Most people who start a new business use personal credit cards, personal savings and family loans for initial financing. However, not all entrepreneurs have the means to self-fund a business, so they may consider a bank business loan to access capital.
Although there are plenty of financing options for start-ups, not all traditional banks approve funds equally. Few are willing to lend thousands of dollars to a business that has yet to bring in revenue. Established businesses might have more loan options, but their success is not guaranteed.
To be successful, you must begin thinking creatively about how you can acquire cash. One way of doing this is to look at alternative sources such as asset based lending. This option just might be the gateway you need to see your big ideas and plans come to fruition.
It helps to understand how asset based loans can benefit start-ups by first knowing the hurdles banks have for getting a business loan. On popular consideration if your business is going to sell on credit terms is to get a small business factoring company to finance your receivable assets.
One of the first thoughts that enters a new entrepreneur’s mind when it comes to start-up funding is a bank loan. There is nothing inherently wrong with a bank loan, but there are better alternatives to funding your start-up. It is important to understand your financing options before seeking out sources.
The best way to start the process is to create a comprehensive business plan that will outline how much initial funding you will need. A business plan also uncovers how much operational cash you will need before the business starts to break even. Once you have your business financials planned out, the next step is to think about how you are going to get that start-up cash.
Funding a business start-up is both exciting and frustrating at the same time. It is exciting because the end result of all your hard work is giving something you built chance to get off the ground. It can be frustrating because even the best laid plans can go astray and cause a lot of problems.
The reason you may not want to fund a start-up with a bank loan is because the overall cost of the loan puts your company in debt the moment the doors open. A bank loan has interest and service charges that make that digs a debt pit before you get started.
When your company starts operating, you will have a difficult time trying to climb out of that pit. You should do your best to avoid taking on those kinds of extra financial burdens.
When you apply for a business loan, lenders carefully consider the following five credit factors:
If you are a first-time borrower, it is important to understand these credit factors. Doing so might improve your chance of successfully obtaining the bank loan. Even seasoned business owners can benefit from brushing up on their banking knowledge before submitting an application.
It is rare to get approved for a business loan from a bank without offering some form of valuable collateral. This helps to reduce the bank’s risk in loaning you a large amount of money. If you get behind on your loan payments or default entirely, the bank can sell the collateral to recoup its investment.
Assets that banks typically accept as collateral include accounts receivable, buildings, equipment and inventory that can quickly be converted into cash. According to the Small Business Administration (SBA), you will need to secure an appraisal on loans greater than $250,000 that are secured by real estate.
In most situations, you are not required to put up your personal home as collateral. However, an exception may be made in the following situations:
If you operate as a partnership, keep in mind that anyone who owns a 20% or greater share in the business must pledge collateral and submit a personal guarantee. However, bankers generally do not turn down a business loan request for weak collateral if all other credit factors are strong.
The bank wants to ensure that an existing company is able to meet all of its financial obligations, not just loan repayments. While evaluating your loan request, the assigned loan officer will look at your financial projections, which includes cash flow.
Loan approval is not likely if your company’s cash outflow exceeds its cash inflow. You must prove that you have the ability to make loan payments from existing cash on hand. To do this, you must prepare and present a cash flow projection report.
The report should indicate the point at which the income your company receives will convert into cash and when you expect to pay other business expenses. Your cash flow projection should cover the three-month period immediately following disbursement of your loan funds.
It is important that you make it clear to the lender how you intend to generate funds, especially as a start-up business. This is also necessary if you expect revenues to be significantly higher during the quarter than it has been in the past.
Commercial loan officers expect you to have a reasonable amount of money invested in your own business. If the amount you have invested is inadequate, the loan officer will probably conclude that you are unable to operate the business on a sound basis even with the loan proceeds.
The loan officer will ask you to prepare a debt-to-loan ratio statement to evaluate how much debt you have relative to business equity. A loan officer is especially interested in seeing an analysis of your company’s earnings along with variability and viability of these earnings.
Any assets that you own on behalf of your business should be included in the debt-to-loan ratio that you prepare. The loan officer may also request that you have the assets professionally appraised. If you own a more established business, you should be prepared to show financial statements that back-up the amount of equity investment you are reporting.
When lenders consider resource management as a credit factor, they are looking at the big picture of your business. The areas lenders are particularly concerned with include:
While you can usually prove your worthiness for a business loan on paper, remember that the loan officer is constantly evaluating your character as well. His or her impression of you may be made within the first few seconds after you are introduced.
