How do I borrow money for a startup? Is that different from a franchise?
To borrow money for any business, these are basic questions that apply equally to a new startup concept, existing business or franchise opportunity.
How much do you need?
What is it for?
How will you pay it back?
Lenders and investors want to know the answers to these questions and more.
How much do you have invested in the business? (Your equity).
How long have you been in business? (Helps to substantiate the projections)
Is the business profitable or to what degree will losses need to be financed?
How diverse is the revenue risk (do you have one customer or lots of customers)?
Individual investors, traditional lending sources or the new online lending sources ask these questions. All are trying to evaluate the company’s ability to earn (be a going concern) and repay (hopefully from cash flow).
The difference for a startup and a franchise is a startup must establish there is a market for their product or service. A franchise can point to other successful franchise operators.
There are, of course, many more questions the lenders and investors will ask. These follow-up questions are further attempts to assess the ability of the company to be sufficiently profitable over the years required to repay the loans or provide a return to investors.
Their analysis will include sophisticated ratio analysis to evaluate returns on assets and equity, asset turnover ratios, revenue and expense trends and determination of risks that may have significant impact on the operation. Explaining this detailed analysis is the subject of college courses and unending discussion and underscores the ultimate need for a good accountant or Chief Financial Officer.
Who loans money? Banks, individuals, etc.?
There are a variety of financing sources available.
Personal sources - (Savings, Home Equity lines, Credit Cards). This is money that would be available for personal emergencies, your kid’s college tuition or your retirement that you have decided to divert to your business.
Friends and Family- Mom and Dad, brothers and sisters, long lost cousins, friends and/or business associates. These are people that know you and have regard for your ideas and potential. This is usually “patient” money without a immediate repayment need.
Vendor Financing. Vendors may allow 60 day or 90 day terms. This is not a long-term loan but it can be a small portion of the financing you need. Remember, as you sell your product or service to your customers, you may not be paid immediately and having extra time to pay your bills due to suppliers will provide some help.
Customer financing. Will your customers prepay for your services? Software licenses are often prepaid. Deposits paid in advance tie the customer to you and can provide a portion of the cash you need.
Online Sources. A brief online search resulted in 10 sites (Kabbage, OnDeck, PayPal etc…). These sites are a mix of bank type lenders, credit card voucher advances, and factors. Sometimes you are repaying from profits and cash flow. Often you are paying from the collections of monies due to you (accounts receivable or a portion of credit card sales).
Equipment leasing - Useful if you need to finance specific equipment.
Factors – These companies will advance cash against your accounts receivable.
Banks/SBA Financing – Bank financing is only limited by the need, risk assessment, repayment ability and house limit of what the bank will loan to a single customer. If the bank requires a SBA guarantee, the limit of the SBA guaranty is $750,000.
Angel Investor - A businessperson or associate with money. This is a person looking to earn higher returns and willing to take on higher risks.
Venture Capital - A professional investor looking for the potential of very very high returns. (Duplicate word is not an error!)
Remember, loans have a specific repayment schedule. Lenders expect to be paid in installments from cash flow or possibly from the sale of collateral assets or from you (the business owner) as the guarantor of the loan. An advantage of debt financing is that it allows you to keep your ownership interest without sale or dilution.
Investors are looking for a return on their investment. They may want dividends (rarely), but usually want a say in how the business is run and ultimately a gain on the sale of their investment. An investor will require an ownership interest.