BUS 202 Financing a SB Spring 2006 copyright 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 term loan)

• EQUITY is an “investment” in your business (silent partner or venture capital)

Remember the Accounting Equation

Asset = Liabilities - Owners’ Equity

Equity vs. Debt FinancingAdvantages

Debt Financing

Advantages:• Relatively Easy & Quick• Maintain control &

ownership• Interest & other costs tax

deductible

Equity Financing

Advantages:• Unsecured (not required

to pay back)• Share of financial risk

(partners)• Less pressure to make

monthly payments• May be able to borrow

more

Equity vs. Debt FinancingDisadvantages

Debt FinancingDisadvantages:• 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 Store

• Start-up costs to cover a term loan

• Equipment• Lease hold

improvements• Inventory• Working capital

Capital to Keep Store Open

• Working capital to cover growth expenditures normally a “line of credit”

• cover overhead• payroll• purchase inventory• maintain cash flow

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 long-term loans to smaller firms.

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• Considerations:

Business Type

Size

Use of Proceeds

Personal Net Worth

Character of Individual

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 be used for:

• Inventory

• Equipment

• Machinery

• Start-Up Costs

• Working Capital

• Real Estate

SBA & State Guarantee LoansSmall 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

Micro-Loans

• 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 redeveloped area

•Lower interest rate and tied to job creation

•Special “Façade” or Signage Loan Programs

• Some local micro-enterprise loans

NOT EXACTLY!!!

• Applicant must be “Credit Worthy”

• 5 “C’s” of Credit• Applicant MUST be

able to demonstrate the ability to re-pay the loan – even with the SBA guarantee

What the Bank and SBA Look For in Analyzing a Loan

Application1. 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

2. Credit History

• Pull your Credit Report BEFORE you go to the bank!

• Mistakes take 3-6 weeks to correct

• 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 VALUETYPE BANK SBA

HOUSE MktVal x 75% - Mortgage Bal

MktVal x 80% - Mortgage Bal

CAR Nothing Nothing

HEAVY EQUIP Dep Val x 50% Same

FURN/FIXT Dep Val x 50% Same

INVENTORY Nothing Nothing

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

STOCKS/BNDS 50% - 90% Same

IRA/Mutual Fnd Nothing Nothing

CD’s 100% 100%

5. EXPERIENCE

• Experience COUNTS!!!

• Industry Knowledge

• Industry CONTACTS

• Competition• Target Market• Product/Service

Niche

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 businesses/people they KNOW!

• Community Banks LIKE investing in their communities

• Banks WANT you to be SUCCESSFUL!

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

ResourcesCheck out these sites for loan programs

• www.sba.gov• www.moneyforsmallbiz.com• www.womensinititative.org• www.obdc.com• www.solanosbdc.org • www.Innovativebank.com • www.Safe-bidco.com

Buying An Existing Business

Buying An Existing Business

For Sale

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 unsuitable

• Location may have become unsatisfactory

• Equipment may be obsolete

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 Analyzingan 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.

• Competitor analysis.

4. What legal aspects must I consider?

5. Is the business financially sound?

Valuing of a Business

• Balance Sheet Approach – Adjusted Balance Sheet Technique

• Earnings Approach– Multiple of Recast Earnings Approach– Discounted Future Earnings Approach

• Market Approach– Comps

Planning For Your Capital NeedsHaving 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 PageII. Cover Letter & Statement of PurposeIII. Table of ContentsIV. Executive SummaryV. Description of BusinessVI. Market AnalysisVII. ManagementVIII. OperationsIX. Use of FundsX. Financial InformationXI. Supporting Information (resumes, agreements)

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 &

services• Lack of Knowledge of Industry• Inadequate Calculations• NOT Clear to the reader