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Want to Access Capital For Your Business? Don’t Forget to Do Your Homework!
By Lathea V. Morris, ACE
First, you need to determine what kind of financing is right for you. We get a lot of calls from small business owners who want to know if we can help them get capital. The first question we ask is, are you looking for debt or equity financing, i.e., a bank loan or angel or venture capital? Many small business owners are not clear on what the differences are between debt and equity financing.
Only consider angel or venture capital if you are not averse to giving up a percentage of ownership of your business. This is called equity financing. Debt financing typically involves a loan from a bank that you pay back, usually in monthly installments over a period of time. Some small business owners are either debt averse or do not want to take on additional debt. So, you must decide whether you are prepared to give up anywhere from 1% to 51% equity in your company or would prefer to incur the necessary debt.
If you decide your business is a candidate and you are ready to give up some equity, you may want to consider angel or venture financing. A key to success in obtaining equity capital is gaining access to the right network of business advisors. A study sponsored by Wells Fargo, Women Entrepreneurs in the Equity Capital Markets: The New Frontier revealed two-thirds of proposals that get serious consideration come from those referral networks. The study also revealed other keys to success:
·Giving up day-to-day control of the business.
·Having a strong management team.
·Having a clear business concept and a realistic marketing plan.
·Having patience and persistence - those who have received financing contacted an average of 15 or more investors.
Do your homework on potential investors or venture funds before you approach them. Find out about their rules, including the type of businesses they consider for financing. Some investors only consider start-ups, early stage or later stage investing opportunities. Others may offer a combination of debt & equity financing to profitable businesses that have been in existence for a specific time period. Knowing the annual growth rate of your company is important. Some investors will only consider companies who are experiencing double digit growth rates. Some of the typical rules of venture capitalist include:
·They expect to be in a business from three to five years.
·They expect a return of at least 25% annually on their investment.
·They expect the business to have an exit strategy. For example, will the company be acquired or go to an initial public offering (IPO)? Research has shown that very few companies go public.
SBA venture capital firms known as Small Business Investment Companies (SBICs) will consider investing from $100,000 - $5,000,000 in a business. There are several women owned SBICs that focus on investing in women-owned businesses. Two of these firms are Capital Across America based in Nashville, TN and Viridian Capital based in San Francisco, CA.
Do you know that your alma mater may be a source of venture capital? A growing number of universities are creating venture funds that are available to former students. Many of these funds favor companies that are technology based.
Do you know anyone who has ever been touched by an angel? Angels wear different wings. It is important that you do the same due diligence with potential angel investors that you would do for a venture capitalist. Many of the same rules apply to angel investors as with venture funds. Some angel investors have invested as little as $50,000 in early stage companies. Check out www.angelinvestorfunding.com to determine if angel investing is right for you.
Before you attempt debt financing for your business, i.e., apply for a commercial loan, you must review the relationship you have had with your credit and debt over the past years. This is a key area lenders will examine. To get this process started, first, order your D&B business credit profile, if applicable, and all three copies of your personal credit reports from the major credit bureaus. The three credit bureaus are: Equifax - 1-800-685-1111; Experian (formerly TRW) - 1-888-397-3742; Transunion - 1-800-916-8800.
Some lenders have developed special loan programs that offer loans in amounts up to $100,000 that may only require completing a one-page application. However, you must have a good credit rating. Since many lenders require you to personally guarantee a loan, they will check your personal credit report to determine how you have managed your credit in the past. Most banks use a small business credit-scoring model, which assigns each applicant a numerical score indicating an applicant’s creditworthiness. Banks use these models because it enables them to make small business loans economically and the decision making time is much shorter. Under many models, the score an applicant receives is based less on their ability to repay the loan and more on the probability that they will not repay it.
Second, complete an analysis of your business and personal credit profile:
·How much credit and outstanding debt do you have? When you take on additional debt, the lender wants to ensure that you will be able to pay back the loan.
·Check for inaccurate information. Correct mistakes in your credit report, uncorrected erroneous information may decrease your credit score.
·Check for closed accounts that show open. Lenders will factor in a percentage of the available credit limit as a part of your debt ratio.
·Check for duplicate information.
Other data that can reduce your credit score include:
·High number of credit inquiries - Each time you apply for financing it will show as an inquiry on your credit report. If a lender sees you have applied for financing at several institutions, this may be reason for concern. This could be a sign that you have too many credit applications that could turn into additional debt.
·Lengthy payments on credit accounts to vendors - If you stretch out payments to your vendors to 90 days, your payment history can negatively affect your chances of a loan approval.
·High number of NSF bank notices – if you continually write checks that are returned for insufficient funds, it will reduce your credit score.
·Lawsuits & judgments – these will almost automatically get your application stamped denied!
Credit scoring not only helps determine whether you’ll be approved or denied financing but also the interest rate you will pay and the overall terms of the financing deal.
A word of caution – the American economy is in a downturn. Most lenders tighten their lending policy in a downturn. In a downturn, some regions of the country may be hit harder than others. You need to be aware of the economic climate in your region because this will effect a lender’s decision on whether or not to lend you money. Typically, during these times, only those business owners with very good credit get the stamp of approval for a loan. If you do get approved with less than good credit, you will probably pay a very high interest rate to borrow the bank’s money.
Third, complete a list of questions to ask the bank representative:
·What are their qualifying criteria?
·How can the financing be used?
·Is the interest rate variable or fixed? If variable is it tied to the prime?
·Do you use debt-to-equity ratio formulas to screen applicants? If so, what is the ratio formula?
·What are the repayment terms? Balloon payments? Pre-payment penalties?
·Are there any fees? If so, what are they & how much?
·What happens if I am late making a payment?
Get the answers to these questions before you complete a loan application. Make sure you know your needs before you approach a bank officer. If you do not know the ground rules, you may be persuaded to accept a loan amount and/or terms that may be in the best interest of the bank, not yours.
Once you decide on the right type of financing for your business, be prepared for the investors or lenders test. Don’t forget to do your homework!
Lathea V. Morris is Co-Founder & COO of The Credit Alternative at 973-509-1903. Their web site is www.TheCreditAlternative.com
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