Sources of Financing

The Small Business Administration reports that: “While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second”.

Obtaining the correct amount of financing is essential to the success of any business. However, no amount of money will be sufficient for your business needs, unless you have the knowledge and planning in place to be able to manage that money effectively. Being prepared will help you avoid common mistakes such as securing the wrong type of financing, or underestimating the amount of money you will need.

Most people think of commercial banks when they realize a need for business financing. Unfortunately, as a source of start-up funding, banks are an unlikely source. Instead, most small businesses are financed through private funding or personal savings.

"But can't I help fund my small business with grants?" This is a question that we hear often at The Maine SBDC. With rare exception, the answer is no. Not only is grant money scarce, few businesses even qualify to receive grants due to tedious qualification requirements. There are many considerations that you must explore before securing financing for your business. The Maine SBDC is here to help.

Financing FAQs

What do I need to borrow money for my business?

A: Your bank is not a charitable institution. It is in business to make (not lose) money. Consequently when a bank lends money it wants to ensure that it will get paid back. To maximize the possibility of being paid back, the bank wants to make sure that there is sufficient assurance that a person can pay back a loan and that she has met such obligations before. The bank will consider the 5”C”s of Credit before it makes a loan.

Capacity to repay is the most critical of the five factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships--personal and commercial--is considered an indicator of future payment performance. Prospective lenders also will want to know about your contingent sources of repayment.

Capital is the money you personally have invested in the business and is an indication of how much you have at risk should the business fail. Prospective lenders and investors will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business you are more likely to do everything in your power to make the business successful.

Collateral or "guarantees" are additional forms of security you can provide the lender. If for some reason, the business cannot repay its bank loan, the bank wants to know there is a second source of repayment. Assets such as equipment, buildings, accounts receivable and in some cases inventory are considered possible sources of repayment if they are sold by the bank for cash. Both business and personal assets can be sources of collateral for a loan. A guarantee, on the other hand, is just that--someone else signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee in addition to collateral as security for a loan.

Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender will also consider the local economic climate and conditions both within your industry and in other industries that could affect your business.

Character is the general impression you make on the potential lender or investor. The lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience of your employees also will be taken into consideration

What is a Credit Score?

A: According to Lee Ann Obringer at HowStuffWorks, a credit score is a number that is calculated based on your credit history to give lenders a simpler "lend/don't lend" answer for people who are applying for credit or loans. This number helps the lender identify the level of risk they may be taking if they lend to someone. While the same end result can come through reviewing the actual credit report (which lenders usually do), the credit score is quicker and less subjective. The system awards points based on information in the credit report, and the resulting score is compared to that of other consumers with similar profiles. With this information, lenders can predict how likely someone is to repay a loan and make payments on time. It's the credit score that makes it possible to get instant credit at places like electronics stores and department stores.

Although there are several scoring methods, the score most commonly used by lenders is known as a FICO because of its origins with Fair Isaac and Company. Fair Isaac is an independent company that came up with the scoring method and software used by banks and lenders, insurers and other businesses. Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with Fair Isaac in the early 1980's to come up with the scoring method. The three national credit bureaus each have their own version of the FICO score with their own names. Equifax has the Beacon system, TransUnion has the Empirica system, and Experian has the Experian/Fair Isaac system. Each is based on the original Fair Isaac FICO scoring method and produces equivalent numerical results for any given credit report. Some lenders also have their own scoring methods. Other scoring methods may include information such as your income or how long you've been at the same job.

What is a Credit Report?

A: According to Lee Ann Obringer at HowStuffWorks, a credit report is an accumulation of information about how you pay your bills and repay loans, how much credit you have available, what your monthly debts are, and other types of information that can help a potential lender decide whether you are a good credit risk or a bad credit risk.

The report itself does not say whether you are a good or bad credit risk -- it provides lenders with the data to make the decision themselves. Credit bureaus, also known as credit reporting agencies (CRAs), collect this information from merchants, lenders, landlords, etc., and then sell the report to businesses so they can evaluate your application for credit. Lenders make their decisions based on different criteria, so having all of the information helps them ensure that they are making the right decision.

What kind of Information is in my Credit Report?

