• Small Business Finance – Finding the Right Mix of Debt and Equity

    Category: Business Financing


    Financing a small business can be most time consuming activity for a business owner. It can be the most important part of growing a business, but one must be careful not to allow it to consume the business. Finance is the relationship between cash, risk and value. Manage each well and you will have healthy finance mix for your business.

    Develop a business plan and loan package that has a well developed strategic plan, which in turn relates to realistic and believable financials. Before you can finance a business, a project, an expansion or an acquisition, you must develop precisely what your finance needs are.

    Finance your business from a position of strength. As a business owner you show your confidence in the business by investing up to ten percent of your finance needs from your own coffers. The remaining twenty to thirty percent of your cash needs can come from private investors or venture capital. Remember, sweat equity is expected, but it is not a replacement for cash.

    Depending on the valuation of your business and the risk involved, the private equity component will want on average a thirty to forty percent equity stake in your company for three to five years. Giving up this equity position in your company, yet maintaining clear majority ownership, will give you leverage in the remaining sixty percent of your finance needs.

    The remaining finance can come in the form of long term debt, short term working capital, equipment finance and inventory finance. By having a strong cash position in your company, a variety of lenders will be available to you. It is advisable to hire an experienced commercial loan broker to do the finance “shopping” for you and present you with a variety of options. It is important at this juncture that you obtain finance that fits your business needs and structures, instead of trying to force your structure into a financial instrument not ideally suited for your operations.

    Having a strong cash position in your company, the additional debt financing will not put an undue strain on your cash flow. Sixty percent debt is a healthy. Debt finance can come in the form of unsecured finance, such as short-term debt, line of credit financing and long term debt. Unsecured debt is typically called cash flow finance and requires credit worthiness. Debt finance can also come in the form of secured or asset based finance, which can include accounts receivable, inventory, equipment, real estate, personal assets, letter of credit, and government guaranteed finance. A customized mix of unsecured and secured debt, designed specifically around your company’s financial needs, is the advantage of having a strong cash position.

    The cash flow statement is an important financial in tracking the effects of certain types of finance. It is critical to have a firm handle on your monthly cash flow, along with the control and planning structure of a financial budget, to successfully plan and monitor your company’s finance.

    Your finance plan is a result and part of your strategic planning process. You need to be careful in matching your cash needs with your cash goals. Using short term capital for long term growth and vice versa is a no-no. Violating the matching rule can bring about high risk levels in the interest rate, re-finance possibilities and operational independence. Some deviation from this age old rule is permissible. For instance, if you have a long term need for working capital, then a permanent capital need may be warranted. Another good finance strategy is having contingency capital on hand for freeing up your working capital needs and providing maximum flexibility. For example, you can use a line of credit to get into an opportunity that quickly arises and then arrange for cheaper, better suited, long term finance subsequently, planning all of this upfront with a lender.

    Unfortunately finance is not typically addressed until a company is in crisis. Plan ahead with an effective business plan and loan package. Equity finance does not stress cash flow as debt can and gives lenders confidence to do business with your company. Good financial structuring reduces the costs of capital and the finance risks. Consider using a business consultant, finance professional or loan broker to help you with your finance plan.

    Frank Goley works for ABC Business Consulting as a business success consultant. He has extensive experience in business finance and has over twenty years experience as an expert business planner.

    Small Business Finance FAQ:

    Question: How do I get money to finance my small business with bad credit?
    My credit is bad from my younger years and I have been working like hell to repair it. No matter how many bills I pay off of my credit report rating stays low. How do I get a small business loan or financing in this situation?

    Answer: Get a partner. You will have to repair you credit first and to do that you should buy a book or two on it. There are lots of good ideas out there on how to do it.

    Question: What are creative ways to finance a small business?
    Other than venture capitalists and banks, (and cash of course), what are some creative ways to finance a small business?

    Answer: Become public and get people to invest.

    Question: Can you use a credit card to finance your small business?

    Answer: In theory yes you can, however it might not be the most cost effective way to do it. To one degree or another, almost ALL businesses do it.

    Question: Is there any free online accounting program for small businesses (not personal finance)?
    I have a small home-based business and do not have money to spend on expensive software or monthly subscriptions. I would prefer to use something online that doesn’t require me to download anything so I can access it from any computer and my phone. Are there any truly free programs like this?

    Answer: Probably not. If it is a small home-based business, then just use microsoft excel or word. I’ve used excel and word for my accounting homework and it wasn’t really hard to use. And if you can’t afford excel, then go to open office and download their free version of excel. If you want something online try using Google Docs. This way you can access your information from any computer that has internet access.

    Question: How do I get a small business loan if I don’t have good credit?
    I would like to open a small tax prep company and a finance company. So how do I get a loan if I don’t have good credit?

    Answer: For small business you have to personally secure any loans, so they are made on your personal credit rating. If your credit is bad, then you will not be able to get a small business loan. Work on improving your credit position so lenders will see you can be responsible with financial obligations.

    Question: What software should I get for my small business?
    I plan on purchasing Quickbooks for my accounting purposes, since I’ve learned that this is the #1 accounting software for small businesses in the USA. But what other software would you recommend? I see a number of businesses use Quicken, but is it necessary? Does it help with organizing finances? If I had Quickbooks, would Quicken just be an added benefit?

    Answer: Quicken is a personal accounting system by microsoft. It is for individuals budgeting & managing their own financials. It is not a “business” tool.

    Quickbooks is a professional business tool and can be used for small to medium sized business. Most of it will be overkill but for the $300 it costs every 3-5 years, I say it is worth it. There are other similar packages available like PeachTree. They are all more or less the same. Quickbooks is good because as you say, it the most popular, and it’s easier to find people who know it to help you.

    Question: How much it costs to start a brick manufacturing business?
    I am considering my options to start a small scale business in Tripura, NE India. Can you please provide me with the details/refer me to a place to find out all the details about brick manufacturing, starting with the kind of finance I need?

    Answer: It is very expensive because you will need the machines. Probably 7 to 10 lakhs on a small scale to start with.

    Question: What are the chances of opening a subway store?
    I just purchased a house at 100% ltv (all finance), so the property does not have equity. However I want to get a small business loan (200k loan) putting the property as collateral = money for opening the store. My income is around $1,400 a month, 23 yr old guy. So do you think the bank will loan the money?

    Answer: NO. Not a chance.

    1. You can’t put something as collateral when you don’t have any equity in it. And even if you owned it outright, doesn’t sound like it’s worth $200K.

    2. How do you plan to pay back a $200K loan?

    3. $200K would not likely be enough anyway to open a Subway store.

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