There are over 27.9 million small businesses and counting, according to the SBA. Over 60,000 new businesses are being formed each year; 20% of small businesses fail in the first year, 30% in the second year, 50% after five years, and 70% within a decade during operation.
Yes, owning a business and calling yourself the chief executive officer is very glamorous and certainly doesn’t hurt — financially speaking. But you need to establish your business the right way and with the right finances or you might end up setting your business up for failure.
So how do you prepare your up and coming business for high success rates and a better chance at surviving its formative years?
The groundwork lies most of the time in finding a way to finance that business.
You need enough working capital to keep your business operational, for purchasing equipment, to hire more competent staff, to re-finance the loans you might already have, and to engage in business ventures that could open new doors of opportunities.
Business Data & Your Business Funding Ability
Fluctuating cash is common in every given business, and that is because it’s being influenced both externally and internally. New and experienced entrepreneurs alike will be the first to tell you that maintaining steady cash flow is a task that goes uphill. And as the business owner, your control over what happens to your business is limited to internal factors only.
So whenever your business is in need of emergency finances, you need to look for lenders who can provide the cash that you need for your business. These financial reserves come in the form of acquiring loans, and these are payable depending on business agreements between you and the lender.
But it’s not that simplistic, and not that cut-and-dry. Lenders scrutinize your business data to determine whether or not your company is going to be worth the funds they give your business.
In looking at your business funding abilities, lenders consider the following business data.
The Size of Your Market
The size of your market is the basis for determining the amount of loan that you can qualify for. The more expansive your market is, the higher the chances of generating more sales. Lenders assume that the size of your market will reflect on the sales you make and on your revenue.
Bigger sales mean a larger market size, opening an opportunity for you to qualify for a greater amount of loans or line of credit.
But what if your business is generating low sales? Lenders will assume that your market is small, and your capacity to repay expensive loans are dubious. You’ll only qualify for a small amount, and truth be told, that won’t help fulfill much of your business needs.
Financial Standing
Money is involved. Banks and financial lending institutions will demand a business’ financial statements. This means a record of bank deposits, balance sheets, proof of business revenues, etc.
Statements like this give insights about your company’s financial position. A stable business assures lenders, and they’ll be more open to granting your credit since your business has the ability to repay debts.
Bank Deposits
Businesses that are financially stable are gauged by the amount of cash flow that it gathers on a monthly, weekly, or day-to-day basis. The larger the cash flow, the higher the deposits being put into the business’ bank accounts.
Depositing money into your business’ bank account every now and then reflects that your company’s revenues are high, and lenders are more lenient and won’t turn down your loan applications.
Business Revenues
Revenues help a business operate, develop, and pay utility bills on time. It’s what helps your business run smoothly. And when it comes to applying for business funding, lenders make use of this data to also determine if your business is capable of repaying the loan that you are applying for. The higher the revenue, the more likely you’ll be able to qualify.
Balance Sheets
Balance sheets are one of the key documents used to prove where your business stands financially. A stable business will have assets that are higher compared to the overall liabilities. Coupled with bank statements, balance sheets are important to find how much loans your company will qualify for. Unconvincing figures will result in your loan application being declined.
The Collateral You Have Available
Most loans require collateral pledged as security. Collaterals are assets that serve as guarantees to lenders, and they can sell this to recover money in case your loan repayment falls on default. Common assets include business equipment or real estate.
Businesses that have valuable assets have an easier time having their loans approved in a shorter period of time. Having other factors for approval present, businesses with valuable pieces of collateral can receive considerable amounts of cash in the form of loans compared to businesses whose collaterals are low.
The Ratio of Debt to Income
Debt to income ratio is calculated by taking the total of monthly obligations and dividing it by the total monthly income generated by your business. And the standard ratio must not exceed 36. The lower the ratio, the better.
Businesses who have high debt to income ratios are riskier and have higher chances of forfeiting in payment. So, for business owners, it’s necessary to pay debts on time in order to lower this crucial ratio as much as possible.
Debt/Credit Repayment History
Businesses have bills, expenses, and financial borrowings all the time. And the difference between poor business management and a terrible one is how the owner responsibly pays and honors its financial agreements.
Your repayment history is an essential factor that lenders use as a priority before they decide to lend credit to any business. They do this by looking for credit reports from credit bureaus. Important indicators that lenders search for in a credit report is how many times you’ve defaulted in payments. They also search for any history of bankruptcy.
