There are many reasons why a business may require an injection of funds. Before you seek finance it is crucial that you establish whether you truly need external finance, how much you need and the most suitable source of funding for your needs.
When to seek funding
Only seek outside funding when:
You have a clearly defined goal
Note the difference (from a prospective investor’s viewpoint) between: “We need $100,000 to expand” and “We need $100,000 to take our current 10,000 users to 50,000 active users inside 12 months. We will use the investment to hire a part-time marketing manager and to fund new marketing campaigns.”
The former is too vague; the latter has clearly defined outcomes.
You have a sound business plan
Those who lend capital to businesses will want to see more than an exciting, but broad-brush, business idea. They will expect a detailed, coherent summary of your business planning that clarifies how you will generate enough cash to repay them, with interest, or give them a strong return on their investment.
You can demonstrate a strategic focus
A thorough approach to business planning should show much more than the immediate or short-term impact of a loan. Potential investors will expect your enterprise to have a future – thriving at least until the loan is scheduled to be paid in full. Therefore you should project growth over one, three and five years.
Your financial projections are supported by credible reasons
Don’t overlook the level of detail required to prove the viability of your project. Support your projections about future revenues and costs with credible explanations.
For example, you might explain that “marketing emails generate 25% of sales leads and the appointment of a marketing manager – through the injection of capital – will boost email output substantially.”
You can budget for a clear and manageable payoff schedule
You must, of course, be clear how you can and will fulfil your repayments. If your projections leave a safety margin then investors will be reassured; e.g., even if sales fall 50% short of your projections, you’ll still be generating enough profit to afford repayments.
The following are some of the most common funding sources:
Traditional financial institutions
Banks are of course the most common source of business loans.
Formal applications should be supported by a comprehensive yet focused business plan – supported by profit and loss figures and credibly supported projections.
A strong credit score is a plus; an adequate credit score usually essential.
Following the credit crunch in 2007-8, securing bank loans became incredibly difficult for any enterprises perceived as risky. Although things have eased, banks remain fairly risk-averse – so make your application as detailed, focused and convincing as possible.
Government loans and grants
Federal and state government helps to bridge the gap between what banks are willing to lend and what businesses need – especially for social enterprises, those with strong environmental credentials, businesses set up by people from disadvantaged groups or those in a sector with profound benefits to the economy as a whole.
Because the government is not out to make a profit, interest rates on such loans are generally lower than those offered by for-profit lenders and the lending criteria less stringent.
Government loans are typically offered through banks and credit unions that partner with the Small Business Administration (SBA).
Merchant cash loans
Any business with a healthy volume of card transactions can access this alternative form of lending without a detailed review of their business finances. With a merchant cash loan you receive a cash advance that is then repaid via a percentage of your future debit/credit card sales.
This is a fast and flexible form of business credit.
This is another method using ‘accounts receivable’ – i.e., money owed to your business – this time evidenced by invoices, which are bulk-sold to a third party in return for cash. The total invoice value is agreed and the lender pays the borrower this amount in advance of receiving the funds, less a discount to cover collection expenses and a profit margin.
In essence, the two preceding methods are loans secured against non-physical assets. Asset-based loans are guaranteed by physical assets: inventory, equipment, real estate and so on.
Interest rates tend to be lower than those charged on conventional unsecured loans because assets can be readily accessed if a borrower should default (unlike, say, invoices, which may not be paid).
Crowdfunding inverses the traditional, one-lender approach. Businesses seeking funds can reach out to thousands of regular citizens via online platforms such as Crowdfunder, Kickstarter and Indiegogo.
The return on investment is more imaginative than simply cash rewards; investors might get discounts or free products in return for small donations of only a few or tens of dollars.
Usually arranged online via an intermediary company, peer-to-peer crowd-lending loans offer lower interest rates than traditional lenders. This model matches qualifying borrowers with suitable lenders – invariably just regular Joes on modest incomes – who usually prefer to limit their lending risk by spreading their investment among several borrowers.
Author: Melanie Luff, staff writer for BusinessesForSale.com, the market-leading directory of business opportunities from Dynamis. Melanie writes for all titles in the Dynamis Stable including PropertySales.com and FranchiseSales.com.