Financing a New Business

Start slowly and develop the business one step at a time rather than borrowing money to start a home business. If possible, market your business from what you earn from it. Sell 100 units of your product and then buy 200 more. Sell the 200 and buy 400. Go slowly.

Begin small. Keep your “day job” and live on the earnings of your current employment. Use the proceeds from your business to build growth. It is a good idea not to leave your day job until you have a year’s gross pay from your salaried job in the bank.

Some entrepreneurs believe that you need twenty, thirty or even fifty thousand dollars to start a business. I don’t agree and my company’s success proves it. I will say that the start-up cost greatly depends on the type of product you have. For example, if your product requires a plastic mold, you will need funds to create one.

Pay these vendors as you go. Do not let debt mount in the early stages of your business.

Later in your company’s development, I have found that the best financing deals come to you. After you reach patent pending status or sell your first item, create and send out a press release. See the chapter on marketing and the resources in the back of this book to learn how to create outstanding press releases that get published for free.

Local banks and lending sources always read the local papers. You will probably be contacted after your press release because a story about a local person creating a new product always creates interest. When banks or lending sources ask you for an appointment, remember: be very careful with debt.

Borrowing should be done with extreme caution. Debt can be very hard to overcome and can sink your home business before it can get off the ground.

Use your time and effort, instead of money, when starting a home business. Do as much as you can yourself. By doing this, you will know every part of the process of your business and will make the most of the resources you have. Be careful buying office furniture and supplies. Check local flea markets, garage sales or yard sales for your needs. They only need to be functional. Don’t get carried away with appearance, and remind yourself that every dollar saved should go into the business to finance growth.

Consider bartering or trading some of your products or services for items or services you require. This can be very effective if a company you need services from can use your product as an incentive or premium.

There are some essentials you must have to run a business in today’s market place. If you do not have a working knowledge of computers or an understanding of the resources of the Internet, you will need to learn them as soon as possible. You will need this knowledge even before you have a prototype of your product made. Check your nearest community college or ask your small business development center for information where you can attend classes.

Play up your strengths and play down your weaknesses. Many people like doing business with small businesses. Focus on the strength that you can give special attention to your customer’s needs. You can make fast decisions without checking with a boss, colleagues, or directors.

I cannot stress the debt issue enough. There are several books out by very wealthy individuals who state that there is good debt and bad debt.

They claim good debt is debt they need to start a business or buy rental property and is repaid by customers or renters. I agree that debt has a place in a business after it reaches a certain level but not for a home-based start-up company. Later, for example, you may want to have a credit line to help with trends that require capital one time of year, but when you collect your receivables later in the year, you must pay the credit line balance off.

If you land a large sale before you are ready, don’t worry. You can always do factoring. Factoring is the process whereby a company sells its accounts receivable to a factoring company at a discount and receives cash. If you have a substantial order from a large company, it is an easy process.

Companies that do factoring advertise in small business magazines. Your local bank can refer you to a company to help with your factoring needs. Another strategy is to offer your customer a discount for prepayment or charge a deposit to pay your cost.

Even though I strongly am in favor of self-financing your business, every product and service is different and you should be aware of some other ways to finance a business.

The best way to find the groups or institutions in the following sections is to contact your local small business association. To find your nearest local offices go to: http://www.sba.gov/localresources/index.html.
Angel Investors
Angel investors are investors, or a small group of investors, that look for high-growth companies in a particular industry. They look for an industry that they have experienced huge success with in the past, or are now experiencing great success with.

These investors look for companies that offer products or services that the other companies they have an interest in can benefit from.

For example, if you invented a product that every hospital in the US would readily purchase and benefit from, and an angel investor controls 5,000 hospitals, the angel investor would be extremely interested in your company. The angel may own a stake in a large medical product distributing company. So, by investing in your company the angel’s hospitals, distribution company and his stake in your company all will, more than likely, grow as they all do business together.

Angel investors do not give you “free money” and their involvement can be expensive. The angel investor will more than likely require 10 to 50 percent equity or ownership of your company.

