How to Finance a Business: Self Employment Course Ford Scott Transcript Slide 1: How to Finance a Business: Self-Employment Course Ford Scott Lender Relations Specialist, SBA Hello! Welcome to the How to Finance a Business course. My name is Ford Scott. I’m a lender relations specialist in the Richmond district office of the US Small Business Administration, or SBA. Slide 2: How to Finance a Business * US Small Business Administration or SBA Established in 1953 to help Americans start, build and grow their own businesses * Sources of Financing * Evaluation of a credit requests * Small Business Resources The SBA is an agency of the Federal government established in 1953 to aid, counsel, assist, and protect the interest of small business concerns; to conserve free and competitive enterprise; and to maintain and strengthen the overall economy of the nation. Our bottom line mission is to help Americans start, build, and grow their businesses. This course will be divided into three parts. Part one will outline sources of financing for your small business including an SBA guaranteed loan. In part two, we will look at how a lender will evaluate your credit request and how entrepreneurs should prepare before approaching a lender. In part three, helpful resources for starting your business will be presented. Slide 3: Sources for a Financing a Small Business Your resources and savings Need equity Savings options Plan for Achieving Self-Success (PASS) Individual Development Account (IDA) Gifts or loans from friends or relatives Write out terms of loan/gift Have all parties sign agreement Part One –Sources of Financing for Your Small Business There are four primary sources of business capital: 1) your resources and savings, 2) gifts or loans from friends or relatives, 3) loans from banks or non-bank lenders, and 4) equity capital from angel investors or venture capitalists. Let’s look at each of these individually. 1.) Your Resources and Savings Financial institutions want to see a certain amount of equity in a business. Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Startup businesses will not be able to obtain 100% financing. A business owner usually must put some of his or her own money into the business. The amount an individual must put into the business varies depending on several factors, but generally, most banks want the owner to put in between 1/3 or 1/4 of the total request. One option for individuals with disabilities to save money towards a business startup is the Social Security’s Plan to Achieve Self-Support or PASS program. PASS lets individuals with disabilities set aside money and/or things they own to pay for items or services needed to achieve a specific work goal such as starting a business. More information is available at www.ssa.gov. Another savings option that is available through one of SBA’s resource partners is an Individual Development Account, or IDA. An IDA is a matched savings program. For every dollar participants save, they receive $2 in matching funds. At the end of a two year commitment, participants could have as much as $6,000 that they may withdrawal to start a business. For more information and eligibility requirements, visit www.nvnv.org and click on the IDA information link in the quick links section. 2) Gifts or Loans from Friends or Relatives Another possible source of capital is a gift or a loan from friends or relatives. It is a good idea to establish the terms of a loan or gift in writing and have both parties sign it. This significantly reduced the potential for misunderstanding. A loan agreement, even if it is just specifies how much is borrowed and when it will be paid back protects both sides. A lender will usually ask you to provide a copy of the written loan or gift agreement when you apply for a loan. The lender may also ask that the loan from your friend or relative be put on standby while you are repaying the bank loan. Putting a loan on standby usually means that no payments are permitted until the bank loan is repaid. Slide 4: Sources for a Financing a Small Business (cont) Loans from banks or non-bank lenders SBA guaranteed loans Other resources DOL Small Business and Self-Employment Service VA Department of Business Assistance NewWell Fund Equity capital from angel investors or venture capitalists Money raised in exchange for a share of ownership in the company 3) A third source of capital for small businesses is loans from banks or non-bank lenders. Banks, credit unions, and state and local development agencies are all potential sources of business financing. If you are unable to obtain financing directly through a bank or credit union, the lender may be willing to make the loan if it has an SBA loan guarantee. The SBA loan guarantee programs will be outlined in just a minute. For a list of state economic development and funding resources for every US state in the nation, visit the Department of Labor’s Small Business and Self-Employment Service website at http://www.jan.wvu.edu/entre/. A list of all of the local state and federal capital resource programs in Virginia is available at the Virginia Department of Business Assistance’s website at www.dba.state.va.us/financing/crd. One source of low-interest funding for self-employed Virginians with disabilities is the assistive technology loan fund authority called the NewWell Fund. This fund can provide financing of computers and other equipment including adaptive equipment and/or modifications to the applicant’s home. Their website is www.atlfa.org. 4) Equity Capital from Angel Investors or