Financing Your Start-Up Businesses

By Susan G. Massey, CPA, Certified SCORE Mentor

 

Are you ready to start your own business, or buy an existing business or franchise operation?  For most prospective business owners, one of the first questions is “Where will I get the money?”  There are many possible financing resources to consider. 

 

The first step is to develop financial projections to help you assess how much capital your business will need.  At a minimum, you should prepare a detailed 12-month spreadsheet showing your start-up costs, projected revenues and projected expenses.  This spreadsheet should have notes that explain all of your assumptions, so you can update them as needed.  The same spreadsheet can be used to determine how much cash you will need and when it will be needed.

 

The next step is to compare your business’s cash needs with your own cash resources.  Self-financing options give you the ultimate amount of control and flexibility, so this is a great route if you are able to finance your business using savings, home equity, or existing personal lines of credit.  Before you do this, though, be sure to map out a realistic plan to meet your existing obligations and living expenses, and consider the effect of “worst-case” scenarios, such as several months of unexpected losses incurred in the business or the loss of spouse’s job.

 

A second possible source of start-up capital is loans from friends and family members.  These arrangements should be approached with extreme care, as this type of loan carries a risk of damaging the personal relationship if the arrangement isn’t well structured.  When borrowing from friends or family, it’s extremely important that everyone be clear on the loan terms and the risks involved.  Approximately half of new small business ventures fail within the first few years, so the risk of failure should be discussed and addressed in the course of structuring the loan.  Will you repay the loan in full even if the business fails, or is the lender sharing the risks with you?  All appropriate terms and agreements should be clearly spelled out in a written document.  You can find sample loan documents for a simple loan using a quick web search, or using a business forms book from your local library.

 

Banks are a possible source for financing the purchase of “hard” assets such as business equipment and inventory.  According to David Imig, VP and Small Business Relationship Manager for U.S. Bank in Central Oregon, “(Banks) have many loan options available to finance purchases of business equipment, provided the borrower has a strong credit rating and a solid business plan that shows the ability to repay the loan.”  Bank loans include loans that are guaranteed by the Small Business Administration (SBA).  Imig indicated that SBA-guaranteed loans may carry higher fees, but they allow the borrower to make a smaller downpayment of 10%, rather than the usual 25%-30%.  In addition to a strong credit score (700 or higher) and collateral for the loan, be prepared to show the bank a solid business plan projecting “free cash flow” in the first year that is 1.3X the amount of the year’s debt service (that is, principal plus interest).

 

For Central Oregon start-ups that will be primarily selling their product or service outside of the region, another possible source of help seeking financing is Economic Development for Central Oregon (EDCO).  “EDCO administers forgivable loan programs for businesses that will create a minimum of five permanent jobs in either the City of Bend or Deschutes County,” said Nate LiaBraaten, EDCO’s Business Development Manager.  EDCO may also be able to provide other forms of assistance to the types of businesses it targets.

 

What if you need start-up funding for “intangibles” (such as franchise fees, start-up costs, etc.) that is more than you can raise from your own savings or from friends or family?  One potential source of such early stage financing is “angel investors.”  These are individuals or groups of individual investors who may lend to a small business or seek to acquire an ownership interest in the new venture.  Since the angel investor seeks to earn a profit on his or her investment, this type of financing is most appropriate for a business that has the potential to grow rapidly and produce significant profits. 

 

According to Bruce Michalski, Chapter President for SCORE of Central Oregon, angel investors are “often willing to invest where there is too much risk for a bank and not enough profit for a venture capitalist.”  Michalski added that angel investors usually have business experience and they may make an excellent mentor. However, they may want to play some sort of active role in managing the company. It is extremely important for any business person thinking of accepting investment from an angel investor to be very careful to spell out all of the terms of the arrangement, including any non-financial agreements.

 

In Bend, the angel investing community conducts the annual Bend Venture Conference, an event in which entrepreneurs compete for the opportunity to present their business plans to angel investors and venture capitalists attending the event.  Other appropriate networking opportunities include meetings of Inventors Northwest, local chamber of commerce events, and Pubtalk, a monthly networking event sponsored by EDCO.

 

Choosing a financing strategy for your start-up business can be complex and confusing.  As you consider your options, carefully consider the benefits and risks of each type of funding.  If you need help evaluating your options, you might consider seeking free business counseling services from the Central Oregon chapter of SCORE, a national nonprofit association dedicated to helping entrepreneurs start, grow, and succeed.  SCORE is America’s confidential source of free small business mentoring and coaching, with more than 12,000 business experts who volunteer as mentors. Sign up for a free consultation at www.SCORECentralOregon.org. SCORE also offers short individual walk-in chats at the Bend Library every Tuesday 5:30 – 7:30 pm.