I spend every day helping small businesses obtain financing so that they can grow. I have recognized how important it is for small-business owners to have access to capital once the business is up and running. Capital can come from many sources.
Some small-business owners rely on their own cash to fund their businesses. Some obtain financing for the inception of their businesses. While both ways work, sometimes obtaining a small-business loan may help build credit for the business. On the other hand, financial institutions may like to see that small-business owners managed to put their own money on the line and did not rely on financing. Frankly, both ways can work. It may depend on what the business owners’ preferences are. Some prefer financing while some have an aversion to debt and seek partners or other sources of cash.
If the business is profitable and not all the distributions are drawn, there may be retained earnings, which serve as capital for the business. In other words, if the funds are not all drawn from deposit accounts after expenses are paid, there may be cash to help grow the business.
Often, during the expansion of the business, owners approach financial institutions for working capital lines of credit to help with the capital needs. This makes sense because liquidity is very important during the growth stage.
It may be helpful for a small-business owner to apply for a line of credit when it is least needed. If the business owner has sufficient collateral and can demonstrate the ability to service the debt, that business owner should consider applying for a line of credit.
We have recently helped a start-up business with their financing by starting them at a low loan amount — but large enough to help them build business credit. As they grow and turn profitable, we will increase the loan amount. It also helped us feel more confident because they opened their account with us so we can see their flow of funds.
Sometimes business owners who wait until the last minute are not approved for financing when they need it. Just like in personal finance, we don’t want to apply for a credit card when we are already extended on all other credit cards and our credit score is compromised. It can be helpful to apply for lines of credit or credit cards when we least “need” them because this is when we probably are in the best financial position to demonstrate the ability to pay those loans back.
A small-business owner may approach a financial institution and request a $50,000 line of credit and use it here and there to demonstrate the payment history, build business credit, and then, as the need arises, use the line for additional capital during the growth stage.
Small-business owners should keep in mind that it can be more difficult for new businesses to obtain financing than it is for established businesses. Lenders like to see the outside sources of cash flow to help with loan repayment ability. Some new business owners keep their day jobs to help with a source of cash inflow until their companies are sustainable and show profits. Additionally, to mitigate the new business risk, lenders like to see whether a new business owner has put “skin in the game,” — personally-owned assets like a home or vehicle used as collateral for the loan.
In addition to conventional loans and SBA-guaranteed loans you can obtain at your local lender, there are other sources of funding you might consider. These include funds from friends and family in the form of gifts, part-ownership or loans. There are private equity firms that also offer financing. Hard money loans are available, but these are often on very unfavorable terms, so be sure to do research to assess the risk-reward factors.
Access to capital is important to keep your new business going or to grow your small business. If you haven’t yet considered how access to funds might help your business, consider what you might be able to do if you have capital for your business now.
Aga Merx is a vice president and SBA department manager for Bank of American Fork. She formerly worked with the Small Business Administration’s Small Business Development Center. She received her bachelor’s degree in business administration and finance from Weber State University.