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Sources of
Business Capital
Savings Accounts

If you have savings, consider using the savings as collateral for a loan, rather than using your savings directly.

For example, you can use your $10,000 savings as collateral for a $50,000 loan, giving you an additional $40,000 to use in your business. If you do this, banks will probably require that you put the $10,000 savings in a certificate of deposit (CD) that you cannot touch.

Remember that by doing this, if your business fails, you will owe $50,000, and you will only have $10,000 to pay it. So make sure that you have a solid plan for paying back the loan.

401(k) Retirement Funds

If you cash out your retirement fund before you are 55, you will owe a 10% penalty plus tax on the amount you cash out. However, there are two other alternatives:

  • Borrow up to 75% of your contributions and interest. You cannot borrow against your employer's contributions; or
  • Set up a corporation with a 401(k) plan; rollover your old plan to the new one, and then invest your new 401(k) plan assets in your new corporation. If you do this, be sure to use professional tax and legal assistance.
Individual Development Accounts

Individual Development Accounts (IDAs) are matched savings accounts that enable low-income families to save and build assets. The working poor agree to save a specific amount per month, which is matched by the sponsoring agency.

The match incentive is provided through government or non-profit sources, such as the United Way.

To find an IDA sponsoring agency in your area, click here.

Stock Accounts

You can sell stock to fund a business or consider borrowing against your stock portfolio. Borrowing against a stock porfolio is called a margin loan. Brokers can lend you a percentage of the value of your stocks (at most 50%) with interest rates based on the federal reserve rates. There is no fixed repayment schedule, but you may be required to deposit funds if the value of your account falls.

The IRS will only allow interest to be deducted if the borrowed funds were used for a taxable investment.

IRA or SEP Retirement Accounts

You cannot borrow against an IRA (individual retirement account). You can withdraw funds for up to 60 days and re-deposit the amount without a penalty. However if you keep the funds for over 60 days, there will be a penalty, plus you have to pay taxes on the amount withdrawn.

You can not borrow against a SEP-IRA account. You can, however, open a Self-Employed Solo 401(k) and do a rollover of your SEP account into your Self-Employed Solo 401(k) account. Once the funds are in a 401(k) account you can borrow against your contributions to the 401(k).

Credit Union Accounts

Credit unions are often an excellent place to find small business micro-loans. Credit unions are member-owned and their mission is to invest in their members and their community. Often loans from credit unions are 1% below bank rates.

Credit unions are currently limited to loaning $50,000 to a member for a business. Any amount beyond that must have a state or federal guarantee.

Advantages and Disadvantages of Funds From Family and Friends

    Advantages

  • Family and friends know your capabilities and are willing to invest in your dreams.
  • If your business works out, the people closest to you also benefit.
  • You are most likely to turn to family and friends for help and advice, and it is better if they have a financial stake in your business.
  • If the funds are a loan, you have an option not repay it because your friend or family will "understand". With a bank loan, you must pay each month.
  • Disadvantages

  • By investing in the business, your family and friends will consider their opinions to be just as valid as yours.
  • If your business closes and they do not re-coup their money, your key relationships may suffer.
  • If the funding isn't documented properly loan or equity, your books can get "messy" and hinder you from getting other loans.
  • If you are offering equity in return for the funding, it may hinder your ability to make business decisions because there is more than one owner.
  • If you are a sole proprietorship, offering equity for the funding will complicate your legal structure and subject your investor to legal liability. If you make them a partner, they are legally obligated for all business debts. The only way to protect them is to incorporate or form an LLC (or take the money as a loan instead).
  • Selling across state lines

    If you are selling securities to people outside your state, you are responsible for complying with SEC rules. Generally, you do not have to file with the SEC if you comply with Regulation D:

  • Rule 504: Offering up to $1 million in securities within a 12 month period. You may not publicly advertise. Unless you sell exclusively to "accredited investors" (they have net worth over $1 million), the securities must be "restricted" - that means they are not to be resold. This restriction should be stated on the stock certificate.
  • Rule 505: Offering up to $5 million in securities to accredited and up to 35 non-accredited investors. You may not publicly advertise. The security is purchased for investment, not the intention to resell. Purchasers cannot be sell the security within a 12 month period (this should be stated on the stock certificate). You must provide audited financial statements.
  • Rule 506: Unlimited offering in securities to accredited and up to 35 "sophisticated" investors. Sophisticated investors must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment. You must provide audited financial statements.
  • Click here for more information about SEC filings

    Partnership or Loan?