Be sure that you arrive for the meeting with your lender dressed in appropriate business attire, that you make eye contact and appear confident at all times. If you are not confident in your company’s ability to repay the money you are requesting, you cannot expect a lender to be either.
The loan officer will also assess your educational background, work experience and skills. You should be prepared to discuss past accomplishments in business as well as what you hope to accomplish with this particular business loan. However, you also need to provide strong references who can verify what you say to the loan officer.
The formal definition of working capital is the difference between your business assets and your liabilities. Lenders like to see that you have a fair amount of liquid assets, which means that you have cash or assets that can quickly be converted into cash.
Anything that is due and payable by your company within the next 12 months is considered to be current liabilities. To arrive at a figure that represents your working capital, a loan officer subtracts your current liabilities from your current assets. The figure can be positive or negative, but obviously you want it to be as high as possible before you apply for a commercial bank loan.
From the bank’s point of view, the availability of working capital is a good indicator of the financial viability of a business. A positive working capital means that you have the ability to meet your short-term debts.
If you have sufficient working capital, you may want to consider paying down some of your smaller debts before applying for a large loan with a bank. The same is true if you are presenting working capital projections for your start-up.
It can be especially challenging for seasonal businesses to have working capital that is acceptable to a business banker. For example, if you take in more money during the holidays than you do the rest of the year, you need to demonstrate that there is enough cash on hand to meet expenses during off-peak times.
If you need to borrow money to meet payroll, pay operating costs and purchase inventory when sales are slower, a banker may interpret this to mean that your company will not be able to make loan payments during these times either.
The bank wants to see that you can budget for expenses in months where sales volume is lower and not overspend in months when you are taking in more money. An alternative lender specializing in asset based finance understands your desire to keep the doors open when things happen outside of your control.
How Banks Determine Interest Rates for Business Loans
Business financing is one of the most complicated parts of owning a company. It can also be one of the chances you get to negotiate in your company’s best interests. Whenever your company secures any type of financing, there is always an interest rate involved.
As every business owner knows, the interest rate is how the finance company makes its money. What every business owner may not know is that interest rates for long-term business loans are affected by many different elements.
Before you sign on the dotted line and accept the financing that a bank lender offers, it is important to take some time to analyze the interest rate. There are steps you can take to help get an interest rate on your financing that creates a better deal for your company in the long run.
A business has a credit rating in the same way that a consumer does. The difference is that a business owner should be extremely proactive about setting up a business credit profile. The next obligation is making sure the profile is properly maintained.
To set up your business credit profile account, you need to contact Dun and Bradstreet and apply for a profile. Once your profile is approved, you have to make sure that there is activity on it.
Just because a company has a credit profile does not mean that information is being added to it. If you want to improve your credit rating, then you need to monitor the credit profile regularly and make certain that your vendors are submitting all of your activity.
If you have a vendor that is not submitting your information, then you should contact that vendor and find out why. If the vendor persists in not submitting your credit payment information to your credit profile, then you may have to switch vendors.
Duration of Financing
Even if you are not an expert in mathematics, it is not hard to figure out that a long-term financing deal means more interest income for the lender. Most corporate borrowers cringe when they see just how much money a lender makes in interest and finance charges through the course of a long-term financing arrangement.
Rather than cringing, a good business owner should look at it as a part of doing business and utilize the interest income as a negotiating point. The length of your agreement can affect your interest rate significantly. If you get financing with longer terms to pay the money back, then try to negotiate a lower interest rate to reduce the overall cost of your loan.
One way some companies try to lower interest rates for long-term financing is to put up company collateral on the loan. Collateral is property owned by the company that can cover the value of the loan. When collateral is used to get a business loan, then that creates a secured loan.
In many cases, the ability to put up collateral to back the value of a loan can motivate the lender to bring down the interest rates and lower the overall cost of the loan.
Remember that property must be paid off before it can be used as collateral. The lender will want to see receipts and proof that the property is paid in full before it will allow something to be used as collateral.
If you want to negotiate a comfortable interest rate with a bank for long-term financing, then it helps to maintain a long-term relationship with the bank. Typically, a bank will hike up the interest rate for a loan to a new company.
This is because the bank is does not have a business relationship with that company. But if the bank has already been through a few loans with a company, then that opens up some room to negotiate the interest rate.
Business financing is just as much a personal relationship between the banker and business owner as it is a professional association between two organizations. A proactive business owner attempts to cultivate relationships with several lenders just in case they need to use a secondary lender for financing. When there is a pre-existing relationship, it becomes easier to get a more competitive interest rate.
