Obtaining Finance For Your Business

1. Obtaining Finance For Your Business Created by: Nina Southern

2. Entrepreneurs Start-up Sources • As you learned in Chapter 19 Entrepreneurship & Small Business Management, there are several ways to finance your business: • The main sources for start-up money for entrepreneurs include: • Friends • Family • Other resources, such as savings, credit cards, loans, and investments • Some sources of financing include: • Banks • Finance Companies • Investment Companies • Government Grants • Some sources of equity financing include: • Angel • Venture Capitalist

3. Start-up FromFriends and/or Family • Friends and family are the most common source of startup capital. • But such loans are not without risk. • For a lot of startups, money is tough to come by. So it's not surprising that many fledgling entrepreneurs think about borrowing from the Bank of Mom and Dad or floating their business plans by college buddies. • In fact, borrowing money from friends and family is the most common method for raising startup capital. • But getting a business loan from your friends and family can't help but become personal -- and there are countless horror stories out there to prove it. • That said, there are also plenty of successful entrepreneurial stories that begin with conversations at the Thanksgiving table or the local bar. • How can you approach this tricky topic and ensure that your personal relationships do not suffer?

4. 5Things You NeedToKnow When BorrowingFromFamily & Friends • Money will impact your relationships • Treat this as a business relationship • If your loan is more than $10,000, enlist an accountant • Put everything in writing • Be realistic

5. Money Will Impact Your Relationships • Not that you haven't considered that. But it's worth really thinking this through. • If you can't pay back the money your friends or family loan you, or if you take it and then don't communicate with them, you could lose your relationship. • And while you may be right if you're thinking, "Mom would never disown me," or, "Chuck and I have been friends since third grade," the respect they have for you could take a hit. • "Make sure that this loan doesn't put the family member or friend in a hardship," urges Lisa Baskfield, a member of the American Institute of Certified Public Accounts' National CPA Financial Literary Commission. • "It's similar to investing in the market. The person loaning the money should be okay with the idea of losing all funds."

6. Treat This As A Business Relationship • Jeffrey L. Yount's advice seems right on the mark. "Treat this transaction as a normal business transaction," advises Yount, a partner at B2B CFO, which provides CFO services for emerging and mid-market companies. • "That's what it is. Don't have an attitude that implies, 'These are my friends and family. They will understand if I miss or delay a monthly payment, or fail to provide timely financial information or fail to communicate financial issues.‘ • " At the same time, Yount says, "This is your business. Don't let the friends and family interfere with the day-to-day operations. • Remember, they have only provided some financing -- they are not co-owners."

7. If Your Loan Is More Than $10,000, Enlist An Accountant • Mitchell Freedman, who owns the Mitchell Freedman Accountancy Corporation in Westlake Village, Calif., correctly observes that many family and friends don't want to charge borrower interest to their relative or pal who is starting up a business. But they may have to. • "If the loan is for more than $10,000, the lender is required by tax law to charge interest on the loan, even if her or she doesn't want to," Freedman says. • “If there is no interest, then OID [Original Issue Discount] effectively reduces the amount of the loan and requires the lender to pick up a portion of the repayment as interest income. The IRS issues monthly minimum interest rates that must be charged, called AFR [Applicable Federal Rate]." • In other words, if the loan is more than $10,000, thank your friend or family member profusely -- and then consult a tax accountant or attorney.

8. Put Everything In Writing • That may sound obvious, but we would be remiss if we didn't stress it. All of the terms -- how much the loan is, when it's going to be paid back, what the interest rate will be if there is one -- should be put down on paper. Freedman adds that if there's any collateral you plan on giving your friends and family if the loan isn't paid back, put that down, too. • Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, suggests explaining what will happen to the loan if you die. "Will the loan be forgiven, or will it still be owed?" she asks. • Now, of course, if we're just talking a loan for a few hundred dollars, the stakes aren't as high. Plus, these are your friends and family we're talking about. Chances are, if you somehow perish before your company is moving along, and you leave some friends and family in the financial lurch, they won't shake down your spouse, kids or elderly parents for the rest of what you owe them. On the other hand, you never know. The more money you borrow, the more of these questions you should ask.

9. Be Realistic • Baskfield urges realism on payment terms and warns, "Don't make false promises." Because they're your friends and family, you may feel the urge to dazzle them with suggestions that they're all going to become rich, fast. But starting a business can be extremely challenging, and this is a tough economy. • When you're borrowing from friends and family, if you can, under-promise and over-deliver. But above all, when structuring your repayments, pad in some extra time for unexpected problems -- like having your own clients or vendors dragging their feet in paying you back.

10. Financing Through Banks • Every business needs a certain amount of money to start. The entrepreneur on the threshold of starting a new venture, has to work out where and how he will get access to sufficient funds. • The first organization that he thinks of is his bank. Yes banks are almost always one of the first organizations to be approached for funds in the form of a loan. It is here that harsh realities hit the entrepreneur who soon learns how difficult it is to get a bank loan to finance his small business venture. A select fortunate few, do manage to fulfill all the pre-requisites for a bank loan, and are successful in procuring them. But for every successful loan application there are many that get rejected. The tough regulations linked to bank loans are gradually undergoing a change with banks realizing the phenomenal potential of small businesses. This explains the special programs and additional services launched by big banks to woo small businesses. • Bank loans are just one of the various options available for small businesses to raise funds. The final decision about where to secure funds depends on the balance between the pros and cons of the source. Like all other funding sources, bank loans also come with their share of advantages and disadvantages.