    It is critical that you decide whether the funds are to be repaid. If yes, this is a loan and it should be put in your business' balance sheet as a liability. You should document the loan (even in a letter) with the interest rate and repayment schedule.

    If funds are not to be repaid, the funds are either a gift or a partnership investment. Unfortunately, setting up a partnership investment has complications. Partners have the same liability as the owner, unless you form a limited partnership, a corporation or an LLC. That means if the business fails, the partners will use their personal assets to pay any business debts. Unless the partner is involved with the day-to-day operations, most people would not agree to this.

    To solve this problem, you can get creative and set it up as a loan, with payment terms be based on the company's net revenue. Then document it as a liability on your balance sheet.

    If you set up a partnership, limited partnership, corporation or LLC:

  • Document the partnership and clearly show the percentage ownership.
  • Provide regular information (reports, financial information) to your partner
  • File taxes as a partnership and pay your partner his/her percentage
  • Funds from Friends of Friends

    To avoid criminal securities violations, you should NEVER publicly advertise the stock and only seek funds from people you directly know. Otherwise, you should work with an attorney to make sure you are following securities laws.

    An attorney can help you do a private placement, which allows you to sell ownership interests to "accredited investors" (people with over $1,000,000 in personal wealth).

    Never advertise ownership interests to the general public. This is a serious violation of SEC (Securities and Exchange) rules.

    If you sell a security, you are responsible for complying with your state's securities regulations. Usually for small transactions there is a simple form to complete (or no form).

    Best Practices

  • Provide full disclosure of your business - your strategy, your operations, and your financial information.
  • Document the agreement as a loan or as an equity investment, ideally with help from an attorney.
  • Have full disclosure on your plans for the business and your expectations for the future.

    Ongoing Responsibilities

  • Provide ongoing disclosure of your business - your strategy, your operations and your financial information.
  • Do not mix personal and business assets or money. Keep your books clean and up-to-date.
  • If it is a loan, repay it per your agreement and document any changes to that agreement.
Advantages and Disadvantages of Using Credit Cards to Fund a Business

    Advantages

  • It is fast, with little or no paperwork
  • You don't have to prepare a business plan or provide income tax returns
  • Using credit cards simplifies bookkeeping - expenses are automatically tracked with one payment per month
  • Some credit cards offer rewards that can be significant (i.e. 5% cash back on all purchases)
  • Disadvantages

  • Interest rate is usually higher than loans
  • It is too easy to mix personal and business expenses. For corporations, separating personal and business expenses is important to retaining your corporate status. For all other businesses, mixing personal and business expenses makes it hard to determine profitability and make good business decisions.
  • There is a strong temptation to use credit cards without a solid plan. Usually when people obtain a business loan, there is a definite plan for the funds. Typically, credit card use is for unexpected (or impulsive) purchases.
  • Your credit score and negotiating credit card interest rates

    Before switching credit cards to get a lower interest rate, consider contacting your existing card company and requesting a lower rate.

  • Visit www.uscreditcardguide.com/en/ or www.bankrate.com to get actual interest rate information to use in your request.
  • Tell them how many years you have been with their company and that you are prepared to switch companies if the rate is not lowered.
  • If you have paid late or exceed your credit limits, do not expect good results.
  • If you are a good customer and you are not initially successful, ask to speak to a supervisor and/or call again in 10 minutes and ask again. Persistence pays.
  • How to choose a credit card

    Credit cards differ, and it is worth comparing them before choosing one. There are at least 5 things to consider:

  1. APR (annual percentage rate) for your purchases
  2. APR on balance transfers
  3. Annual fees
  4. Incentive rewards
  5. Credit limit
  6. http://www.creditcardguide.com/business-credit-cards.html allows you to easily compare online credit card offers. You should also contact your local bank to learn about their credit card offers.

    Personal Guarantees

    When you get a business credit card, be sure to ask about required personal guarantees. A personal guarantee means that if there are not enough business funds to pay the debt, the guarantor will use his/her personal assets to pay it. If your business is a corporations or LLC, this means that if your business closes, you will still be liable for the credit card debt.

    It is possible, but not likely, that you can get a business credit card without a personal guarantee. Your business would have to have a good credit rating.