When a company needs to get long-term business financing, it wants to leverage its credit history and its history with the lender as much as possible. The more that a company can do to help bring down the interest rate on long-term financing, the more that company will save on the total cost of the loan.
The key is to remember that the lender needs to show a profit as well. When there is an atmosphere of mutual respect, then there can be productive interest rate negotiations on long-term loans.
Bank lending can be a tough process when your company is just starting out because you do not have a borrowing history for the bank to use as a reference. That means that your interest rates will be high. Most likely, you will wind up paying a lot for your start-up if you get financing from a bank.
The best approach is to investigate all other options and put together a start-up financing plan that prevents you from having to borrow from a bank. In the long run, it will be a decision that can be a tremendous benefit to your company.
Consider Starting Your Company with Partners Instead of Employees
Avoiding the costly effects of using a bank to finance your new company may require a little creativity. In fact, everything you do in the beginning can affect how well your company thrives in the future. Two primary activities are how you initially setup the company and whether you hire employees.
The ability to pay employees a regular salary is not something you can realistically expect to do until your company is earning a consistent profit. However, you cannot always do everything yourself. A practical solution to this dilemma is to start your business with people who can afford to work for a deferred salary.
You can also offer your partners equity in the company in lieu of cash payments. When forming your initial business team, look for people with various strengths to ensure that you can meet the needs of your growing business.
A good business partner is one who can offer start-up capital as well as other valuable resources to your organization. For example, you could connect with one or more partners who provide a significant portion of the start-up cash.
Another partner can bring in a customer base that is interested in your product or service. Just make sure you get a contract between yourself and the partners so that there are solid guidelines that can be followed.
Another partnership to create is with shareholders. You can print up shareholder agreements and start looking for people to buy shares in your start-up business idea. While it is easier to have shareholders when you are a corporation, it is not necessary to be a corporation to take on business investors.
The important thing to remember is that there are shareholder rules you will need to follow when you do incorporate the business. Talk with an attorney to find out specific guidelines you need to follow.
Talk to Investors
Sometimes taking on investors early in the start-up process is easier than trying to bring investors in after you have already developed a corporate culture. When you talk to investors who have money and resources to offer, you can make room for those resources in your corporate structure from the beginning and then work with that arrangement as the company grows.
Starting a Business with a Small Budget
According to business experts, the majority of small business owners start their companies with a budget of less than $10,000. This money usually comes from:
If you have great business ideas but not a lot of money to invest, these strategies can improve your chance of success with your start-up business.
Know How Much it Will Cost to Make Your First Sale
It is a common mistake for new business owners to underestimate the investment required before the first income is received. You need to factor important processes to producing a product or service such as:
If the grand total of creating your product is more than you currently have, you must find a way to cut expenses. You also need to be careful about taking on too much business debt before your company is profitable. This can easily happen if you work with a bank that is willing to finance your venture.
With asset based lending, you could use the value of raw materials to fund your budding company.
Invest Only in the Essentials
Eventually, you may get to the point of having a large corner office, a private secretary and an unlimited expense account, but you are not there yet. Being realistic and setting low expectations during your first several months in business can go a long way to sustaining a profitable business.
This may mean sharing office space, renting office furniture and working in a sparsely decorated building until you can afford to do more. It is also important that you put off major purchases for as long as possible. This gives you time to research the product and comparison shop for the best deals.
Provide Outstanding Customer Service
Many people prefer doing business with smaller organizations due to the level of personal attention they receive. You can use this to your advantage and focus on building relationships with your customers.
Actions from you and your team should show them that your company cares about their well-being and not just making a sale. If your customers are fellow business owners, refer people to them as often as you can. They are likely to respond in kind.
Focus on Building a Passive Income Stream
It is fine when your company focuses on one-time big ticket items to sell, but you should also have back-up sources of income to even out the inevitable sales peaks. Examples include paid subscriptions, accessories for your main product and electronic books.
It may seem like offering your customers lower priced items is too much work, but consistent sales throughout the year can make a big difference to your bottom line.
Make Cash Flow a Priority
As you are building your new company, concentrate on also building cash flow over other measures of financial success like market share and profits. It is important to be extremely realistic about revenue projections.
This way, you can avoid dealing with a constant lack of cash flow. Research as much as you can about ways to accelerate cash flow into your business and determine to make it a priority.
Financing the Ongoing Operations of Your New Start-Up
Many unknown factors are at work when you write the business plan for a new start-up. You have a general idea of the amount of cash needed to get the company off the ground. Your meticulous work in figuring out a starting budget has helped.
