How to Finance Your Business for Growth with IOUs
Equity is not the only way to finance the growth of your business. Debt vehicles — IOUs with interest — are another way to acquire the capital you need to grow. When you choose this route, you typically hand over title to a business or personal asset as collateral for a loan bearing a market rate of interest. You normally pay principal and interest on the note until it’s paid off.
Some arrangements, however, combine debt and equity. For example, a debenture is a debt vehicle that can be converted to common stock at some predetermined time in the future. In the meantime, the holder of the debenture receives interest on his or her loan to the company.
Here are some of the more common sources of debt financing for growth.
Commercial banks: Banks are better sources for growth capital than for startup capital, because by the time you come to them, your company has, in all likelihood, developed a good track record. Banks make loans based on the Five C’s: character of the entrepreneur, capacity to repay the loan, capital needed, collateral the entrepreneur can provide to secure the loan, and condition of the entrepreneur’s overall financial health and situation. For entrepreneurs with new ventures, character and capacity become the overriding factors.
Commercial finance companies: Also known as asset‐based lenders, these companies are typically more expensive to use than commercial banks by as much as 5 percent above the prime interest rate. But they are also more likely to lend to a startup entrepreneur than a commercial bank is. And when you weigh the difference between starting the business and not starting because of money, a commercial lender may not be that expensive.
Small Business Administration: For over 60 years the SBA (www.sba.gov) has provided many forms of financial assistance to small businesses. This assistance includes grants, counseling, and loan guarantees. SBA loan programs are designed to help small businesses obtain funding when they can’t obtain suitable financing through traditional means. The SBA doesn’t directly make loans to small businesses. Instead, it provides a guarantee to banks and other authorized lenders for loans provided to qualifying businesses.
This guarantee protects the lender by promising to repay a portion of the loan in the event the borrower defaults. Therefore an SBA loan application is not submitted directly to the agency but rather through an authorized lender. Note that not all lenders offer SBA loans, and authorized lenders may not offer all of the several types of SBA loans. Because the SBA is a government agency, its programs frequently change based upon current fiscal policy.
The following are three of the more typical SBA loan programs currently being offered:
SBA 7(a) loans: This is the SBA’s traditional loan program. Currently, 7(a) loans have a maximum of $5 million and no minimum. In fiscal 2012, the average 7(a) loan was $337,730. The SBA guarantees 75–85 percent of the loan, depending on the loan amount. In the fiscal year ending September 30, 2014, the SBA had approved 52,044 7(a) loans for nearly $20 billion.
SBA Express: A relatively new program, SBA Express aims to reduce all the paperwork associated with a traditional SBA loan. If you qualify at a bank, you can borrow up to $350,000 without going through the standard SBA application process. In fact, this program promises to give you a decision within 36 hours. Because the Small Business Administration only guarantees these loans to 50 percent of their face value, not all the SBA‐qualified lenders have signed on to the program.
Microloan program: This is another newer program that provides up to $50,000 to help small business with funding for various needs, such as working capital, inventory, and equipment acquisition. The SBA provides funds to specially designated intermediary lenders — nonprofit, community‐based organizations with experience in lending and providing other technical and management assistance. These intermediaries administer the microloan program for eligible borrowers.
Each intermediary lender establishes its own credit requirements. Often these lenders require some sort of collateral as well as the personal guarantee of the business owner. The average microloan is about $13,000.