    Secured credit cards

    Secured credit cards are for people with no credit history. You can build credit by depositing money equal to your requested card limit. Then, if you default, the bank has a way to get its money back.

    Generally secured credit cards are only used until you can establish credit and obtain a regular credit card.

    Please note that even though you have deposited money equal to your card limit, you are still required to pay monthly payments like regular credit cards. These monthly payments are the only way that you are establishing credit. (Cards where you don't have to make monthly fees are called cash advance cards; however they do not help you establish credit.)

    Secured credit cards with lower fees are often available through credit unions. Whatever company you use, it is important to compare fees and service. Watch out for companies that require additional "insurance" or high fees.

Advantages and Disadvantages of Using Home Equity Funds

    Advantages

  • Fast. You can get approval for a home equity loan quickly.
  • Good for new businesses without a track record or financial statements.
  • Lower interest rate and lower monthly payments than credit cards.
  • Flexibility to use the funds any way that you want.
  • Little paperwork; no business plan; no tax returns.
  • With equity lines of credit, you only pay interest on the funds that you use.
  • Disadvantages

  • You are mixing personal and business assets. Corporations, in particular, should not do this. (Corporations can have personal loans between the corporation and a shareholder, but it must be documented.)
  • With no business plan, there is a strong temptation to use the funds haphazardly.
  • Your spouse will be very unhappy if your business fails and you lose equity in your house.

Use equity for SBA guaranteed loan?

Instead of using the equity directly in a home equity loan, consider using it as collateral for an SBA loan. Although the loan process will take longer, your money will go further.

For example, if you have $50,000 equity that you could use in a line of credit, consider using that as 20% collateral for a $250,000 SBA loan.

Remember, that you have to pay back the full amount of the loan, so be sure to have a solid repayment plan.

Line or loan

A home equity line of credit allows you to use some or all of your equity (up to the line of credit limit). Payments are based on the amount of the line that has been used. You are expected to continually use and pay down your equity line of credit; there is no loan payoff-date.

Equity lines are best for purchases that you will be able to repay in one or two months. Usually there is an annual fee for a line of credit.

A home equity loan is a fixed amount that you take and use. Payments are fixed each month and you are expected to pay the loan off at a future date. Home equity loans are best for lump-sum purchases that you want to pay back over time. There are no annual fees for home equity loans.

Corporation? Here are some tips

Officially, you are not supposed to combine personal assets with corporate assets. If you use home equity loan to fund your corporation, you should do it as purchasing stock or as a loan between the corporation and yourself. Either way, you should document it in your corporate minutes and advise your accountant.

Home equity lines of credit mix personal assets with corporate assets and really aren't appropriate for funding corporations.

Best Practices

    Make a plan.

  • Why do you need the money?
  • How much do you need?
  • Take some time to decide how you can make your equity work the hardest for you.
How equipment loans work

Equipment loans are used to finance business vehicles, tools, fixed assets, and large computer systems. The equipment can be new or used. If new equipment, the loan can be for the total amount of the purchase. Used equipment is often 75% of the current cost of the equipment. It is easier to finance equipment that has a strong resale market (such as trucks) than specialized equipment with little resale use.

Even though the equipment will be used as collateral, borrowers still need to show they can repay the loan. They must provide business financial statements and business tax returns. Sometimes borrowers may be required to personally guarantee the loan.

Difference between equipment loans and leases

Equipment loans and equipment leases are different. At the end of a loan, you own the equipment. At the end of a lease, you return the equipment and presumably start the lease process again.

For bookkeeping purposes, if you have a loan, you put the asset and loan on your balance sheet. If you have a lease, you do not put them on your balance sheet, the lease payments are strictly operating expenses.

In both cases, if you don't make payments, the lender (or leaseholder) will repossess the equipment.

Information from the Equipment Leasing and Finance Association

The Equipment Leasing and Finance Association has developed Equipment Finance 101, with information on the benefits of equipment leasing, finance types, and loan/lease comparisons. Click here to go to Equipment Finance 101

Advantages and disadvantages of equipment loans

    Advantages

  • You can actually earn money if the income generated by the equipment exceeds the payments.
  • Usually, you do not have to use personal collateral or guarantees to obtain the loan.
  • The loan matches the economic life of the equipment so you can use the earnings from the equipment to pay for the loan.
  • Equipment loans are a good way for businesses to establish credit.
  • You can get a (partial) loan on used equipment, but probably cannot lease used equipment.
  • Equipment purchases (not leases) can be used as Section 179 federal tax deductions. You can deduct the entire purchase in the first year, even though you pay for it over several years.
  • Disadvantages

