $5.5 million, depending on the project type. Pros: Because a substantial portion of SBA loans are guaranteed by the government, they can be easier to obtain than traditional financing. These loans offer long terms e.g., up to 7 to 10 years for 7(a) loans, and up to 20 years for CDC/504 financing. Down payments for CDC/504 loans are as low as 10%. Cons: The application process for SBA loans can be potentially longer and more complex than conventional financing. (Accelerated turnaround times for smaller loans may be available through the SBAExpress program). Financing Options: Finding the Best Fit for Your Business 4

6 Microloans Business owners who need to borrow a relatively small amount and who may not meet traditional lending criteria may try microlenders nonprofits that provide short-term, smaller loans (generally $50,000 or less). The organization Accion provides microloans to businesses nationwide; other groups, including the Opportunity Fund and Access to Capital for Entrepreneurs, lend within specific states. Some organizations offer opportunities specifically for women-owned, minority-owned and veteran-owned firms. The SBA also offers a microloan program, which provides amounts of up to $50,000. Pros: Microloans have less stringent requirements than conventional financing. Cons: Some of these loans may require extensive documentation and a lengthier application process. Credit Cards For many businesses, credit cards are an attractive form of short-term financing. They can be particularly convenient for making frequent transactions or short-term purchases, such as office supplies and business travel. If paid off within a month, no interest is charged. Many business cards offer rewards such as cash back or travel points; these can add up to a substantial benefit for businesses that spend heavily on a card and pay their balance every month. Many cards also offer account management tools that make it easy to track and categorize expenses. Pros: The short-term flexibility credit cards offer can help businesses manage monthly cash flow. The application process is typically easier than for some other lending products. Cons: Credit cards generally are not the best choice for long-term financing because of the cost to revolve a balance aka not pay it off at the end of the month. Financing Options: Finding the Best Fit for Your Business 5

7 Asset-Based Lending This type of financing, offered through banks and independent finance companies, provides a cash advance that is equal to a percentage of assets such as inventory, equipment or accounts receivable. Because assets are used as collateral, businesses pursuing asset-based lending are typically not subject to the credit requirements of more traditional forms of financing. Lenders will generally review customers payment histories and consider how consistently inventory sells. Invoice factoring is a somewhat similar type of financing. In this case, a business sells its unpaid invoices to a factoring company, which advances a percentage of the invoice amount. The balance (minus fees) is released once the business s customers pay the invoices. Pros: Funds may be faster to obtain compared to conventional financing. Cons: These forms of financing can be more expensive than traditional loans or lines of credit. Interest rates vary greatly, and lenders may charge additional fees. Financing Options: Finding the Best Fit for Your Business 7

8 Alternative Lenders Web-based lending services, sometimes called alternative lenders, typically have more lenient requirements than traditional lenders. Business owners can apply online. An algorithm weighs factors such as personal credit and time in business, providing a decision almost instantly. Though these loans are fast and convenient, the interest rates can be significantly higher than those for traditional and SBA loans. Pros: Requirements are less rigorous than for many other forms of financing; some loans do not require collateral. Cons: Interest rates are often very high. Annual rates of 30% to 40% are not unusual. Peer-to-Peer Lenders Some online lending platforms get the money they lend from individual investors. When a borrower applies, the platform evaluates lending offers from these investors and matches them to borrowers. Amounts offered through peer-to-peer platforms vary widely, with maximum amounts often ranging from $35,000 to $500,000. Borrowers with strong credit profiles may get lower interest rates this way as opposed to some other lending sources. Pros: This type of lending may have a short application process and fast credit decision. Loan terms may be longer (e.g., up to 5 years) and rates lower than alternative platforms. Cons: Origination and late payment fees on these loans may drive up borrowing costs. Financing Options: Finding the Best Fit for Your Business 6

9 Equity Financing Some financers will offer money in exchange for equity or partial ownership of a company. Two common examples of equity financing are angel investing and venture capital (VC). Angel investors: Typically invest in early-stage businesses VC firms: More likely to invest in businesses that already took their product or service to market Both of these equity financers will look to capture a return on their investment, often by helping prepare companies for acquisition or to go public. They may also take an active role in these companies VC investors, for instance, frequently want a seat on the board. Pros: Equity investors may provide valuable expertise, guidance and introductions that can help businesses grow quickly. They take on much of the business risk (and stand to lose if a business fails). Cons: Accepting equity funding typically requires giving up a stake in the company and, potentially, a significant amount of managerial control. Financing Options: Finding the Best Fit for Your Business 8

10 Crowdfunding Crowdfunding platforms allow entrepreneurs to post their concept online and create fundraising goals to source small donations from many contributors. Those who donate typically receive a product, service or other item of value once the fundraising goal is reached. Some crowdfunding platforms such as EquityNet, MicroVentures and SeedInvest work on venture capital principles, connecting businesses to investors who receive an equity stake. These sites can provide exposure to a large pool of investors. Pros: Many platforms do not require business owners to give up equity. Equity-based sites may simplify the process for connecting with potential investors. Cons: Platforms may charge a usage fee or a commission on fees a business raises. Financing Options: Finding the Best Fit for Your Business 9

