It can be challenging, if not impossible to find money to start a new business from outside sources. The majority of entrepreneurs rely on their own resources and those of friends and family for start-up capital. Financial institutions are understandably cautious about loaning money for start-up enterprises because they’re new and don’t have a history of success. Lenders will look for the following when considering a business loan application; cash flow, credit and collateral. Remember when seeking financing you must show you are positioned to repay the debt and if not, there is a remedy for the lender.
Most lenders want to see three to six consecutive months of cash flow. That means you need to be operating and showing a profit before they will consider loaning money or extending credit.
Anyone wanting to borrow money needs to have an acceptable credit rating. The required score varies based on the standards of each financial institution. The borrower is almost always asked to sign a “Personal Guarantee”
A personal guarantee is an agreement that makes one liable for debts or obligations The agreement signifies that the lender can lay claim to the guarantor's (borrower’s) assets in case of borrower default. It is equivalent of a signed blank check without a date. The lender's actions are usually based on seeking assets that are easier to take control of and sell. Once signed, a personal guarantee can only be cancelled by the lender.
Lenders look for you to have collateral (assets) that can be pledged and sold as a remedy if you default on a loan. This can include personal assets such as cash and/or real estate or tangible property that is already owned by the business such as equipment and/or real estate.
Denver Capital Matrix
An excellent resource on funding sources for entrepreneurs and small businesses has been compiled by Paul Washington with the Denver Office of Economic Development.
7(a) Loan Program
The 7(a) is the SBA's most popular loan program. As a small-business owner, you can get up to $750,000 from your local 7(a) lender, backed by a partial guarantee from the SBA. Note that the SBA is not lending you any money directly. What they are doing is making it less risky for a local lender to provide you with financing. 7(a) loans are typically used for working capital, asset purchases and leasehold improvements. All the owners of a business who hold an ownership stake of 20 percent or more are required to personally guarantee the loan.
Once your lender decides that 7(a) money is what you need, you'll probably start hearing the names of the different 7(a) programs. For example if you're borrowing less than $150,000, you may be headed toward the Lowdoc program, which was created in 1993 to reduce burdensome paperwork. A Lowdoc loan application is a one-page form; your application is on one side and the lender's request to the SBA for the guaranty for your loan is on the other. The SBA responds to Lowdoc applications within 36 hours.
The SBA Express is a program for lenders with a good SBA-lending track record. It's aimed at getting money--in this case, as much as $250,000--quickly into the hands of entrepreneurs. Based on the success of the SBA Express program, the SBA initiated CommunityExpress, specifically designed to improve access to capital for low- and moderate-income entrepreneurs and to provide both pre- and post-loan technical assistance.
Eligibility: The eligibility criteria for the 7(a) program are the broadest of all the SBA loan programs, but they're still quite restrictive for startups and businesses related to financial services. Visit the SBA's web site for a list of the types of business that are eligible. In general, all SBA programs are targeted at small companies (that is, businesses with less than $7 million in tangible net worth and less than $2.5 million in net income), but typically most banks won't lend to startup businesses that don't have two to three years' worth of financial statements and some owner's equity in the business. Some banks will allow you to use money from relatives as part of your equity, but you're required to formalize these loans with a repayment plan that's subordinate to the bank debt.
504 Loan Program
The 504 loan program is intended to supply funds for asset purchases, such as land or equipment. Typically, the asset purchase is funded by a loan from a bank or other lender in your area, along with a second loan from a certified development company (CDC) that's funded with an SBA guarantee for up to 40 percent of the value of the asset--which is generally a loan of up to $1 million--and a contribution of 10 percent from the equity of the borrower. This financing structure helps the primary lender--the bank--reduce its exposure by relying on the CDC and the SBA to shoulder much of the risk.
Eligibility: Like the 7(a) program, the 504 program is restricted to small businesses with less than $7 million in tangible net worth and less than $2.5 million in net income. However, since funds from 504 loans can't be used for working capital or inventory, consolidating or repaying debt, or refinancing, this program tends to exclude most service businesses that need to purchase land or equipment. Personal guarantees are also required for 504 loans.
7(m) Microloan Program
The Microloan program is presently under budgetary review, and the political winds aren't currently blowing in its favor. The program is intended to provide "small" loans of up to $35,000 that can be used for a broad range of purposes to start and grow a business. Unlike the 7(a) program, the funds to be loaned don't come from banks; rather, they come directly from the SBA (now you know why it's unpopular with the folks in charge of the budget) and are administered to business owners via nonprofit community-based intermediaries. Visit the SBA's Microloan Program to find an intermediary micro-lender in your area.
Eligibility: The Microloan program is startup friendly. All new businesses are eligible to apply. Although the maximum loan amount is $35,000, the average loan is approximately $10,000. The only catch is that Microloan borrowers typically have to enroll in technical assistance classes administered by the micro-lender intermediaries. For some entrepreneurs, this is a very helpful resource that provides cost-effective business training. Others, however, perceive it as a waste of time, although it's a necessary pre-condition to getting a Microloan.