  • If obsolescence is a problem, leasing may be a better option. That way you are not stuck with trying to dispose of an obsolete asset.
  • If you plan to upgrade equipment, leasing may be a better option.
  • The loan is based on each piece of equipment that you purchase; so you must go through the same approval process with each new purchase.
  • UCC Statements

  • A UCC-1 Statement is the legal document showing that equipment or other property has been financed and the lender has a claim on that property until it is paid. The forms are filed with the county.
  • Best Practices

  • Lease equipment when you expect the equipment to improve in the next few years and you want to trade-in for the new product.
  • Buy equipment when the equipment is established, when you want immediate tax write-offs, or when the life of the equipment will extend beyond the financed years.
  • Use the lease/buy calculator to compare actual costs.
  • Ongoing Responsibilities

  • Insure the equipment.
  • Provide training on how to use the equipment safely.
  • Maintain the equipment (leases often require a maintenance agreement).
Advantages and disadvantages of using personal lines or loans to fund a business

    Advantages

  • No business plan required.
  • Fast - decision is made on your credit score
  • Sole proprietors are personally liable for any loan, so it doesn't matter what kind of loan they get.
  • Disadvantages

  • Your personal credit score is at risk.
  • Lines or Loans?

  • A personal line of credit is like a credit card - you only pay interest on the amount used. Your payments will vary each month based on the balance. You are expected to continually use and pay back the line of credit, without a final payoff date.
  • For a loan, all the funds are distributed to you and you pay interest on the total amount. You continue to pay regular payments until the loan is paid in full.
  • Corporation? Here are some tips

  • Using a personal line of credit for a corporation mixes personal and business assets. This could invalidate your corporate status. If you want to use a personal loan, it is best to use the person as a guarantor on a business loan. That way, you can keep personal and business assets separate.
  • If a shareholder is using a personal loan to fund his/her initial shares of stock, the shareholder should pay back the personal loan; NOT the corporation. Think of how it works with Google stock. If you borrow money for 10 shares of Google stock, you pay the loan back - you don't expect Google to pay the loan for you.
  • Best Practices

  • Use personal lines and loans for guaranteeing business debt. This keeps business and personal assets separate - which is a good business practice, and a requirement for corporations.
Advantages and Disadvantages of Micro-Loans

Micro-loans are usually for $5,000 to $35,000. The loans are often available for start-up businesses.

    Advantages:

  • The loan process is fast.
  • Loan funds are available for start-up business use.
  • Minimal required documents: a short business plan and income tax returns (business and personal)
  • The loan is usually combined with business training and technical assistance.
  • Disadvantages:

  • Average loan amount is $13,000, which usually is not enough to fund a business
  • If funds are used for operating deficits, it makes it harder to become profitable - because the business must pay for operating expenses plus the loan.

Where to find micro-lenders

    Micro-lenders can be found through at least 5 sources:

    SBA approved micro-lenders

  • Check the information in the Funding section of the Tools for local micro-loan programs
  • Local CDBG loan funds

  • Some communities have used part of their Community Development Block Grants for a business loan program. Contact your city economic development department for information.
  • Local banks and credit unions with small business focus

  • Contact your Small Business Development Center to request a list of local micro-lenders. The SBDC will probably ask that you meet with them first to prepare a business plan. Working with the SBDC will give you a more favorable standing with the micro-lender.
  • Accion Microloans

  • As a last resort (i.e. you have to exhaust all other sources first), Accion Microloans funds micro-loans.
  • Ongoing Responsibilities

  • Micro-loans usually require some training or one-on-one consulting to strengthen your business skills.
  • Many micro-loans require you to send quarterly financial reports to the lender.
Advantages and Disadvantages of Business Lines or Loans

    Advantages of business lines:

  • You can easily obtain an increase in your business line of credit when your business grows.
  • Business lines of credit helps businesses manage cash flow, when customers pay invoices one to three months after performing the work.
  • You are only paying for the amount used on your line of credit. If your line of credit is for $50,000, but you have only used $10,000, you are only charged interest on the $10,000.
  • You don't have to provide a business plan for use of the proceeds.
  • Disadvantages of business lines:

  • There is a temptation to use the business line without a solid plan to repay it.
  • Advantages of business loans:

  • The interest rate is usually lower than business lines.
  • When you pay off a loan, your payments stop.
  • If you are purchasing equipment, you can improve cash flow by choosing a Section 179 tax deduction for the full equipment (up to $250,000) this year, and pay for the equipment over many years.
  • Disadvantages of business loans:

  • You cannot "increase" a business loan. As your business grows, you can only obtain a new loan or refinance the loan.
  • You are paying for the whole loan, whether you use it or not. This is only beneficial if you are using the entire proceeds.

