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Joy
of Owning a Business
What kind of Business |
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Feasibility
Study Workbook
Collecting the Info
Making the decision
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Marketing Plan
Operating Plan
Organization Plan
Finance Plan
Present it |
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Market
Advertise
Follow up |
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Manage
your Time
Manage your Money
Manage your Customers
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Capital
Alternatives
Loans
WHAT
TYPE OF CAPITAL DOES YOUR BUSINESS NEED?
What
Does Your Business Need? - Equity, Debt or Alternative
Financing. Too often business owners look for
financing in the wrong place. They think that
since they are a start-up business they need "venture
capital" or a Small Business Administration (SBA)
term loan will help when they face a crunch for
working capital. The following paragraphs will
provide some guidance to helping you identify
the type of financing you need for your business.
EQUITY
When
an individual or an institution "invests" in your
company, they are making a capital contribution
to your business. In return, they own and have
control over some portion of the business and
will get repaid through profit sharing or when
the company is sold.
The
business has to have the following characteristics
in order to be attractive to investors:
High
profit margins to provide attractive profit-sharing
income (dividends) to the investors.
Product
or service must have significant market appeal
and show the potential for rapid future expansion.
Potential
for a significant return on investment through
an "exit strategy" such as "going public" or acquisition
by a larger corporation.
Size
of Equity Investment and potential Sources:
Under $500,000: go
to private investors such as Ace-Net.
$500,000 and up: Small
Business Investment Corporations
$1 million and
up: Venture Capital
Funding
Process:
lengthy and expensive
Attracting
Private Investors
Most
equity injections are provided through private
investors. This so-called angel market is estimated
to be 5 to 10 times greater than the institutional
venture capital pool. The angel market is most
often in search of investments in the $50,000
- $500,000 range. The difficult task is finding
these investors because this market is highly
fragmented and disorganized and has often been
part of the "old boy's network."
Where
to look for investors?
Start
with business acquaintances that understand and
know your business acumen.
Look
for people in a similar business who could provide
needed expertise and can see the potential of
your business.
Talk
to your banker. (e.g. a recent client wanted to
open a restaurant. When she talked to her local
banker about financing he immediately referred
her to several people in the community who would
be interested in investing in a local restaurant.)
MIT
Forum: started at MIT and the format has now been
take around the world.
What
are private investors looking for?
Better
returns than they could get on a portfolio of
blue chip stocks but less than professional venture
capitalists look for.
In
addition to financial gain, they also look for
"psychic income." Based on their background, many
investors want to contribute their expertise as
well.
Investors
are looking for good management and industry potential.
What
deal do I offer them?
When
most people are faced with asking friends and
family and other private investors for capital,
they have very little knowledge on how to approach
the deal to make it favorable for both the entrepreneur
and the investor. With investor financing as opposed
to conventional financing, you can be creative
and flexible for the needs of the business.
For
example: You could structure an agreement that
has both debt and equity elements. Offer to repay
the principal of the investment like a loan over
a certain period of time. Because the investor
has offered to risk his/her capital on your business,
it is often required that you provide a "kicker"
as well. This "kicker" could be a percentage of
profits for several years. In the first year or
so there may be no profits and therefore no "kicker".
However in the ensuing years the investor may
reap extra income as your business becomes profitable.
Many people want to structure an agreement with
an investor so that there is a timely exit for
that investor. Many people do not want an investor
involved in their business forever, but want to
ensure they are paid off and out of the business
in a reasonable period of time. Likewise investors
want to know when they can reap their investment.
Be
sure and consult with an attorney and get her
to help you make all the necessary disclosures,
etc. -- even though you are working with a private
offering it requires careful analysis and legal
agreements. Here's some suggestions for communicating
with potential investors:
Have
a carefully designed business plan with a two
or three page investor prospectus.
Investor
prospectus should include:
how
return on investment will be calculated and
distributed
guarantees
(if any) to reduce risk
exit
requirements for the investor
length
of time for the terms of the prospectus
DEBT
Debt
financing is when you borrow money from a bank
or alternative financial institution. The lender
expects to get paid back over a specified period.
In order to make sure that the lender will be
paid back, the lender determines if there is enough
cash flow to repay the debt and asks for a lien
on additional assets that can be sold to repay
the debt if a borrower defaults. A business is
considered to be attractive to lenders if it displays
the following characteristics:
Borrower
has good personal and business credit history
that indicates good "character".
Business
financial history indicates there is enough cash
flow to repay the loan or,
There
is substantial information provided which shows
the potential for the business to generate enough
profit to repay the loan.
The
business is not carrying significant debt already
(debt/net worth should not be more than 4:1).
The
business and borrower have sufficient collateral
to offer as a second source of repayment.
Types:
Term loans: Usually for start-up, expansion,
purchasing of fixed assets, real estate and other
one-time costs that have to amortized over time.
Working capital can often be included in a term
loan.
Line
of Credit: Usually to cover variable/seasonal or working
capital needs of the business. Money is borrowed for short
periods of time, can be repaid, and then is required again.
Special Loan Programs: Government (SBA, state, city)
and alternative loan programs (e.g.microloans) offer primarily
term loans and some lines of credit . Most loan programs
are offered in conjunction with a bank. Special loan programs
are used when:
There
is insufficient collateral
There
is insufficient owner equity or downpayment
Loan
is considered "risky" because of the type
of industry, the business is a start-up or
emerging business, or there may be a problem
in the ability to repay the debt through traditional
means.
Loan
size is small (under $25,000 are often originated
through microloan programs).
Funding
Process: Once all documentation has been received
and reviewed, many bank loans can be closed within
2-3 weeks. If a special loan program is used the
processing time can increase to 6-8 weeks.
For
more information check out the following:
Loan
Sources - list of some state, federal and
small business loans available.
Loan
Check List - a list of documents you will
need when applying for a loan
Do
you qualify for a loan?
Next:
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