Sources Available for

Financing a Small Business

Types of Sources Used to Finance a Small Business

• Equity sources: Money or capital contributed by owners; capital sources that trade cash for some portion of ownership or equity in a business. Equity is sometimes called risk capital because the investor

puts his/her money at risk.

Since the investor acquires ownership in the business, no repayment of money with interest is required.

• Debt sources:  Sources of funding that require the money borrowed to be paid back with interest.

Personal savings

Friends and relatives

Partners

Private investors

Venture capitalists

State-sponsored venture capital funds

Personal Savings Advantages 

o Owner keeps all the profits.

o Owner's risk of loss provides motivation to succeed.

Disadvantageso Creates chance of loss

o Causes personal sacrifice

o Causes loss of return from use of savings

o Carries unlimited liability

Partnership With People or With Other Companies Having Compatible Goods Advantages 

o Brings in more cash

o Shares financial risks and responsibilities

o Increases borrowing power

Disadvantageso Requires giving up a portion of profits

o Results in the loss of some control and ownership 

Family and friends - Sometimes called "love money"

Advantages o Provides quick and easy source of funds

o Allows less formal arrangements

o Imposes fewer restrictions

Disadvantageso Creates chance of loss

o Causes possible loss of return from use of savings

o Carries unlimited liability

Private investors - also called Angels:  Wealthy individuals functioning as non-professional investors who are willing to invest in local businesses for financial or emotional reasons and who sometimes prefer to remain anonymous.

Advantages o Invest in region in which they live

o Will finance startup businesses

Disadvantageso Not easy to locate

o Must be chosen carefully and may not always be a reliable source

Venture capitalists:  Individuals or firms that invest money professionally to make money, expect a large capital gain, and look for high growth potential (30-50% return on investment).

Advantages o Provide large amounts of moneyo Allow owner to maintain control and operation of the businesso Provide for additional assistance, when available

Disadvantageso Most businesses do not qualify.o Entrepreneur must give up part ownership.o Small businesses may have trouble attracting venture

capitalists.

State-Sponsored Venture Capital Funds:  Funds provided to entrepreneurs by the state in an effort to encourage economic development and creation of jobs.

Advantages o Create jobs

o Do not focus solely on profits

Disadvantageso None noted

Money or capital that is borrowed and must be paid back with interest.

Banks

Trade credit through venders

Finance companies

Credit unions

Government agencies

Analysis of Debt Sources Advantages 

o Relatively easy and quick to obtaino Maintain control and ownership of the businesso Repay at a more advantageous timeo Tax deduction for interest and related costs

Disadvantageso Higher interest rateso Risk of insufficient profit to cover repaymento Easy to abuse and overuseo Restrictions and limitations imposed by the lender

1. Most common source of business financing

2. A line of credit allows businesses to borrow a stated amount of money at a stated interest rate to use as the business chooses.

3. Require that money be paid back on a regular basis according to the repayment plan specified

4. Very conservative and not inclined to lend to businesses that are not well established

5. Usually require some kind of collateral

Banks

1. Short-term financing

2. Credit from within the industry or trade  Example:  • One may purchase goods on 30-90 days of credit,

interest-free.  • The business owner then has the use of the money for

at least 30 days.  • Provided customers pay for goods and services on

time, the owner can then pay his/her bills on time.

Trade Credit Through Vendors

1. Take more risks than banks

2. Are more expensive than banks

3. Will ask for some form of security like the entrepreneur's home, accounts receivable, or business inventories

Finance Companies

Credit Unions

Cooperatives formed by labor unions or employees for the benefit of the members

1. Terms of repayment may be quite flexible.

2. Interest rate may be low or the loan might be interest free.

3. Mixing financial affairs with family relationships or friendships can sometimes cause problems.

Personal Loan From a Family Member or Close Friend

1. Uses a commercial bank to process and release the money and guarantees up to 90% of the loan if the business fails

2. Also lends public funds to veterans and handicapped persons who qualify

Government Agencies

Small Business Administration (SBA)

Government Agencies

Minority Enterprise Small Business Investment Companies (MESBIC's)

1. Established by SBA

2. Provide funding to businesses whose ownership is at least 51% minority, female, or disabled

Government Agencies

Small Business Investment Companies (SBIC's)Minority

1. Licensed by SBA

2. Provide equity and debt financing to young businesses

3. Invest about twice as often in startup ventures as do venture capitalists

4. Privately owned

5. Requirements vary

Government Agencies

Department of Housing and Urban Development (HUD):  Provides grants to cities to lend money to private developers to help improve impoverished areas.

Government Agencies

The Economic Development Administration (EDA)

1. Division of the U. S. Department of Commerce

2. Lends money to businesses that operate in and benefit economically distressed parts of the country

3. Similar to SBA, but more restricted

4. Most states have economic development agencies and finance authorities that make or guarantee loans to small businesses.

Government Agencies• Local and municipal governments can be

sources.

• Sometimes these agencies make small loans of $10,000 or less