Business line or business loan?

Businesss loans are used for one-time purchases that you will repay over a period of years. This includes equipment, facilities, start-up costs, and property. Business loans are expected to be paid off.

Business loans can be guaranteed by the SBA or other state programs. Business loans also require collateral - either from the owner or the business.

Business lines are used for ongoing purchases that are connected to a sale. Usually inventory and overhead is funded with a business line of credit. Business lines of credit are expected to be used each month, repaid and then used again.

Business lines of credit do not have collateral, but the owners are often asked to guarantee the line. That means if the business fails, the owner agrees to use his/her personal assets to repay the line of credit.

Required collateral and documentation

For loans, most banks require either a personal guarantee or specific collateral. A personal guarantee means if your business assets are insufficient, you will use your personal assets to pay back the loan. For sole proprietors and partnerships, this is irrelevant, since your business debts and personal debts are mixed. However, it is significant for LLCs and corporations, which normally are protected from business debts.

Collateral can be cash, home equity, equipment, receivables, or investments. Banks will also require your business and personal tax returns, business financial statements, and a plan for the proceeds. You will also need to provide a copy of your business formation documents.

Lines of credit are usually based on a guarantor's personal credit, with business financial statements showing the ability to repay. You will need to provide a copy of your business formation documents.

Based on your credit score, banks may require that your collateral be "protected" so it is not spent. You may have to deposit cash into a long-term CD, they may file a UCC statement on equipment so it cannot be sold, or they may place a deed of trust on your home, so they are paid if your home is sold.

Federal SBA or state guaranteed loans

Federal SBA or state guaranteed loans protect the lender from 50 to 80% of any loss on an insured loan. It does not protect the borrower - so if a loan is in default, the entire loan goes against the borrower's credit record.

You get a guaranteed loan through your bank. Each bank has its own lending policies, so if you are rejected by one bank, it does not mean you will be rejected by the bank next door.

Click here for a list of preferred lenders for your area.

Building business credit

You will reach a major business milestone when you are able to get business credit based on your business alone. To do that, you need to build business credit.

Click here for information from the Funding Toolkit within the Tools for Business.

Best Practices

Know whether you need a line of credit to deal with cash flow timing, or a loan to purchase something over time.

It is faster, requires less paperwork, and banks make more money by giving you a business line of credit rather than a guaranteed loan. But your interest rate for the loan will be much less for the guaranteed loan than for the line of credit.

Lines of credit:

Use the line of credit for purchases directly connected to your sales.

When you receive payments from your customers, pay the amount of your cost of sales towards your line of credit.

Ongoing Responsibilities

With lines of credit, you are expected to:

Make the monthly payments, paying the line of credit down as you receive payments from your customers

Limit use of your line of credit for expenses related directly to sales.

With business loans, you are expected to:

Make the regular monthly payment

Provide your lender quarterly accounting reports, with a balance sheet and your net profit.

What is Seller Carryback Financing?

Seller carryback financing is when the seller of an existing business takes a note for part of the purchase price. Usually the note is subordinate to the primary financing, which means if the business fails, the primary funder gets repaid before the subordinate (seller).

About 40% of businesses sold have some type of seller carryback financing. It is usually because the buyer cannot get financing for the full purchase price and does not have enough cash to pay the full purchase price.

Advantages/Disadvantages

    Advantages

  • If sellers don't offer carryback financing, they will have fewer purchasers or will have to reduce their sales price.
  • If sellers are willing to take carryback financing, it indicates they are confident in the purchaser's ability to make a profit.
  • Disadvantages

  • Lenders often prohibit or restrict carryback financing, because they want their borrower to have enough cash to pay debt service plus make a profit. Carryback financing reduces the borrower's cash flow and profit levels. Lenders also want the borrower to have significant personal investment in the business, and carryback financing reduces that investment.
  • Not disclosing carryback financing to lenders can be considered fraud.
  • If the business fails, there are major legal entanglements to enforce a subordinate loan.
  • Carryback financing can be used as a way to inflate the price of a business, if realistically the business cannot support the primary loan plus carryback financing.
Online Sources of Capital

The Internet has opened new avenues for financing a business. Person-to-person lending, dubbed Banking 2.0, allows individuals to lend to each other at a set rate on a certain timetable and offers a mechanism for tracking and payment. On these sites you can post your business plan and potential lenders (individuals) can decide whether they want to loan to you. Most sites require that you have a good credit score (640 or higher) to participate.

