Obtaining Finance For Your Business
Created by: Nina Southern
Entrepreneurs Start-up Sources
• As you learned in Chapter 19 Entrepreneurship & Small
Business Management, there are several ways to
finance your business:
– The main sources for start-up money for entrepreneurs
include:
 Friends
 Family
 Other resources, such as savings, credit cards, loans, and investments
– Some sources of financing include:
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Banks
Finance Companies
Investment Companies
Government Grants
– Some sources of equity financing include:
 Angel
 Venture Capitalist
Start-up From
Friends and/or Family
• Friends and family are the most common source of startup capital.
• But such loans are not without risk.
• For a lot of startups, money is tough to come by. So it's not
surprising that many fledgling entrepreneurs think about borrowing
from the Bank of Mom and Dad or floating their business plans by
college buddies.
• In fact, borrowing money from friends and family is the most
common method for raising startup capital.
• But getting a business loan from your friends and family can't help
but become personal -- and there are countless horror stories out
there to prove it.
• That said, there are also plenty of successful entrepreneurial stories
that begin with conversations at the Thanksgiving table or the local
bar.
• How can you approach this tricky topic and ensure that your
personal relationships do not suffer?
5 Things You Need To Know When
Borrowing From Family & Friends
1. Money will impact your relationships
2. Treat this as a business relationship
3. If your loan is more than $10,000, enlist an
accountant
4. Put everything in writing
5. Be realistic
Money Will Impact Your Relationships
• Not that you haven't considered that. But it's worth really
thinking this through.
• If you can't pay back the money your friends or family loan
you, or if you take it and then don't communicate with them,
you could lose your relationship.
• And while you may be right if you're thinking, "Mom would
never disown me," or, "Chuck and I have been friends since
third grade," the respect they have for you could take a hit.
• "Make sure that this loan doesn't put the family member or
friend in a hardship," urges Lisa Baskfield, a member of the
American Institute of Certified Public Accounts' National CPA
Financial Literary Commission.
• "It's similar to investing in the market. The person loaning the
money should be okay with the idea of losing all funds."
Treat This As A Business Relationship
• Jeffrey L. Yount's advice seems right on the mark. "Treat this
transaction as a normal business transaction," advises Yount, a
partner at B2B CFO, which provides CFO services for emerging and
mid-market companies.
• "That's what it is. Don't have an attitude that implies, 'These are my
friends and family. They will understand if I miss or delay a monthly
payment, or fail to provide timely financial information or fail to
communicate financial issues.‘
• " At the same time, Yount says, "This is your business. Don't let the
friends and family interfere with the day-to-day operations.
• Remember, they have only provided some financing -- they are not
co-owners."
If Your Loan Is More Than
$10,000, Enlist An Accountant
• Mitchell Freedman, who owns the Mitchell Freedman Accountancy
Corporation in Westlake Village, Calif., correctly observes that many family
and friends don't want to charge borrower interest to their relative or pal
who is starting up a business. But they may have to.
• "If the loan is for more than $10,000, the lender is required by tax law to
charge interest on the loan, even if her or she doesn't want to," Freedman
says.
• “If there is no interest, then OID [Original Issue Discount] effectively
reduces the amount of the loan and requires the lender to pick up a
portion of the repayment as interest income. The IRS issues monthly
minimum interest rates that must be charged, called AFR [Applicable
Federal Rate]."
• In other words, if the loan is more than $10,000, thank your friend or
family member profusely -- and then consult a tax accountant or attorney.
Put Everything In Writing
• That may sound obvious, but we would be remiss if we didn't stress it. All
of the terms -- how much the loan is, when it's going to be paid back, what
the interest rate will be if there is one -- should be put down on paper.
Freedman adds that if there's any collateral you plan on giving your friends
and family if the loan isn't paid back, put that down, too.
• Gail Cunningham, a spokeswoman for the National Foundation for Credit
Counseling, suggests explaining what will happen to the loan if you die.
"Will the loan be forgiven, or will it still be owed?" she asks.
• Now, of course, if we're just talking a loan for a few hundred dollars, the
stakes aren't as high. Plus, these are your friends and family we're talking
about. Chances are, if you somehow perish before your company is
moving along, and you leave some friends and family in the financial lurch,
they won't shake down your spouse, kids or elderly parents for the rest of
what you owe them. On the other hand, you never know. The more
money you borrow, the more of these questions you should ask.
Be Realistic
• Baskfield urges realism on payment terms and warns,
"Don't make false promises." Because they're your friends
and family, you may feel the urge to dazzle them with
suggestions that they're all going to become rich, fast. But
starting a business can be extremely challenging, and this is
a tough economy.
• When you're borrowing from friends and family, if you can,
under-promise and over-deliver. But above all, when
structuring your repayments, pad in some extra time for
unexpected problems -- like having your own clients or
vendors dragging their feet in paying you back.
Financing Through Banks
• Every business needs a certain amount of money to start. The
entrepreneur on the threshold of starting a new venture, has to work out
where and how he will get access to sufficient funds.
• The first organization that he thinks of is his bank. Yes banks are almost
always one of the first organizations to be approached for funds in the
form of a loan. It is here that harsh realities hit the entrepreneur who soon
learns how difficult it is to get a bank loan to finance his small business
venture. A select fortunate few, do manage to fulfill all the pre-requisites
for a bank loan, and are successful in procuring them. But for every
successful loan application there are many that get rejected. The tough
regulations linked to bank loans are gradually undergoing a change with
banks realizing the phenomenal potential of small businesses. This
explains the special programs and additional services launched by big
banks to woo small businesses.
