Starting a small business is one of the most challenging individual endeavors a person can undertake. It is basically putting yourself and your future on the line and gambling that you and your business idea are valuable enough to provide you with freedom and financial security without having to rely on anyone else. It is a risk that few people are willing to take for fear of failure, and failure is an unfortunate reality for many who try; but to those who succeed, the rewards of starting, growing and achieving success by their own ideas and hard work are immeasurable.
It is not for everyone, but for those that are willing to try, the two most fundamental elements required in starting a new business are developing a strong business plan and searching for sources of capital to fund the project. Writing a business plan is something that most individuals can accomplish with a little help from a good software program or research on the Internet; but most individuals really struggle when it comes to finding and securing financial support for their business venture. This is where many businesses fail before they even start because many people just don't understand the financial options available to them or where to discover those opportunities.
There are two types of business lending structures, each with multiple variations:
Debt financing is where individuals borrow money from a traditional or nontraditional lending source and agree to repay the debt according to a particular timeline and at a certain interest rate. Whether or not the business is successful or not is irrelevant to this structure because the individual is responsible for the debt either way. The advantage to this structure is that the individual is in complete control of their business and its direction without having to answer to investors or partners. The disadvantage is that if the business doesn't succeed, the individual has to face failure and financial debt as well.
This is where the individual sells or shares a portion of their company in one way or another in exchange for financing. Investors are favorable to equity financing because it usually provides a greater return on their investment than they can realize through interest rate lending. The advantage to this structure is that the investors assume all the financial risk if the business does not succeed. The disadvantage is that investors or partners will want to be more involved with the operation of the company, and if the venture is successful, it will cost the individual more in dividend payments to the investors than would otherwise be paid out in interest on a loan from a bank.
Debt financing can be structured under both traditional and nontraditional types of borrowing scenarios. Most individuals that utilize debt financing have good or excellent credit scores and have the ability to borrow money from traditional sources such as banks or credit unions.
Small Business Administration (SBA) guaranteed loans are also a popular method for individuals with a good credit history to access loans from SBA approved lenders. The variety of loans available and the streamlined application process makes the SBA an excellent first stop for anyone with a good credit rating and a good business plan.
Debt financing can also take the form of venture capital loans, and private loans from other sources such as family or friends. If borrowing money from a friend or family member, it is important to avoid mistakes made by many individuals that don't properly document the loan.
By using a promissory note, a professional standard is followed regarding loan structuring and documentation, which can become invaluable later on when the business seeks more conventional and larger amounts of financing from banks or other licensed lending sources.
These sources will see the promissory note as a legitimate loan structure and it will be an excellent loan reference for your business and will aid in the acquisition of additional funding.
Equity financing can also take the form of traditional and nontraditional structures of borrowing, but unlike debt financing, it has many flexible options for individuals with little to no credit history or even poor credit scores. Having a very good business idea and plan are keys to acquiring equity financing because the individual is selling a portion of their business in order to get the funding needed to start it in the first place. Investors will give money to people with a bad credit history if they see the potential for a substantial return on their investment.
The trade-off for this is that the investors will want to have some sort of oversight or input as to the operation of the business in order to protect their interests. Another possibility is to bring on a partner in the venture that has the financial backing but not the expertise in operating the business. A partnership agreement can be established that clearly outlines the responsibilities and ownership percentages of each partner and what they are entitled to.
The partnership agreement can also be crafted in a way to provide a buyout clause for the owner should the business become very successful and they wish to buy back their company from the investors or partners. Giving up a portion of the business in order to get needed financing is an option that many individuals take because at least it allows them to get their business started and, in many cases, investors will utilize their own contacts and business resources to assist in the development of the business because it is in their own best interests to do so, and this is a bonus to any business owner.
Funding a business startup does not have to be a confusing and desperate task as long as the individual takes the time to carefully look into all the options open to them. If credit scores are not a problem, there are many different financing solutions available. Some people with good credit even use credit cards with low introductory rates to get their business started and then pay off those balances quickly after they start to see a return on their investment.
People with poor credit scores can leverage their business in order to attract investors or partners that will finance them and even help them to succeed. Whatever your situation may be, it is important to understand that as long as you come up with a winning idea and plan for a business, there will be someone out there savvy enough to see its potential and reward you with financing. The key is to believe in what you are doing and be persistent in your efforts.