It is still too early to know the downsides of online lending for borrowers. However, a few have been noted:

  • The loans are fixed, with both principal and interest due each month. If you can't make a payment, you have to negotiate online (if that is even possible). It is much easier to go visit a local lender and negotiate face-to-face.
  • These private lenders aren't regulated, so the documentation and fine print are critical. You should definitely consult an attorney before signing a loan agreement.
  • Never advertise shares for sale at any site. It is illegal to advertise securities to the general public.
Advantages and Disadvantages of Factoring

    Advantages

  • Allows you to seek large contracts if you have the capability to perform them, but not the capital.
  • The factoring company tracks and collects the invoices - you don't have to.
  • Good for cash flow stabilization - you don't have to worry about when invoices are paid.
  • Fast - funding can be done in a few days.
  • You don't have to increase your company's debt levels.
  • Disadvantages

  • Cost is usually higher than a short-term commercial loan.
  • Usually not a long-term solution.
  • Usually for invoices over $10,000. The payee must be reputable with good credit.
  • Cannot be done if you owe back taxes or have pledged your receivables for other loans.

What is factoring?

Factoring is a method of financing used to fulfill large contracts. Businesses with large contracts need to purchase inventory and make the product (or provide the service) before they are paid, requiring significant capital. Often the business is unable to get lines of credit or loans using its own credit. This is where factoring comes in.

The factoring finance company evaluates the credit worthiness of your customer - not you. If your customer is creditworthy, the finance company purchases your contract and gives you a percentage of the contract's value. You can use this money to purchase inventory and provide the product or service. When you have completed the job, your customer pays the factoring company, the factoring company keeps the amount it paid you plus interest, and pays you any remaining amount.

To use factoring, you must have a purchase order and it should be from a reputable company.

Finding finance companies that factor

In addition to looking on the Internet, you should ask for references from your banker and accountant.

Factoring process

You will need to complete an application, provide your company's most recent accounts receivable and accounts payable aging reports, a master customer list and a sample invoice. You will also need to provide your company's legal formation document (articles of incorporation, articles of organization or dba).

In order to provide you a quote, the factoring company will evaluate your customer list and the age of your accounts receivable.

Once you are approved, your customers will be notified that receivables are handled through them and that payments should be made to them. New invoices should be processed through your factoring company. You will immediately receive a percentage of the invoiced amount (90% is common), with the balance sent to you when the invoice has been paid.

Best Practices

Use factoring funds to fund a specific job. Do not use the funds for outstanding bills or other jobs.

Ongoing Responsibilities

Provide your factoring company new invoices.

Forward any payments received by you to your factoring company.

SBA Export Loans

The SBA typically handles export loans for amounts under $2 million through its SBA Export Working Capital Program.

The Export/Import Bank processes export loans for amounts over $2 million. Global Trade Financing: Who takes the risk

Financing to operate a business involved in international trade is complicated. But it all comes down to who will take the risk that:

  • The seller has enough money to purchase inventory to make the goods
  • The seller actually makes the goods
  • The shipment is made and no theft or damage occurs.
  • The buyer pays the seller
  • Who owns the goods at each point, in case something goes wrong.
  • In addition, shipping time means that payment can be delayed for weeks or even months.

    All this requires choosing reliable vendors and customers plus a combination of financing and insurance.

    Here are 4 ways global trade is financed:

    Cash in advance benefits the seller; the buyer takes all the risk.

    Open account (extending credit to the buyer for 30, 60 or 90 days) benefits the buyer; the seller takes all the risk.

    Letter of credit is mutually beneficial. The purchaser's bank issues a letter of credit saying that it has the money and will release it on certain terms.

    Documentary collection is also mutually beneficial. The buyer sends document to the purchaser's bank and after the buyer agrees to the terms, the bank releases funds according to the terms of the collection.