Many times, they also charge a management fee or retainer. Sometimes they require the placement of a board member on your board of directors if you have a corporation. They may require a new general manager for your business. This secures their investment but you lose some control of your business.

Angels usually invest between $300,000 and $5 million per company. A list of Angels or Angel Investor Groups can be obtained from your local small business association.
Finance a Company from Your Retirement or 401-k Account.
A 401(k) is a tax-deferred savings and retirement fund set up by employers. This account can be used for start-up capital. In many cases, there are substantial penalties for early withdrawal. Some plans allow for loans based on your 401(k) balance. In effect, you are borrowing your own money from your fund. Your plan administrator can advise you as to the term length and interest rate you will pay.
Borrow on the Equity of Your Home.
It is easy to borrow on the equity of your home, as you can control the amount needed and the repayment terms. Shop around for the best deal. This is widely done to get capital to start a business.

You will have monthly payments and this will put pressure on your new business to obtain a certain sales volume to pay the payments.

Depending on current mortgage rates you may be able to refinance at a lower rate than your first mortgage and take some funds out and keep your payments low.
Borrow Against Insurance Policies
Each month, you may pay for several kinds of insurance policies. You can only borrow against whole life insurance, but many policies have some cash value after a few years.

All you need to do is contact your insurance agent. Tell him you are interested in taking out a policy loan. Many companies will lend up to 90% of the cash value of the policy.

As long as you continue to pay the premiums, your insurance coverage continues. Keep in mind that if you die with a policy loan outstanding, the benefits might be reduced. One advantage of this kind of financing is a low interest rate. This is because most of the interest rate is tied to the money-market rate.
Credit Cards
Credit cards are easy credit. Using a credit card is a great way to buy some inventory or to get a prototype made. Certainly care should be used to make sure balances don’t climb.

I started my company CLIPEZE by buying 200 units with a credit card. I sold them and paid my balance and bought 400 units, etc.

If you can find a credit card with a good rewards program, it can help later when you need to do some traveling to market your products or services.
Family and Friends
Sometimes you know someone or have a family member who has an interest in seeing you succeed and has the ability to lend you funds. Many times it is a person who has had or has a business and wants to help you be successful as well. They believe in you and/or your product.

I recommend that if you borrow from friends or family, you create a written contract. You want to make sure that both parties understand the terms of the loan. You don’t want a loan that is going to be repaid and terminated to be misunderstood as a partnership or as equity in your company.
Bank Term and SBA Loans
It is my experience that a bank term and an SBA loan are, in fact, one and the same. Most banks only give term loans to companies already in business that have shown financial strength. Your company’s financial strength requirement varies from bank to bank for these loans. These term loans usually carry a fixed rate of interest.

The federal government, which has abundant funds and programs, backs the SBA loans but most of the same banks that issue their own term loans are also SBA lenders.

Your company does not apply directly to the SBA for SBA loans. You apply to the bank and the bank obtains the SBA loan. The banks use the same standards for SBA as their own term loans. The only thing they do is approve some SBA loans backed by the government to earn processing fees and stay in government programs so they can advertise as full-service business lenders.

The government funds that have been earmarked for new or start-up companies rarely get to them. The funds only reach companies that can otherwise qualify for regular term business loans.

According to the N.F.I.B (National Federation of Independent Businesses) less than 1 % of small businesses receive SBA loans.

Private Guarantee Loans
A private guarantee load is when an angel investor or wealthy individual guarantees a loan from a bank or other institution. These guarantee loans are unusual, but sometimes they are used for a year or two until the new company has enough revenue to raise capital to repay the loan.
Royalty-based Loans
A royalty-based loan is an advance of funds to be paid back by a percentage of future sales or revenue. Most of the time this is done with established companies or companies that are about to launch a new high-margin product into the market place. Usually royalty financing appeals to investors who do not make a lot of investments into private companies.

Several colleges and universities have made royalty deals with new products that they help invent or produce.

I would encourage you to keep this type of financing in mind if you utilize a college or university in the development of your prototype as suggested earlier in this book. One advantage to this type of financing is that most of the time it is considered a loan and does not come under state and federal securities laws.