Maine Small Business Development Center

FINANCING YOUR BUSINESS START-UP

Funding your start-up business may be the most difficult task you will encounter (although not necessarily the most important; finding a viable market is!). There is much to be said for "bootstrapping" your business (i.e., getting by with savings and money generated by the business.) In some cases, this may be the only way to get your business going. However, in many circumstances this is not feasible and under capitalization can be a very serious problem for start-ups. 

Start-Up Financing Sources

Most people immediately think of commercial banks when they determine a need for business financing. Unfortunately, as a source of start-up funding, banks end up far down on the list of likely sources. Instead, most small businesses are financed through private funding and other sources. Some of these sources include: 

  • Personal savings
  • Loan from family or friends
  • Personal bank loan
  • Refinancing or a second mortgage on real estate or other assets

(Note: Sources 3 & 4 are generally contingent upon your having a regular source of income, i.e., a job; thus, if you plan to travel this route, you need to secure this financing while you're still employed.)

  • Cash value of assets you could sell
  • Cash value of life insurance, stocks or bonds
  • Credit cards
  • Investments from partners
  • Advance payments from contracts (not a likely source)
  • Credit from suppliers 

Commercial Bank Financing

Most small business start-ups are inherently risky and commercial banks are traditionally risk averse. Bankers are neither investors in small businesses nor speculators, but they will lend money to a small business if its repayment is relatively assured. Commercial banks generally provide financing at comparatively low rates but in return expect a strict repayment schedule and detailed recordkeeping. Their main concern is whether or not you will be able to repay the loan in full and on time. The bank's lending officers look for specific criteria when evaulating your loan proposal. They will rate you on the following characteristics: 

  • Experienced management - Are you familiar with the business and do you know the industry?
  • Substantial investment - Are you willing to make a substantial investment of time and money?
  • Strong credit history - Have you borrowed similar amounts and repaid them in a timely manner?
  • Responsible character - Can your references vouch for your honesty and good business sense?
  • Good collateral - Do you have satisfactory collateral appraised high enough to secure the loan?
  • Adequate cash flow - With the loan, will the business generate enough dollars to pay off the loan and then some? 

Meeting the preceding criteria can be very difficult for a start-up business. Often one or more criteria cannot be met. It may be especially difficult to convince a banker that your projections of sales and cash flow are realistic. This can be accomplished but only by exhibiting extensive knowledge of the business and the market. The bank will expect to see a formal business plan, complete with pro-forma financial statements, and will expect you to complete a personal financial statement. 

Loan Insurance/Guarantees

When all the bank's criteria have been met, the banker will look for additional means to secure the loan. This can be done through a variety of methods: 

  • Personal guarantee - First of all, you will be required to personally guarantee the loan. If your business fails, you personally will be responsible for repaying the loan.
  • Co-Signer - If your ability to repay the loan - should the business fail - is in question, the bank may require that you find another person with the financial capacity to guarantee repayment.
  • SBA or FAME Guarantee - The U.S. Small Business Administration (SBA) and Finance Authority of Maine (FAME) primarily assist small start-up businesses by providing commercial loan insurance. The first step, to take advantage of these programs, is to get a bank committed to your project - for it is a bank that will make applications to SBA or FAME. SBA or FAME will have similar requirements of you in terms of experience, character, credit worthiness, collateral and cash investment. The primary difference is that they may be willing to accept more risk than the bank in the name of promoting small business. (Note: Even if you do get a guarantee from SBA or FAME, these agencies will still hold you personally responsible for the debt.) Finally, guarantees do not mean low interest loans. The loan is made at the bank's current rate and a fee is charged by the guarantee agency. 

Your first step in evaluating any business prospect should be a feasibility study to determine the potential of your particular product or service. The cash flow projection is a basic piece of any feasibility study. In it you estimate revenues and expenses of your business, generally on a monthly basis, for a year or two. This analysis is important in that it will tell you (and your banker or investor) what amount of funds you will need to invest in the business to keep it running until sales reach a point where they will support the business. This analysis will also illustrate the burden placed on a fledgling business by borrowed funds and will assist you in making the difficult financing decisions. Be aware that banks vary in their aggressiveness over time and between one another and that bankers themselves vary according to their own background and experience. Thus, you must be persistent and willing to shop around.