Venture Capitalists The final source of capital for small business is equity capital. Equity capital or financing is money raised by a business in exchange for a share of ownership in the company. Ownership is represented by owning shares of stock out right or having the right to convert other financial instruments into stock of that private company. Two key sources of equity capital for new and emerging businesses are angel investors and venture capital firms. Typically, equity capital investors provide funds unsecured by assets to young private companies with the potential for rapid growth. Such investing covers most industries and is appropriate for businesses through the range of developmental stages. Additional information on angel investing and venture capitalists is available on our website at www.sba.gov. Click on the services tab and then the equity capital link. Slide 5: SBA Loan Guarantee Programs Does not offer grants to business Makes disaster related loans only 7A Loan Program (most popular) SBA Express Loan Program Patriot Express Loan Program Community Express Program Now let’s take a more detailed look at the SBA loan guarantee programs. SBA provides a number of financial assistance programs for small businesses including our 7a, 504, and micro-loan programs. Within this section, we’ll review SBA’s role in providing financing, the different types of SBA loan guarantee programs available, and some of the SBA loan requirements. First, let’s look at SBA’s role in providing financing. SBA does not make grants to businesses. SBA does not make loans itself except for under its disaster lending programs. Proceeds for SBA loans are provided directly by a lender who receives a SBA guarantee. The loan guarantee transfers a portion of the risk of borrower non-payment from the lender to SBA. If the business borrower defaults on the loan, SBA will reimburse the lender for a portion of their loss. This is a benefit to small businesses, because it may allow a lender to make a loan that they would not make without SBA’s guarantee. In fiscal year, 2007, SBA loan guarantees provided over 110,000 loans totaling over $20 billion to American small businesses. SBA has three primary loan programs: the 7a loan program, the 504 loan program, and the micro-loan program. The 7a loan program is our most popular program and can be used for most business related purposes including, land and building acquisition or construction that are occupied by the business applicant; renovation or expansion of facilities; acquisition of machinery and equipment, furniture and fixtures, and/or inventory; financing of receivables and working capital needs; refinancing of existing debt under certain conditions; and acquisition of an existing business. 7a loans are available from as little as $5000 up to $2 million. 7a loan terms range up to 7 years for working capital and up to 25 years for real estate acquisition. SBA sets maximum 7a interest rates based on the current prime rate. For loans of less than seven years, the maximum rate is the prime rate plus 2 1/4 percent. For loans of seven years or more, the maximum rate is the prime rate plus 2 3/4 percent. Higher interest rates may be charged on smaller loans and some express loans. Under the 7a umbrella there are several programs called express loan programs which require less paperwork and speed up the loan process. They are the SBA Express Loan Program which provides loans up to $350,000; the Patriot Express Loan Program, which provides loans up to $500,000 to current and former members of the military community and their spouses; and finally the Community Express loan program. The Community Express Program may be of particular interest to entrepreneurs with disabilities, because several Community Express lenders provide loans from $5000 up to $25,000, amounts that disabled entrepreneurs typically need to start home-based business ventures. In addition to funding, the program also provides technical and management assistance, which is designed to increased the loan applicants’ chances of success. To be eligible for the Community Express Loan Program, the business must be at least 51 percent owned by veterans, women, minorities, or be located in a low to moderate income area. Both term loans and lines of credit are available through the SBA Express and Patriot Express Loan programs. Slide 6: SBA Loan Guarantee Programs (cont) Microloan Program 504 Loan Program Must meet eligibility requirements Business must be for-profit and small SBA loan proceeds must be used for a legitimate business purpose Good credit and character Invest equity Business plan Financial records Another program that may be of interest to entrepreneurs with disabilities is the Microloan program, which can provide up to $35,000 for up to six years. SBA approved microlenders borrow money from SBA and then lend it out to small business borrowers. The microlender also provides management and technical assistance. Microloans cannot be used to purchase real estate and generally cannot be used for debt repayment. To find a Virginia microlender in your area, please visit our website at www.sba.gov/va and click on the financing link - then scroll down to the nonprofit intermediaries' link and the Microloan program paragraph. The final SBA loan program is the 504 Loan Program, which you may want to keep in mind as your business grows and you contemplate moving your business to a permanent facility. The 504 program provides businesses with long-term fixed rate financing for major fixed assets such as land