11. Advantages and Disadvantages of Small Business Loans from Banks Advantages Disadvantages Lengthy application process- banks need to verify all the credentials and details about the business before sanctioning a loan. Therefore its application process is very long and its review etc. takes a long time. Cumbersome- The prospect of getting into the detailing that banks require is really cumbersome, and from the entrepreneur’s point of view, totally unnecessary. Preference given to existing, running businesses- banks prefer running businesses because they can gauge its profitability and credit history before sanctioning the loan. Long list of prerequisites to qualify for the loan- banks have long list of conditions that a business should fulfill before they clear the loan. It is sometimes not possible to meet all of them. Risk of losing Collateral- bank loans are generally sanctioned against some collateral, often the entrepreneur’s house and property. This stands the risk of being lost to the bank should the business fail to take off. Entire amount not granted- banks are known to not agree to grant the whole amount requested for a loan. They may grant 70 or 80 % of the sum applied for. This makes it difficult for the entrepreneur to begin since he has to scout around for the remaining balance and find agencies to funs that before he can start. • Convenient and accessible- Banks are always accessible since they are used regularly for depositing savings or withdrawing them. After being bank customers for years, the bank becomes convenient and familiar, and personalized service makes it the first place to consider for a loan. • Multiple Loan options- All banks advertise various types of schemes to woo entrepreneurs setting up or running a business. The real earnings for a bank come from the interest they charge on these loans. Options like term loans, standard business loans and others are available for the entrepreneur. • Non profit sharing- Venture capitalists and angel investors agree to provide a loan in exchange for part ownership, the right to influence decision making and a share of the profits. Banks do not ask for any of these. If they do sanction a loan, they are only interested in getting their interest and partial loan payment installments. • Lower rates of interest-Though tough to get, banks provide loans at lower rates of interest than other lending agencies and instruments like credit cards. • Bank loans offer tax benefits- Small businesses taking loans from banks enjoy some relief from tax, since the percentage of profits used to repay the loan is exempted from tax.

12. Financing Through Finance Companies • A Finance Company is a company which makes loans to individuals and/or businesses. • It is usually easier to obtain a business loan from a finance company than a bank, however, the interest rates on a business loan through a finance company is more.

13. Finance Through Investment Companies • An Investment Company is a corporation or trust engaged in the business of investing the pooled capital of investors in  financial securities.  • This is most often done either through a closed-end fund or an open-end fund (also referred to as a mutual fund). • In the U.S., most investment companies are registered with and regulated by the Securities & Exchange Commission under the Investment Company Act of 1940. • Also known as "fund company" or "fund sponsor". • Investment companies are business entities, both privately and publicly owned, that manage, sell, and market funds to the public. • They typically offer investors a variety of funds and investment services, which include portfolio management, recordkeeping, custodial, legal, accounting and tax management services.

14. Equity Financing Angel Venture Capitalist Individual investors or investment firms that invest venture capital professionally • A private, nonprofessional investor, such as a friend, a relative, or a business associate, who funds start-up companies

15. Angel Investors vs. Venture Capital Angel Investors Venture Capital Typically general partners investing 3rd party money Do not typically provide early stage investment Diversified portfolio expecting a large home run on approximately 1 out of 10 Need to generate a specific return on investment (usually around 25-30% internal rate of return annually across the entire portfolio) Will remain active in the management of the business Typically will require a board seat and may seek majority control Investment size typically ranges between $1,500,000 to $10,000,000 Some venture firms are set up to invest in early stage companies and make investments more similar in scope to those of an angel or angel group • Individual, accredited investors • Typically have industry expertise in the area they are investing • Provide early-stage investment • Typically invest $25,000 to $1,500,000 • May invest individually or with groups of other angels • Offer guidance and advice to management team

16. WhichisBetter? Friends Family • Now after viewing the “Obtaining Finance For Your Business” presentation, which source of finance do you think is best for a business? • Which is better for your business? Angel Investor Bank Investment Company Finance Company Government Grants Venture Capitalist

17. Obtaining Finance For Your Business Quiz • Go to Quia to take your quiz: • http://www.quia.com/quiz/3900799.html

18. References • Angel Investors vs. Venture Capital. (2008). Ladies Who Launch. Retrieved October 28, 2012, from http://www.ladieswholaunch.com/magazine/angel-investors-vs-venture-capital/1385 • Finance Company. (2012). Investor Words. Retrieved October 28, 2012, from http://www.investorwords.com/1942/finance_company.html • Investment Company. (2010). Investopedia. Retrieved October 28, 2012, from http://www.investopedia.com/terms/i/investmentcompany.asp#axzz2AbhfQf5E • Williams, G. (2010). Borrowing from Friends and Family. Retrieved October 28, 2012, from http://smallbusiness.aol.com/2010/07/19/how-to-borrow-money-from-friends-and-family/