If you are looking to start a business, one of the most critical components of your business plan is likely to be acquiring sufficient funding to carry you from inception to your first sales and profits.
While some new enterprises are good candidates to attract investment capital, the vast majority of new businesses in the United States aren’t “sexy” enough to attract money from Silicon Valley or Wall Street. Of the more than 600,000 new businesses that are started each year in the U.S.,
Loans for a new business, however, can be challenging to acquire from “traditional” sources. Almost all bank loans to new businesses are guaranteed by the Small Business Association – a glance at the SBA’s weekly report will show that through the 3rd quarter of 2014, a grand total of 16,970 new businesses received funding that was backed by the SBA – less than 3%.
Why is it so difficult to get a loan for your new business?
While there is much arguing as to the true rate of business failure, there is no question that the chances of a new business failing are pretty high. Analysis of a number of studies indicate that within 4 years of opening their doors, just half of small businesses are still open.
In light of this information, if you were a lender, and someone came to you looking for a loan to start a business with, your biggest concern is going to be that, since half of new businesses default:
- What is the likelihood that the person coming to me is going to be in the “default” pool? (The 50% of businesses that won’t survive 4 or more years).
- If the person defaults, what can I take (repossess) from them to limit losses?
What steps can you take to increase your chances of being in the “better risk” pool?
#1. Having a Startup Business Plan is Essential
In your first conversation with a lender, you are likely to be asked questions about the business you are going to start. In many cases, what can raise (or destroy) your chances of being considered for business startup loans is not so much what your answers are, but how you answer.
For example, one of the first questions you may be asked is what your expected revenues (sales) are going to be and what sort of profit margins you expect.
(You might be surprised how often the answer is, “I haven’t looked into that yet”).
While you don’t necessarily need a 100-page business school-style exposition for a small business, before you make you first call, you should have an idea of (and be able to communicate) the following:
- How much money you need
- How you will get customers
- Your expected sales and cash flow numbers
- Your basic costs
- How much profit there will be before accounting for loan payments
By being able to present a case that you have a good handle on how you will get customers and what the numbers will be, you will greatly increase your chances of being considered for startup funding.
#2. Look into Business Funding Before You Need it
It’s quite common for lenders to get calls from borrowers who have spent every penny they had prior to starting and prior to launch found they didn’t have enough left to get started. Unfortunately, if you find yourself in that situation, your chances of approval for business startup loans is very poor because:
- You are starting out by demonstrating your history of poor planning
- By the time you get to this point your finances look terrible
To be comfortable lending money to a startup, a loan company has to feel that if you hit an unexpected bump in the road (since virtually all new businesses do) that won’t immediately throw you into default.
As a rule of thumb, take the total amount of money you think you will need to start, increase it by about 20% or so, and take into account how you are going pay to live until you are generating enough income to take money out of the business – if things will be tight, look into financing before you start spending money on the business.
#3. Finance Hard Assets First
When you borrow money, the more safety you are providing to the entity lending to you, the more likely you are to be able to get financing. For that reason, borrowing for hard assets is the easiest business financing to come by for new businesses.
“Hard assets” are usually real estate or business equipment. In many startups, acquisition of equipment is the single largest expense in opening the doors. Equipment such as machinery or vehicles tend to hold their value, so they are much easier to get financing for, as if you don’t make your payments the equipment can be repossessed and resold.
By financing these larger ticket items, new businesses are able to preserve their working capital such that they greatly increase their chances of success.
#4. Be Realistic about Startup Loan Interest Rates
Since half of small businesses will fail (and likely default on the loans), the rates you will pay to borrow money as a new business will be much higher than you might think they should be.
As a general rule, when loaning money to startups, default rates are assumed to range from 30 to 50%. The company or person providing funding will have to charge finance charges high enough to account for their own borrowing costs, the percentage of loans that will not be paid, their administrative and sales costs, and have some left over for profit.
When shopping for new business financing, it is very common for borrowers to think the rates they are being charged are unjustified, but without high interest rate loans, no financing options would exist for new businesses.
More important that what the interest rates will be is:
- How much income will be generated from the money borrowed?
- Is there a less expensive way to gain access to the money?
- If you don’t borrow the money, what are the repercussions?
#5. Don’t try to Start a Business With Nothing
Another common inquiry financiers tend to receive is from folks with no experience, no savings, and no assets who are looking for a business startup loan. Unfortunately, if you try to start a business in this situation, you are highly likely to fail, and it is extremely unlikely that any lender will take a chance on you.
In these situations, you are far better off either starting the business on your spare time, or working a second job until you have enough savings to sustain yourself while you start the business and show a finance company that you are more likely to encompass the successful half of small business startups.
How Hard is It to Qualify for New Business Funding?
Even if you have a business plan, and some savings, it will still take some effort to fund a startup, but for reasonable risks, the funds are out there.
While banks are usually not good candidates (they usually can’t charge rates high enough to compensate for the risks) there are plenty of avenues available for “decent” business risks, particularly if you have decent credit and/or collateral.
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