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Types of Financing
Debt Financing
Lenders provide the asset with the expectation of loan repayment with interest and the value of your collateral, such as your home, car, stocks or bonds, or anything of value you own.
Equity Financing
The lender does not require collateral but will participate in ownership of your business. The benefit of equity financing is the expertise and experience you also get in addition to money for your business. The most common form of professional equity financing is venture capital.
Debt Financing - The Loan Process
The best way to get a loan is to work with a bank or lending company. These experts will help you decide which type of loan suits your business best. Their advice is valuable and learning about loan types and processes yourself will supplement your knowledge to help you make the best decision.
Applying for a Loan
If you decide to apply for a business loan, your application should include the following information. Your written business plan will include much of the necessary material.- A description of your business: products or services, target market, competitive advantages, unique strengths.
- A discussion of management's qualifications.
- A budget detailing how the funds will be used.
- A statement of your equity injection. If possible, this should be 20% of the total budget. The remainder is the amount of the requested loan.
- Business financial statements and tax returns for the last three years, if applicable.
- Cash flow projections for at least the next 12 months.
- Personal financial statement and three years tax returns for each owner of the business.
- A description of the collateral being offered. In addition to business assets, this often includes personal assets such as marketable securities or real estate.
The lender will evaluate all of this information before making a decision. In some cases, the application is not quite strong enough to stand on its own. This is often true of start-up businesses, or in cases where the collateral is insufficient or the equity injection too small. In those cases, the lender will sometimes agree to make the loan only with the guaranty of the U.S. Small Business Administration. The lender will guide you through the process and additional paper work is involved in obtaining the SBA guaranty (see below for Types of Loan Guarantees).
Types of Loans Line of Credit: A line of credit is a specific amount of money that has been approved and set aside by the bank for you to draw upon as needed. Interest is charged only on the amount of the line that you use. However, banks may charge a commitment fee of 0.5% – 1% of the total line for reserving these funds. Line of credit is used mostly for construction projects. The amount of available funds drops by the amount of money you withdraw and increases as you repay the funds in monthly installments of interest plus principal.
Term Loan:These loans are usually repaid within five years in equal installments of principal, plus interest on the outstanding amount of the loan. As the outstanding principal is reduced, the amount of your total installment payments will go down over the life of the loan.
Accounts Receivable: An accounts receivable loan is based on the payment history of your customers. Banks will either write separate loans, or set aside funds for your use, in an amount usually between 75% and 90% of all accounts receivable invoices that are less than 90 days old, depending on whether the receivables are from Federal agencies or from local governments or private companies. A government contract is more reliable than a private, so the size and length of the loan change accordingly. Available money is drawn as needed and paid as your customers pay you. Interest is charged only on the outstanding portion of the loan.
Commercial and Industrial Mortgages: These are typically used to finance the purchase of real property or a major expansion of the business. Depending on the property you would like to buy or build, most banks will finance up to 75% of its appraised value or construction cost in the form of a mortgage. However, commercial loans are generally offered for ten years or less.
Personal Loans: Owners of a start-up or new business can take out long-term personal loans from a bank. Because there is no existing track record to evaluate, a banker can instead base the loan on your personal assets and borrowing record.
Micro-loans:If you only need a few thousand dollars for your business, micro-loans (from $500 to $35,000) are a good source of financing. They are usually offered by non-traditional lenders with less stringent financial guidelines than banks, which may consider small debts less profitable and more risky. Micro-loans can be used for working capital, machinery, inventory and leasehold improvements. To receive a micro-loan contact:
H Street Community Development Corporation
501 H Street, NE
Washington, DC 20002
(202) 544-8353
www.hstreetcdc.org
Choosing the Right Loan
Trying to figure out which loan is appropriate for your business and how much you need can be overwhelming as there are dozens of loan combinations. You are advised to work with your lender to decide the type of loan based on what you need it for and how you intend to use it.
Make sure that you feel comfortable with your banker, the bank loan terms, your interest rates, and your ability to repay any loans before you commit yourself. Do your research, as it is often advisable to compare loan packages from more than one lender before making a decision. The SBA offers a wealth of information on financing options. For more information, visit www.sba.gov/dc.
Consult with your lender to see if you need to secure a loan guarantee from the SBA. Though the SBA does not loan directly to small businesses, it does operate a number of programs that can give your prospective lender additional security and incentives when financing your business.
Types of Loan Guarantees 504 Loan Program
The 504 Loan Program provides long-term, fixed-rate, subordinate mortgage financing for the acquisition and/or renovation of capital assets (includes land, buildings, and equipment). Typically, 50% of the project is funded through a local commercial lender; 10% is contributed by you the business owner as equity, and 40% comes from the 504 lender at a below market, 20-year fixed interest rate. For new businesses two years old or less, 15% equity is required. It can be used for all project costs, and nearly all for-profit small businesses will be eligible. Below are the three Washington, DC area 504 lenders:
7(a) Program
The 7(a) program is the SBA's primary loan program. To qualify for the guaranty, a small business must meet the 7(a) criteria, and the lender must certify that it could not provide funding without the guaranty. The SBA can then guarantee up to 85% on loans of up to $150,000 and 75% on loans in excess of $150,000. The maximum is usually $1.5 million. By guaranteeing a portion of the loan, SBA shares the risk with the lender when a borrower is not able to repay the loan in full. Under this program, the borrower remains obligated for the full amount due.
7(a) loan decisions are made by your lender. It can be used to expand or renovate facilities, for working capital, or to purchase equipment.
CommunityExpress Loan Program
The CommunityExpress Pilot Loan Program is a unique SBA loan program designed to provide streamlined business financing and management and technical assistance to targeted small business. As a joint initiative between the U.S. Small Business Administration and the National Community Reinvestment Coalition, the CommunityExpress program is targeted primarily to businesses owned by minorities, women and veterans who are under represented in the population of business owners compared to their representation in the overall population.
The program is offered through hundreds of selected SBA lenders located throughout the nation. Under CommunityExpress, approved lenders are allowed to use streamlined and expedited loan review and approval procedures to process SBA guaranteed loans. These lenders may use their own loan analysis, loan procedures and loan documentation to process SBA loans up to $250,000.
For more specific information on all loan programs, please visit www.sba.gov/financing or contact the National Community Reinvestment Coalition at (202) 628-8866 or visit www.ncrc.org.
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