    Forfaiting

    Forfaiting is the process where a middle-man (intermediary) purchases the accounts receivable from the seller at a discount, takes all the risk of non-payment, and makes money when the accounts receivable is paid. It is most commonly used in Europe.

    Loans against import

    Loans against import are bank loans that allow you time to convert the imported goods into manufacturered and saleable items. When you use an LAI, technically you do not own the goods until you have paid for the loan. However the goods are released to you by the bank under a TR (Trust receipts) agreement during that manufacturing period.

    You must use Documentary Credit or Documentary Collection terms with the seller.

    With Documentary Credit, the seller receives documents from the buyer's bank listing the documents necessary to release the funds. The seller must present those documents in order to receive payment.

    With Documentary Collection, the seller ships the goods and presents documents to his or her bank specifying that the documents should be released to the buyer only upon payment, or acceptance of a time draft promising payment at a later date. The seller's bank sends the documents to the buyer's bank in order to collect payment.

    Clean import financing (loan against supplier invoice and evidence of shipping)

    The benefit of a Clean Import Loan is that it provides a business owner with the money to pay suppliers without having to wait to sell the merchandise first. The loan is funded based on a supplier's invoice and evidence of shipping.

    What is Mezzanine Debt?

    Mezzanine debt uses a combination of subordinate debt and equity options to raise money for an acquisition or business expansion. The lender/investor loans the company part of the money and invests in the company for the remainder. The debt is subordinate to the company's other debt, meaning it has claims on the cash flow after the primary debt has been paid. The investment is usually in the form of warrants or conversion options that are paid out when the company goes public or refinances all of its debt.

    Mezzanine debt only works for companies with healthy cash flows. Service companies with little brick and mortar collateral required by traditional lenders, can benefit from mezzanine financing.

    Mezzanine debt is for middle-market companies with total revenue of generally less than $500 million.

    Because the lender/investor has two roles, they are concerned about short-term cash as well as long term equity gains.

    Advantages/Disadvantages

      Advantages

    • Good if your business isn't quite ready to go public, but needs funds for growth.
    • A company can leverage its cash flow by 4 or 5 times (cash flow of $2 million can raise $8 to $10 million), where a traditional loan will leverage 2 times (cash flow of $2 million can raise $4 million).
    • Very flexible loan terms
    • Doesn't require bricks and mortar as collateral.
    • Disadvantages

    • Your business must have a history of significant cash flow.
    • Investors expect higher return rate.
    • It takes a long time (3-6 months) to develop a mezzanine agreement.
    • Mezzanine debt is meant as a temporary level of financing, to be cashed out when the company goes public or refinances all of its debt. Despite this, mezzanine lenders are longer-term investors than angels or venture investors (usually 5-8 years).

    Legal requirements

    You are not allowed to advertise ownership interests in your business or sell to people you do not know unless you have registered with the SEC (Securities and Exchange Commission). Registering with the SEC is a cumbersome process, and few non-public companies go through the process.

    You can, however, sell an ownership interest to people who meet the SEC requirements for an "accredited investor" through a private placement. There are multiple ways that someone can be an accredited investor, but usually it means they have a net worth of $1 million at the time of purchase. Click here for complete information.

    Private placement means that the sale was made to someone known to the financial intermediary or the seller; i.e. there was no advertising to the public at large.

    Even if you use a private placement to an accredited investor, it is strongly suggested that you work with an attorney experienced in private placements.

    The difference between angels and early stage venture investors

    Angel investors are wealthy individuals who invest in businesses on a part-time basis. Early stage venture investors are professional investors who invest for a living.

    Angels are willing to invest in people - they like the founder and the idea. Venture investors are looking for the highest chance of success and profit

    Angels want to be part of the process of growing the business and are more open to how that is done. Venture investors want to use their professional, "proven" teams to grow the business quickly and then sell their interest.

    Expectations of early stage investors

  • You will be open to their ideas and use their strategies.
  • Regular communication.
  • You will have full disclosure to the investors - both the good and bad.
  • Decisions are made on what is best for the business, not what is best for the owner or what has been done before.
  • Books and records will be properly kept.
  • Costs are kept to a minimum until the company reaches breakeven.
  • You agree to sell the company within a 2 to 3 year period.
  • Ongoing Responsibilities

  • Regular financial reporting to investors (quarterly)
  • Online Sources of Capital

    The Internet has opened new avenues for financing a business. Person-to-person lending, dubbed Banking 2.0, allows individuals to lend to each other at a set rate on a certain timetable and offers a mechanism for tracking and payment. On these sites you can post your business plan and potential lenders (individuals) can decide whether they want to loan to you. Most sites require that you have a good credit score (640 or higher) to participate.