For this reason, keeping up with financial payments, and having pristine repayment histories build a good reputation, and is deemed as honest in contracting deals with.
Personal & Business Credit Scores
Both personal and business credit scores are used by lenders to determine whether or not your business deserves funding or not. And for your startup business, you need to establish credit ratings.
Good credit ratings in both personal and business credit scores prove to be attractive to lenders. It reflects how well you pay your bills on time and how well your business is doing financially.
Lenders don’t turn down loan applications by businesses with credible credit history.
5 Ways to Fund Your Startup Business
Starting businesses aren’t a cheap affair. It takes money to make money, and getting funds for your business is one of the first — and most important — financial choices you make. And how you choose your business funding affects your business structure and how your business is going to run.
#1 Estimate how much funding you need
Each business has unique needs, and as such, there is no such thing as a one-size-fits-all solution. Your goals and your vision for your business, as well as your personal financial situation, will determine how your financial future is shaped.
When you’re educated about startup costs and how much you might need, your business can benefit from this estimation. It’s much better than not having a plan at all, and you’re more prepared to face surprises down the road.
According to Entrepreneur guest writer, Tim Berry, you can make estimates on your starting costs by making three simple lists, and then a couple of educated guesses.
- Assets: List your assets. These are the things you need to use for your business during the long term. For bookstores (for instance), you need stocks of books and shelves. And for a brick-and-mortar clothing store, your assets would be shelves, cash registers, tables, etc.
- Expenses: Your list of expenses are different from your list of assets. Not everything you’re going to be spending your money on would be an asset. Your business expenses will include the money you spend to develop your website, the cost of making renovations to the administrative office, the salaries you’ll be paying your employees, etc.
- Estimate your startup fund: Tim suggests estimating your first 12 months of sales, the cost of those sales, and then your expenses. “Subtract the costs and expenses from the sales for each month, and the result should show you whether you’re short of cash.” From there, you can determine how long it will take you to start breaking and how much money you’re missing. That’s how much you’ll need as starting cash.
#2 Fund the business with self-funding
Self-funding the business is also known as bootstrapping. In self-funding, you can leverage your own financial resources to support your business. You can also turn to family and friends for financial loans, or even use your savings.
The good thing about self-funding is that you retain complete control over your business. And at the same time, you shoulder all the risk by yourself. So experts advise that you shouldn’t spend more than you can afford.
#3 Crowdfunding
Crowdfunders aren’t technically investors. They don’t receive shares or ownership of your business, and they don’t expect financial returns for their money either. What they expect are “gifts” from your company in exchange for their contributions to your startup success.
Your “gifts” can come in the form of products you plan to sell or special privileges to your services.
In addition, crowdfunding also has low risks for a lot of business owners — which makes it so popular. You keep full control of your company, and if things go awry, you have no obligation to repay your crowdfunders.
#4 Acquire venture capital
You can get venture capital from investors. These are often offered in exchange for ownership shares and an active role in your company. So, how is it different from traditional financing methods?
Venture capitals:
- Invest capital in return for equity rather than debt.
- Have a longer investment horizon than other types of financing.
- Focus on high-growth companies.
- Incur steeper risks in exchange for potentially higher returns.
And as for how to get venture capital from investors, there is no guaranteed way of doing it, but the general process is as follows:
- Looking for individual investors or venture capital firms.
- Sharing your business plan, reviewing your business plan, and making sure it meets their qualifying criteria.
- Undergo diligence review — where investors check your market, products and services, management team, official documents, and financial statements.
- Agree on certain terms.
- Acquiring investment.
#5 Getting small business loans
A popular form of merchant financing is getting a small business loan. Small business loans let you keep control of your business even if you don’t have enough funds to being. For a better chance at securing loans, you need a business plan along with gathering important business documents that financial institutions would require.
The Takeaway
Small businesses need capital to grow, but when you lack the financial resources to get your business up and starting, other means of financing becomes necessary. But before you seek out funds, you must do your part to ensure that your chances for success are exponential.
You can raise your success rate for your business funding ability by remembering that your financial resources will look for:
- The size of your market
- Your financial standing (bank deposits, business revenues, & balance sheets)
- Collateral
- Ratio of debt to income
- Your repayment history
- Personal and business credit scores