However, the sales and expense projections you have created are guesses at best. They may be educated guesses based on plenty of reliable information, but they are still guesses. Until your start-up begins operating, ongoing costs will remain a mystery.
One good thing about sustaining operations for your start-up is that the need for more cash usually indicates brisk sales and capital is needed to fulfill invoiced sales. If sales are not brisk, then the need for excessive operating capital indicates a poorly run organization that will probably not be around for very long.
As the company grows, it needs to constantly feed itself with cash to sustain operations. That is often easier than it sounds.
Start-Ups Lack Credit History
Most companies go through a financial limbo where the cash used to start runs out. At the same time, cash flow from invoices is still slow because of late paying customers.
When invoices go 30 and 60 days late, the impact on the start-up’s cash flow can be devastating. The reality of relying on customers with credit terms to pay their invoices suddenly hits home when the company tries to meet financial obligations with little cash on hand.
If the company were established with years of operations, then it may be able to fall back on a credit profile that allows it to borrow the funds to keep operating. But, start-ups do not have the credit histories necessary to borrow funds, and that makes the limbo phase of a start-up even more dangerous.
Credit Cards are a Bad Option
A stop-gap measure that many start-ups attempt to use to sustain operations while waiting for clients to pay on their invoices is to sign up for credit cards. Business owners can sometimes get credit cards in the company’s name. However, it is more likely that the credit cards are in the owner’s personal name.
Mingling business and personal funds can become extremely complicated when the business owner is trying to determine company expenses. It becomes an even greater nightmare when it is time to file taxes. Generally, credit cards are an unreliable and expensive way to fund the ongoing operations of any business.
Bills Start to Pile Up
Using credit cards to pay for operational expenses might not be the best financial decision, but it is understandable. That point where a start-up runs out of initial funding and is still waiting on customers to pay their invoices is daunting. The company’s credit score starts to take a hit if bills remain unpaid.
Vendor bills are usually the first to go unpaid because financial resources company are put into payroll and making sure the lights stay on. After a while, the start-up finds itself being that company which is paying its bills 30 and 60 days late.
It does not take long for the vicious cycle of past due invoices slowing cash flow to start dragging a company down. The business owner in this position may feel like their hands are tied when they do not qualify for bank financing. But, there is an option for enough cash flow to meet ongoing obligations
Asset Based Finance is the Solution
It can be frustrating to watch accounts receivable pile up while your company suffocates from lack of cash flow. 1st Commercial Credit is an international leader in invoice factoring services for small to medium sized businesses. These are receivables-based lending services that use qualified invoices as collateral against cash advances.
We take your qualified invoices with creditworthy clients and turn them into the cash flow you need to meet ongoing financial obligations. With accounts receivable funding, you will be able to utilize your company's own financial resources to get through the limbo phase and start to grow.
1st Commercial Credit Works with Start-Ups
We make all financial decisions based on the credit scores of your clients, not your company. Whether your start-up opened its doors last week or last year, we can help you get the cash you need through invoice factoring. 1st Commercial Credit has customized asset based financing programs you need to make sure that all bills are paid.
Imagine your start-up being able to meet payroll every pay period through its own invoiced sales. Think of how much you could accomplish if you used asset based loans instead of bank loans to pay your vendor bills on time and preserve your company’s good credit score.
The future of your start-up would definitely look brighter if you took advantage of accounts receivable financing programs offered by 1st Commercial Credit.
Asset-Based Financing Works Fast
A start-up does not have a lot of time to wait around for a bank to respond to an application for help. The 1st Commercial Credit website has a two-page application online that you can use to get an answer the same day.
It only takes us five business days or less to set up your account, and then we can advance you funds within 24 hours of receiving qualified invoices. It is that fast and that easy.
We do not charge you any set-up or facilities fees. We advance you the full face value of your invoices, minus our small lending fee. We do not have a per month or per invoice minimum that would restrict our ability to meet your financial needs.
Our goal is to make sure that you get the cash you need regardless of how many invoices you have and how much they are worth.
A receivables-based line of credit from 1st Commercial Credit is a flexible form of financing that grows as your company grows. As your start-up starts to experience an increase in invoiced sales, you will also see your cash flow increase.
This is the ideal solution for any start-up that cannot get its customers to pay their invoices on time, but still needs that cash flow to meet ongoing obligations.
Do not let your start-up develop a bad credit score or even go out of business just because you have past due invoices. Contact 1st Commercial Credit today and we will use our invoice factoring services to turn those outstanding invoices into the cash flow you need.