On Monday I gave you an excerpt from my book It Starts With an Idea – Tax Tips for Small Businesses; regarding entity selection and Tuesday was another excerpt discussing Employees. Today is still another excerpt with funding your business.
The first thing we need to determine is what it will take to get our business off the ground. In determining your start-up costs, you need to be realistic. On paper, you would want to have an office, employees, and have the best equipment. The truth of the matter is that all of that costs a lot of money. That being said, you need to be realistic when it comes to start-up costs. You are either going to fund your start-up with your own money, try to attract investors, or try to get a bank to loan you money. Whichever way you choose, you should be as frugal as possible getting your idea off the ground. You don’t want to spend a lot of money on a business that might fail. The cold hard fact is that half of all small businesses fail within their first five years. This may happen to you. If it does, you want to make sure that you aren’t out a lot of money, or on the hook for paying back a large sum of money.
Depending on what your idea is, you have to determine what it is going to take to get your idea off the ground. Some ideas require a considerable amount of capital, and other businesses require a nominal investment. In the first chapter we discussed someone that was going into business as a web designer. Using this business as model for our discussion, would require a minimum investment by the business owner. The business owner may, or may not already have the equipment and software he needs to start his web design business. For our discussion, let’s assume that the business owner does not have all of the equipment and software required to start his business. The start-up costs for this type of business is minimal. The business owner would probably need a computer, an internet connect, and some software. The total start-up costs would probably be less than $5,000.00.
The following are different ways that you can raise capital.
Investors and Venture Capital
One way to raise capital is to ask investors to invest in your business. In exchange for the money, the person that invests will typically ask for a percentage of your business for their investment. Depending on your business valuation, and the amount of money that you are seeking, you will have to be willing to give up a portion of ownership. Depending on the investor, they may want a controlling interest in your business. They would want this for a few reasons, but the main reason is that they would want to be able to call the shots. They want to control the management decisions so that their investment is safe. You would have to be willing to give this control up depending on what the investor is bringing to the party. If the investor has experience in the type of business that you are starting, they could provide a wealth of information, and connections (aside from money) that can help your business grow.
The first thing to keep in mind about seeking venture capital from investors is that the money that you receive is not long-term money. From the investor’s point of view, the idea is to invest in your company’s infrastructure until it reaches a sufficient size so that they can either make money on their investment, or they can sell the company to another company.
Asking for venture capital could be as easy as asking friends or family. Typically friends and family will give you money, and not want a huge percentage of your business.
Not interested in the world of venture capitalist? Then you can seek a small business loan. You can obtain financing from your family, friends, or a bank. There is a difference between getting a loan and seeking investors. When you seek a loan, you are guaranteeing that in exchange for the money that you receive, you will pay the money back over a period of time with interest. It is important to note that when you ask for a loan, no matter what your entity structure, you will have to personally guarantee that you will pay that money back. Even if you go out of business, the bank will still want to be paid.
The most common type of loan that is given is an SBA Loan. The Small Business Administration has a number of loans programs to choose from. They even offer grants that your business may qualify for. It is important to note that the SBA doesn’t loan money directly to small business owners, rather the SBA sets guidelines for loans that are made by other institutions. The SBA guarantees that these loans will be repaid. This eliminates the risk to the financial institution that actually lends the money. The SBA has three different loan programs; the 7(a) Loan Program, Microloan Program, and CDC/504 Loan Program.
The 7(a) Loan Program is the most popular of the three programs and is separated into many different types of loans for many different purposes. It is important to note that the SBA sets guidelines on how the funds from this program can be used. The proceeds can only be used to purchase land or buildings, purchase equipment, short-term working capital, long-term working capital, financing against existing inventory, refinancing of existing business indebtedness that is not already structured with reasonable terms and conditions, and to purchase an existing business. The proceeds from a 7(a) Loan cannot be used to refinance existing debt where the lender is in a position to sustain a loss and the SBA would take over that loss through refinancing, to effect a partial change of business ownership or a change that will not benefit the business, and to permit the reimbursement of funds owed to any owner, including any equity injection of capital for the business’s continuance until the loan supported by the SBA is disbursed.
The Microloan Program is used to provide small, short-term loans to small businesses. The SBA makes the funds available to specially designated intermediary lenders. The intermediaries make the loans to eligible borrowers. The amount of the loan cannot exceed $50,000.00, and according to the SBA, the average loan is $13,000.00. The Microloan can be used to provide working capital, to purchase inventory or supplies, and to purchase equipment.
The CDC/504 Loan Program provides approved small businesses with long-term, fixed-rate financing. This financing is used to acquire fixed assets for expansion or modernization. The loans are made through, Certified Development Companies (CDC). A CDC is a non-profit corporation that promotes economic development within its community through 504 Loans. 504 Loans are typically structured with SBA providing 40% of the total projected costs, the lending institution covering 50% of the projected costs, and the borrower contributing 10% of the total costs.
To qualify for an SBA loan you should have your business plan; your personal financial statements; your business financial statements, or projections if you are not already in business; collateral available to secure the loan; assumptions used in your projected earnings statements; management resumes of those involved in operating the business; and proforma balance sheets showing what the business will look like if the loan were granted.
As you can see there are different ways to fund your business.
For more information visit www.smalleynco.com
If you have any questions you can email Craig W. Smalley E.A.
Author of the books: It Starts With an Idea – Tax Tips for Small Businesses available on Nook and Kindle, The Ultimate Real Estate Investor Tax Guide, available on Nook and Kindle, The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012 available on Nook and Kindle, Everything You Wanted to Know about the IRS – Audits, Appeals and Collections available on Nook and Kindle, Tax Avoidance is Legal! The Complete Guide to Individual Income Tax available on Nook and Kindle, The Complete Guide to the Affordable Care Act’s Tax Provisions available on Nook and Kindle, The Complete Guide to Retirement Plans for Small Businesses available on Nook and Kindle, The Complete Guide to Estate, Gift and Trust Taxation, available on Nook and Kindle, The Complete Guide to Hiring an Accountant, available on Nook and Kindle, and The Complete Guide to Subchapter S-Corporations, available on Nook and Kindle