A: According to Lee Ann Obringer at HowStuffWorks, information that makes up your credit report includes:

• Personal identifying information - This includes your name, address (current and previous), social security number, telephone number, birth date, your current and previous employers, and (on the version you get) your spouse's name may be included as well.

• Credit history - This section includes your bill-paying history with banks, retail stores, finance companies, mortgage companies, and others who have granted you credit. It includes information about each account your have, such as when it was opened, what type of account it is, how much credit it includes (or the amount of the loan), what your monthly payment is, etc. If you've closed the account or the loan has been paid off, then that information shows up as well. If there were missed or late payments, this is where that appears.

• Public records - Information that might indicate your credit worthiness, such as tax liens, court judgements and bankruptcies. This information is readily available from public records.

• Report inquiries - This section includes all credit granters who have received a copy of your credit report. It also includes any others who were authorized to view it. In addition, lists of companies that have received your name and address in order to offer you credit are included. These companies don't actually see your report, but get your name if you meet their criteria for an offer of credit, insurance or other product. This is where all of those "pre-approved" credit card offers come from.

• Dispute statements - The report may also include any statements you've made disputing information on the report. Most credit bureaus allow both the consumer and the creditor to make statements to report what happened if there is a dispute about something on the report. Things that don't appear on most credit reports include bank account balances, race, religion, health (although medical bills may show up as debts), criminal records, income, and driving records.

How can I get a copy of my credit report?

A: See Annual Credit Report

Order a 3-bureau report which includes your complete information from all 3 national credit bureaus – Equifax, Experian, & TransUnion. A single-bureau report contains your information on file at one of those 3 bureaus. Although many national lending institutions report consumer credit information to all three, smaller banks and other credit grantors may report to only one-or even none. Therefore, your credit report from one credit bureau is not necessarily exactly the same as your credit report from another. You can obtain a 3-burearu report by contacting any of the three major bureaus:

• Equifax – To order your report, call: 800-685-1111

or write:

P.O. Box 740241, Atlanta, GA 30374-0241

• Experian – To order your report, call: 888-EXPERIAN (397-3742) or write: P.O. Box 2104, Allen, TX 75013

• TransUnion – To order your report, call: 800-916-8800 or write: P.O. Box 1000, Chester, PA 19022

How can I improve my credit and manage my debt?

A: You may want to consider the services of a credit counselor. Many credit counseling organizations are nonprofit and work with you to solve your financial problems. But beware — just because an organization says it is "nonprofit" doesn't guarantee that its services are free or affordable. Reputable credit counseling organizations advise you on managing your money and debts, help you develop a budget, and usually offer free educational materials and workshops. Their counselors are certified and trained in the areas of consumer credit, money and debt management, and budgeting. Counselors discuss your entire financial situation with you, and help you develop a personalized plan to solve your money problems. Some questions to ask to help you find the best counselor for you can be found in the Federal Trade Commission’s Facts for Consumers on Fiscal Fitness.

What is a microloan?

A: Microloans are loans made to small and home-based businesses which are unable to obtain loans through regular channels (banks and investors). Microloans generally range from a few hundred dollars to $40,000, and often are funded in part by the SBA. Economic Development Corporations and Community Development Corporations make most of Maine’s Microloans; your Maine SBDC counselor can help you find a microloan lender.

What are Revolving Loan Funds?

A: A Revolving Loan Fund (RLF) Loan Program is a local economic development program designed to assist area businesses by providing "gap" financing for new business start-up, expansion or retention projects. Gap financing is typically subordinated financing that can be thought of in terms of the "short fall" in equity portion of total project funding required. Through an RLF Loan Program, regional economic development corporations work directly with a local business, its bank lender and community/economic development organization to design a financing package that meets the RLF program guidelines and needs of the business. Many RLF programs in Maine are funded in part by FAME.

How can I get a grant to start or expand my business?

A: Unless your business involves the development of new technology or is a non-profit organization, 99.9% of the time you will be wasting your time looking for a grant.

Will the Maine SBDC lend me money?

A: The Maine SBDC does not have any money to loan but your Maine SBDC Business Counselor will suggest appropriate sources for financing based on your business needs and personal situation.

Source: http://www.mainesbdc.org/resource_cat_detail.cfm?category=Financing&topic=7&lookup=fin