    It is still too early to know the downsides of online lending for borrowers. However, a few have been noted:

    The loans are fixed, with both principal and interest due each month. If you can't make a payment, you have to negotiate online (if that is even possible). It is much easier to go visit a local lender and negotiate face-to-face.

    These private lenders aren't regulated, so the documentation and fine print are critical. You should definitely consult an attorney before signing a loan agreement.

    Never advertise shares for sale at any site. It is illegal to advertise securities to the general public.

    What is Private Placement Debt?

    Private placement debt allows larger companies to obtain long term capital without giving up equity in your business or registering with the SEC. The private placement market operates through banks and investment companies with access to wealthy individuals and institutional funds. The benefits include:

  • Quick execution
  • Pre-packaged documentation
  • No SEC registration
  • Flexible deals
  • What are Early Stage Investors?

    Early stage investors are usually angel (individual) investors who invest in a business and help scale it so that it is attractive to venture capital investment. Early stage investors are likely to be very involved in developing the business' strategic plan and creating a good management team.

    Once you have early stage investors, the business becomes separate from the founders, and decisions are made on the best interest of the company only. This means that founders are often replaced because their skills are not what the business needs to grow.

    Is your business ready for an equity investor?

    Your business is ready for equity investment if

  • It can be scaled to a very large size
  • The founders are willing to reduce (or eliminate) their control in the company,
  • Everyone agrees to a strategic plan which allows the company to be sold within 2 to 3 years.
  • Early stage investors are looking for companies that have created traction - which shows you have a good idea, you can get it ready for sale, and the market likes it. The investor's expertise will be to provide capital so that your business can be scaled and sold it to someone with lots of money. Legal requirements

    You are not allowed to advertise ownership interests in your business or sell to people you do not know unless you have registered with the SEC (Securities and Exchange Commission). Registering with the SEC is a cumbersome process, and few non-public companies go through the process.

    You can, however, sell an ownership interest to people who meet the SEC requirements for an "accredited investor" through a private placement. There are multiple ways that someone can be an accredited investor, but usually it means they have a net worth of $1 million at the time of purchase. Click here for complete information.

    Private placement means that the sale was made to someone known to the financial intermediary or the seller; i.e. there was no advertising to the public at large.

    Even if you use a private placement to an accredited investor, it is strongly suggested that you work with an attorney experienced in private placements.

    The difference between angels and early stage venture investors

    Angel investors are wealthy individuals who invest in businesses on a part-time basis. Early stage venture investors are professional investors who invest for a living.

    Angels are willing to invest in people - they like the founder and the idea. Venture investors are looking for the highest chance of success and profit

    Angels want to be part of the process of growing the business and are more open to how that is done. Venture investors want to use their professional, "proven" teams to grow the business quickly and then sell their interest.

    How much equity should you give an investor?

    Here is a simulation tool that helps you see the effects of having several investment rounds. Investment simulation tool

    What is the investment process?

    The most important contribution of early stage investors is their expertise, not their money. This is because they will be working with you to identify which business model and strategy will be most profitable and sustainable. So, you are looking for angel investors that have expertise in your industry. This involves a lot of networking and research. One way is to hire attorneys and accountants with expertise and connections in your industry and then ask them for contacts.

    You are looking for one investor. That investor will open doors to others. So it is much better to carefully target who you talk to, rather than pitching your idea to lots of people hoping for a group to be interested.

    For additional insight into attracting investors, consider reading these books:

    Click here for books on angel, venture and other forms of business financing

    Expectations of early stage investors

  • You will be open to their ideas and use their strategies.
  • Regular communication.
  • You will have full disclosure to the investors - both the good and bad.
  • Decisions are made on what is best for the business, not what is best for the owner or what has been done before.
  • Books and records will be properly kept.
  • Costs are kept to a minimum until the company reaches breakeven.
  • You agree to sell the company within a 2 to 3 year period.
  • Ongoing Responsibilities

  • Regular financial reporting to investors (quarterly)
  • Where to find early stage investors seeking business investments

  • Click here to go to Angel Investors in the Tools for Business.