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Sources Of Financing:
Each Presents Its Own Unique Challenges
By Stephen Windhaus
Many small business owners and start-ups fail to consider the advantages and disadvantages of several common sources of financing. After 18 years in small business development, I have seen success and failure for entrepreneurs attempting to secure financing from each of these sources. But some are more advantageous than others. And some present potential dangers, both personal and professional, for which you need to be aware.
The most well known source of financing is the traditional commercial lending bank. We all deposit our money in the bank, but many wonder why it is so difficult to get a loan from that same place. Well, consider the fact that they are lending out your money so as to make a profit while storing your funds. Naturally, you want anybody holding your money to avoid any possibility of loosing it to defaults on loans. Secondly, banks are among the most scrutinized of loan sources by federal and state regulatory agencies. Therefore, expect these institutions to be among the most conservative when evaluating the risk of a loan application.
A second, lesser source in the same family of lenders is the savings and loan. They are not in the business of commercial loans. They make a significant portion of their money on residential real estate loans, and that's where they are likely stay. Of course, if desired, you can refinance or secure a second line on your home for those business-related funds. But business failure could endanger the home you own.
The second major category of financing sources is the individual. And we all know about venture capitalists, typically called VC's. Many present day VC's are commonly found investing in high-tech and Internet related ventures. They expect to invest significant amounts of money, many of which range from $2 million and up. Of course, the general formula for success in securing this type of financing is a unique product or service, which adequately projects a very significant return on the investment in a very short period of time. Now you ask what is a significant return and what is a very short period of time. There is no set-and-fast rule. But consider the more common commercial loan. Depending on the prime interest rate at the time, banks typically lend at 3% to 4% above prime for a term consistent with the amount of the loan. For example, the bank may lend you $50,000 at 12% for a period of 3 to 5 years. VC's will invest millions of dollars, want significantly more than 12% return and with a payout in 2 to 3 years. Remember this is only an example. Factors, including the returns based on market research, the near-future marketability of the product or service and the prime rate will influence the final negotiations. Furthermore, VC's are given investment options ranging from lending source with guarantees to equity investment to buyouts, from no involvement in policy decisions to an equitable voting right consistent with the level of ownership investment. And they are much more willing to take a risk than institutions.
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