11 Preparing to Seek Funding Your ability to successfully secure financing has everything to do with how well you prepare. Regardless of what type of financing you seek, be sure to cover these bases first: Develop a crisp customer definition. Customers supply the cash you will use to repay your lender. By sourcing your revenue, they set the foundation of your future success. Be able to clearly articulate who your customers are, what they care about, and how you will continue to win their business. Describe how you will use the money. Be prepared to tell lenders how you will put funding to good use for example, purchasing equipment to increase production or expanding your facility to serve more customers. Explain how you will repay. Funders of all types want to know how you will generate the cash to pay back the borrowed money or expect to deliver a desirable return on their investment. Provide detailed financial statements that zero in on cash flow to cover repayment. Show how your experience has prepared you to succeed. Demonstrate your ability to reach your goals by highlighting past achievements. If you lack experience in the specific pursuit ahead (i.e., your past experience was in a different type of business or industry), explain why you are still qualified to pull it off. Prepare your financial statements. Potential financiers will want to see well-prepared financial statements. Your financials strengthen your profile and demonstrate that you run an organized company. Secure the help of an accounting professional to prepare your balance sheet, income statements, cash projections, and any other financial documents your funding source requests. Preparing to Seek Funding 10

12 Financing Terms You Should Know Getting familiar with the vocabulary associated with financing may help you move through the process more easily. Review these common terms that could come up as you look at your lending options: Amortization: The gradual repayment of a debt over time, with payments including a portion of principal plus interest. Annual Percentage Rate (APR): The yearly total cost of a loan, including the interest rate, fees and other charges. When deciding among loan offers, comparing APRs can help to gauge how much they would truly cost. Debt Financing: A method of financing in which a firm borrows money with a promise to repay. Debt financing includes secured (i.e., putting up collateral) and unsecured loans. Unlike equity financing, debt financing does not require giving up ownership. Debt to Equity: The ratio of dollars you have borrowed to dollars you have invested in your business. Lenders will consider this measure when making decisions; lower ratios (signaling higher equity) are desirable. Effective Annual Interest Rate: The interest rate on a loan or investment with compounding taken into account. As an example, borrowing $10,000 at a 10% annual interest rate would result in $1,000 paid in interest. However, if compounding occurs monthly, interest payments at the end of the year would total $1,047 for an effective annual interest rate of 10.47%. Understanding this rate can be useful in comparing the cost of loans with different compounding terms (e.g., daily, monthly, annually). Fixed Rate: An interest rate that does not change over the life of a loan or is set for a specific period of time. This allows borrowers better accuracy in predicting their payment amounts. Term loans often offer a fixed-rate option. Guarantee Fee: For SBA loans, this is assessed on the SBA-guaranteed portion of the loan. The lending bank initially pays the guarantee fee and has the option of passing it on to the borrower at closing. Loans of less than $150,000 currently do not have a guarantee fee. Financing Terms You Should Know 11

13 Financing Terms You Should Know - continued Origination Fee: Lendors charge this up-front cost for processing new loan applications. This fee may be taken out of the total loan proceeds; for instance, a $10,000 term loan with $250 in origination fees would give the borrower $9,750 when the loan closes. Prime Rate: Banks most creditworthy customers are candidates for this highly competitive interest rate. It is largely determined by the federal funds rate aka the rate banks charge for lending money to each other. Though the prime rate is generally offered to large corporations, it directly affects the lending rates available for small business loans. Seed Capital: Financing used to launch a business, often provided by the founders or friends and family, is known as seed capital. These start-up funds typically go toward research and development as well as covering initial operating expenses. Series Funding: Successive rounds of financing from outside investors, such as a venture capital firm, can occur in a series. These generally begin when a business is seeing its first revenues but is not yet making a profit. These investment rounds may be followed by plans for an initial public offering or an acquisition by another company. Variable Rate: An interest rate on a loan balance that changes as market interest rates change. Lines of credit commonly have variable rates, though loans may have them as well. Working Capital: Current assets (e.g., cash, inventory and receivables) minus current liabilities (i.e., obligations due within one year). Working capital represents the margin of protection that businesses can give their short-term creditors, and it is an important measure of a company s short-term health. Financing Terms You Should Know 12

14 Good Luck! In this guide, we ve taken a closer look at loan types and strategies to help growing businesses get financing. With some extra cash on hand, you ll have the opportunity to fuel your company s growth and invest in your short- and long-term goals. To ensure that you balance your financing with a healthy cash flow strategy, be sure to check out our business guide A Guide to Cash Flow Management for Successful Businesses. Good luck getting in front of your potential lenders to secure funding and stay proactive about the future success of your business. *Capital One Spark Business 2015 Study on Small Businesses, a phone survey of 600 U.S.-based small business principals, 9/2-11/16/2015, margin of error +/-4%. Capital One Spark Business put together this guide for educational purposes only. It is not intended to provide tax, accounting, or legal advice. Please consult an expert for advice related to your specific needs Capital One