In our last blog, we discussed equity financing as a tool to fund your new venture. In this blog, we will discuss borrowing money to launch your new enterprise, also known as debt financing. There are several different debt options we will discuss.
Debt allows you to leverage your assets to build your business. Financing is very hard to obtain for a startup, but some entrepreneurs are able to do so. Incurring debt allows you to lever your limited resources. By levering your assets, you can obtain capital to increase the size of your balance sheet and invest in your company. To use a boxing reference, borrowing startup funds gives you the opportunity to box above your class. Using debt is a very powerful tool but it carries a lot or risk.
Types of Loans:
Many entrepreneurs turn to the Small Business Lending Fund administered by the Small Business Administration (SBA) for a government-backed loan. The Small Business Lending Fund is a 30 billion dollar fund that helps to facilitate the funding of small businesses. The fund provides capital to community institutions with less than 10 billion dollars in funding. The purpose of this model is to encourage small banks and businesses to collaborate in an effort to create job opportunities and promote an increase in economic growth. The SBA loan process can be onerous, but it helps entrepreneurs who might not otherwise be able to commercially borrow the capital they need to get their new venture off the ground.
Asset-based lending (ABL) is a loan secured by collateral (assets). Typically, the asset-based loan, or line of credit, is secured by inventory, accounts receivable, equipment, and/or other balance-sheet assets. This type of lending is common in commercial and industrial businesses that are required to carry assets that are recorded on their balance sheet. Many service-based businesses that use tangible assets to perform their service, i.e., a construction company with a lot of dirt-moving equipment, obtain this type of financing. However, service companies like professional service firms or software companies have difficulty with these types of loans, as they do not carry these types of hard assets and therefore, do not have the correct type of collateral.
Factoring is the next form of financing that we will discuss. Factoring enables businesses to sell their accounts receivable to a third party, and collect most of the amount due on an invoice as soon as the bill has been presented. Factoring is form of debt, as the business is responsible for any amounts that are not paid. The idea behind factoring is to speed up cash flows, but still give customers payment terms of payment such as Net 30 days.
Unsecured – Line of Credit/Credit Cards/Signature Loans. There are a myriad of options available for borrowers to access unsecured debt. Since these options only require a personal guarantee of the borrower with no collateral, the interest rates are typically higher than other forms of debt. While this form of debt is the most flexible for the borrower, it costs more to access this type of capital.
It is important that small business owners research and consider the entire spectrum of their financing options, how it will impact them both in the short and long term, and the potential risks they are willing to accept. For many of the above options, traditional banks require businesses to operate at least 2 years before they become “bankable.” There are workarounds, namely using personal assets to secure the business debt. For example, you might be able to fund your business with access to multiple credit cards or using retirement assets you might have accumulated when working in corporate America.
Additionally, there are hybrid arrangements that are assorted combinations of debt and equity. Typically, these arrangements are referred to as Venture Debt. These arrangements carry a very high cost, as the lender/investor expects a 12–25% return on their capital, through a combination of loan interest and equity returns.
CFO Shield is experts in helping business owners understand the value of their enterprise so they can more effectively raise investment capital. CFO Shield is in the business of helping small business to understand the market place, create the strategic plan, execute that plan, and achieve the prosperity that is your goal. We can leverage our offerings and enable small businesses to solve problems and share in the same economies of scale that larger companies enjoy. We have the experience needed to create custom solutions to help small business owners better manage their back office and help them formulate strategies to adequately manage working capital, thereby ensuring stability and prosperity.