and buildings. A 504 loan has a low down payment of generally 10%, a 20 year term, and a low fixed rate of interest on the SBA portion. The 504 Program is administered by Certified Development Companies, or CDCs, which are nonprofit corporations, set up to contribute to the economic development of the communities. CDCs work with the SBA and private sector lenders to provide financing to small business. A listing of Virginia Certified Development Companies is available on our website at www.sba.gov/va then click on the financing link and scroll down to the Certified Development Company link. [Similar listings are available on other state's websites. Please review the links provided at the end of this lesson's materials.] SBA has several eligibility requirements. While we cannot cover all of them in this presentation, several are worth mentioning. The business must be a for-profit enterprise, and it must be small. Each industry has a size standard based either on average revenues or number of employees. If the business falls below the size standard, then it is considered small. SBA loan proceeds must be used for a legitimate business purpose. For example, you cannot buy a Rembrandt painting and hang it on your wall and justify it as a legitimate business purpose. Also, the owners and managers must have good credit and be a good character. You do not necessarily have to have perfect credit, but a poor credit history will generally make obtaining financing very difficult. Also, an equity investment is required. An SBA loan cannot provide 100 percent of the funds needed to start a business or to require real estate. There are also some general SBA requirements that you should be aware of. Any person owning 20% or more of the business must guarantee the note. Business financial statements for three years and personal financial statements will be required, and the lender will verify the business information with the IRS. Business plans are generally required for new businesses, and if the loan is to purchase a business, you need a copy of the terms of the sale, financial statements on the existing business, and a statement of the benefit to the business as a result of the change. Slide 7: Key Points Ability to repay the loan Cash flow and collateral Credit history Make sure mistakes are corrected Use a credit card or store card to build credit Equity Must have a reasonable amount invested in the business Strong equity increases business resiliency and sustainability Now, let’s look at how a lender will evaluate your credit request and what to do before you approach a lender. Borrowing money is one of the most common sources of funding for small business, but obtaining a loan is not always easy. Before you approach your banker for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider making you a loan either with or without an SBA guarantee. Let’s explore some of the key points your banker will review: 1) The first area that your lender will look at is your ability to repay the loan: The ability to repay must be justified in your loan package. Banks want to see two sources of repayment: cash flow from the business plus a secondary source such as collateral. In order to analyze the cash flow of the business, the lender will review the businesses' past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years, because they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, then it is likely that the loan will be approved. If however, the business has been operating marginally and now has a new opportunity to grow, or if that business is a startup, then it is necessary to prepare a thorough loan package with a detailed explanation detailing how the business will be able to repay the loan. 2) The second area that your lender will look at is your credit history. One of the first things a bank will determine when a business requests a loan is whether their personal and business credit is good. Personal credit reports may contain errors or be out of date. In many cases, people find that a bill that they thought had been paid off has not been recorded on their credit report. You want to make sure that when the bank pulls the credit report that all of the errors have been corrected and your history is up to date. If you do not have a credit history, it may be a good idea to apply for a credit card and begin to establish a good payment history. A retail store card or a gasoline store card might be easier to obtain than a typical bank credit card. Another option is a secured credit card, which is one that is attached to a savings account. You deposit a sum of money into the account and you can borrow up to that amount. If you don’t repay what you borrowed, the lender will access your account to cover the debt. 3) The third area that your lender will look at is equity. Business loan applicants must have a reasonable amount invested in their business. This insures that when combined with borrowed funds, the business can operate on a sound basis. There will be a careful examination of the debt to worth ratio of the business to understand how much money the lender is being asked to lend or debt in relation to how much the owner has invested or worth. Owners invest either assets that are applicable to the operation of the business and/or cash that can be used to acquire such assets. A strong equity base with a manageable debt level provides financial resiliency to help a firm weather periods of adversity. Minimal or nonexistent equity makes a business susceptible to miscalculation and thereby increases the