• Bank loans are just one of the various options available for small
businesses to raise funds. The final decision about where to secure funds
depends on the balance between the pros and cons of the source. Like all
other funding sources, bank loans also come with their share of
advantages and disadvantages.
Advantages and Disadvantages of
Small Business Loans from Banks
Advantages
Disadvantages
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Convenient and accessible- Banks are always
accessible since they are used regularly for
depositing savings or withdrawing them. After
being bank customers for years, the bank becomes
convenient and familiar, and personalized service
makes it the first place to consider for a loan.
Multiple Loan options- All banks advertise various
types of schemes to woo entrepreneurs setting up
or running a business. The real earnings for a bank
come from the interest they charge on these loans.
Options like term loans, standard business loans
and others are available for the entrepreneur.
Non profit sharing- Venture capitalists and angel
investors agree to provide a loan in exchange for
part ownership, the right to influence decision
making and a share of the profits. Banks do not ask
for any of these. If they do sanction a loan, they are
only interested in getting their interest and partial
loan payment installments.
Lower rates of interest-Though tough to get, banks
provide loans at lower rates of interest than other
lending agencies and instruments like credit cards.
Bank loans offer tax benefits- Small businesses
taking loans from banks enjoy some relief from tax,
since the percentage of profits used to repay the
loan is exempted from tax.
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Lengthy application process- banks need to verify all the
credentials and details about the business before
sanctioning a loan. Therefore its application process is very
long and its review etc. takes a long time.
Cumbersome- The prospect of getting into the detailing
that banks require is really cumbersome, and from the
entrepreneur’s point of view, totally unnecessary.
Preference given to existing, running businesses- banks
prefer running businesses because they can gauge its
profitability and credit history before sanctioning the loan.
Long list of prerequisites to qualify for the loan- banks
have long list of conditions that a business should fulfill
before they clear the loan. It is sometimes not possible to
meet all of them.
Risk of losing Collateral- bank loans are generally
sanctioned against some collateral, often the
entrepreneur’s house and property. This stands the risk of
being lost to the bank should the business fail to take off.
Entire amount not granted- banks are known to not agree
to grant the whole amount requested for a loan. They may
grant 70 or 80 % of the sum applied for. This makes it
difficult for the entrepreneur to begin since he has to
scout around for the remaining balance and find agencies
to funs that before he can start.
Financing Through Finance Companies
• A Finance Company is a company which
makes loans to individuals and/or businesses.
• It is usually easier to obtain a business loan
from a finance company than a bank,
however, the interest rates on a business loan
through a finance company is more.
Finance Through Investment
Companies
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An Investment Company is a corporation or trust engaged in the business
of investing the pooled capital of investors in financial securities.
This is most often done either through a closed-end fund or an open-end fund
(also referred to as a mutual fund).
In the U.S., most investment companies are registered with and regulated by the
Securities & Exchange Commission under the Investment Company Act of 1940.
Also known as "fund company" or "fund sponsor".
Investment companies are business entities, both privately and publicly owned,
that manage, sell, and market funds to the public.
They typically offer investors a variety of funds and investment services, which
include portfolio management, recordkeeping, custodial, legal, accounting and tax
management services.
Equity Financing
Angel
• A private, nonprofessional
investor, such as a friend, a
relative, or a business
associate, who funds startup companies
Venture Capitalist
• Individual investors or
investment firms that invest
venture capital
professionally
Angel Investors vs. Venture Capital
Angel Investors
Venture Capital
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Individual, accredited investors
Typically have industry expertise in the area
they are investing
Provide early-stage investment
Typically invest $25,000 to $1,500,000
May invest individually or with groups of
other angels
Offer guidance and advice to management
team
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Typically general partners investing 3rd party
money
Do not typically provide early stage
investment
Diversified portfolio expecting a large home
run on approximately 1 out of 10
Need to generate a specific return on
investment (usually around 25-30% internal
rate of return annually across the entire
portfolio)
Will remain active in the management of the
business
Typically will require a board seat and may
seek majority control
Investment size typically ranges between
$1,500,000 to $10,000,000
Some venture firms are set up to invest in
early stage companies and make investments
more similar in scope to those of an angel or
angel group
Friends
Which is Better?
Family
• Now after viewing the “Obtaining Finance For
Your Business” presentation, which source of
finance do you think is best for a business?
• Which is better for your business?
Angel Investor
Bank
Finance
Company
Government
Grants
Investment
Company
Venture
Capitalist
Obtaining Finance For Your Business
Quiz
• Go to Quia to take your quiz:
– http://www.quia.com/quiz/3900799.html
References
• Angel Investors vs. Venture Capital. (2008). Ladies Who Launch.
Retrieved October 28, 2012, from
http://www.ladieswholaunch.com/magazine/angel-investors-vsventure-capital/1385
• Finance Company. (2012). Investor Words. Retrieved October 28,
2012, from
http://www.investorwords.com/1942/finance_company.html
• Investment Company. (2010). Investopedia. Retrieved October 28,
2012, from
http://www.investopedia.com/terms/i/investmentcompany.asp#ax
zz2AbhfQf5E
• Williams, G. (2010). Borrowing from Friends and Family. Retrieved
October 28, 2012, from
http://smallbusiness.aol.com/2010/07/19/how-to-borrow-moneyfrom-friends-and-family/