Learn how to start a small business

A checklist for financing

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Financing a Small Business

Steps to Financing a Small Business

One of the worst things that can happen when running a business is to end up in cash crisis mode. To avoid this it's critical to obtain enough funding at the very beginning. Below are the steps for how to start a small business and finance it successfully.

1. Develop a Solid Business Plan

Begin your search for financing by presenting your business idea to prospective lenders or investors. A business plan is usually required reading for anyone considering handing you cash or credit to get your small business started.

2. Understand Some Key Financial Factors

Once you've developed your business plan, you must be completely aware of the resources that exist for financing a new small business.

  • Equity Versus Debt — Business financing comes from either equity or debt. Debt financing refers to a loan — money from a commercial bank or other source, where you have a definite timetable for repayment. Equity financing from investors involves sharing the ownership of your small business. The investor receives a cut from future earnings.
  • Control — Many small business owners need to give up some control when financing a small business. Think about how much power you will agree to surrender in order to obtain financing.
  • Security — How will the investor or lender acquire the capital? If you fail to pay, who will they go after in a settlement? Could there be a lien on your property?
  • Other Factors — With every financing arrangement you make, there will be financial, tax and legal factors to consider. Your accountant or tax adviser should keep you informed of the consequences of each.
3. Determine Where You'll Obtain Your Financing
  • Commercial Banks — This may be the most obvious source of small business financing. Prior to applying for a bank loan, get your business credit report and take the time to inspect it carefully for any oversights or inaccuracies.
  • Venture Capital Firms/Individuals — Despite today's economy, there are many people who make a living from investing in startups. If you choose this route, you will be giving up some control. Be sure you know how much control before you sign anything. If you believe that all your new product needs is an amazing ad campaign, then working with a venture capitalist may be right for you.
  • Friends and Relatives — Although this can create tension in a relationship, the more professional and detailed you are with the arrangements (signing and notarizing a written agreement and payment schedule, for example), the less everyone will suffer from the stress that may occur in these situations.
  • Small Business Grants from State Development Organizations — Sometimes foundations and governments set up plans to fuel their social objectives; for instance, minority-owned companies or business startups in inner-city neighborhoods.
  • Small Business Loans from the Federal Government — These are limited, low-interest loans for expansion plans. Some government agencies, such as the Small Business Administration (SBA), provide discounted rates for small businesses that will create jobs or help them reach certain development goals.
  • Local Nonprofit Lenders — When considering a request for funding, many nonprofit lenders take additional criteria into account, such as your integrity or how dedicated you are to starting your small business.
  • Retirement Funds — Borrowing against a 401(k) or IRA is often used to fund a startup business. Talk with your tax accountant about the advantages and drawbacks of this type of small business financing. A major downside is that the money taken out of your retirement account will not increase tax-free until it's paid back.
  • Credit Cards — This form of financing can be a huge timesaver when you're in the throes of starting a business. However, failing to manage your credit card debt properly is often the beginning of the end of many American small businesses.

No matter where you search, a potential lender is going to evaluate your creditworthiness. As an entrepreneur, you may be determined to get your new small business up and running as soon as possible. Maintaining that determination, while taking these important steps, should enable you to find the right mix of financing options for your new small business.

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