risk of default, or failure to repay the borrowed funds. Strong equity insures the owner remains committed to the business. Sufficient equity is particularly important to the new businesses. Weak equity makes a lender more hesitant to provide any financial assistance. Slide 8: Key Points (cont) Collateral A secondary source of repayment Personal and business assets that can be sold to pay back the loan Borrower may need a cosigner if s/he does not have collateral Experience Take some time to get experience and education Before you meet with a lender Obtain a copy of your credit report www.annualcreditreport.com 4) The fourth area that your lender will look at is collateral. Financial institutions will look for a secondary source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Many loan programs require at least some collateral to secure a loan. The SBA Community Express loan program is one exception. Unsecured loans are available for up to $25,000 for participating SBA lenders. Also, a SBA guarantee may increase a lender’s level of comfort in making a loan when there is little to no collateral available. For larger loans, if a potential borrower has no collateral to secure a loan, he or she may need a cosigner that has collateral to pledge. 5) The final area that your lender will look at is experience. An individual who wants to open a business and has no experience in that business should not seek financing unless they intend to hire someone who knows the industry or take out a partner who has the appropriate experience. Regardless, it is advisable to take some time to work in the industry first and take some entrepreneurial training classes before opening the business or seeking financing. So what should you do before you meet with a lender? First, obtain a copy of your credit report and clear up any past due accounts or errors. Too often, entrepreneurs think that their business credit and personal credit are separate. A business’ credit is built upon the owners’ personal credit. If you have not established the business history, lenders and suppliers will use your personal credit history to determine your terms of payment. You’re allowed to receive a free credit report from each of the three credit reporting agencies once per year. Visit www.annualcreditreport.com to order it online or call 1- 877-322-8228 to request a copy by phone. Hearing impaired consumers can access the TDD service at 1-877-730-4104. Slide 9: Prepare a Loan Proposal Cover letter or executive summary Description of the business Management experience of the owners Personal financial statements Performance balance sheet (New Business Start ups) Financial statements (Existing Business) Collateral offered Other items may include: copy of lease, franchise agreement, purchase agreement Use the outline offered on line by the SBA The second thing that you should do before approaching a lender is to prepare a loan proposal. Many different loan proposal formats are available, but they all generally include the following elements: one, a cover letter or executive summary that clearly and briefly explains who you are, your business background, the nature of your business, the amount and purpose of your loan request, your request in terms of repayment; how the funds will benefit your business; and how you will repay the loan. Keep this cover page simple and direct. Next, is a description of the business including the type or organization, date of the information, location of the business, products or services offered, a brief history and outline of proposed future operations, and an analysis of your competition, customers, and suppliers. Next, is a section describing the management experience of the owners of the business. Resumes of each owner and key management members should be included. Next, are personal financial statements for each 20% or more owners of the business and any cosigners or guarantors. For startup businesses, a Performa balance sheet reflecting sources and uses of both equity and borrowed funds and a projection of future operations for at least one year or until positive cash flow can be shown should be included. Existing business should include financial statements for the last three years. Next, include a list of collateral to be offered to secure the loan. List / include real property and other assets to be held as collateral. Other items should be included in your loan proposal when applicable, such as a copy of your lease, a franchise agreement, and a purchase agreement. For a loan proposal outline, visit our website at www.sba.gov and click on the services tab then on the financial assistance link, then the loan eligibility link, and then the applying for the loan link. Part three of this course will provide the names of several organizations that can review your loan proposal before you take it to a lender. After checking your credit and preparing your loan proposal, you are ready to approach a lender. A listing of SBA lenders in VA is available at our website at www.sba.gov/va then click on the financing link in the blue section on the right hand side of the page. This listing includes contact names and phone numbers for each lender. Each SBA office also has a similar website listing. For other SBA offices, go to www.sba.gov and click on the local resources tab. We recommend that if you see a lending institution on our listing where you currently have your checking or savings account, approach that lender first. Your relationship with that lender should increase your chances of getting a business loan. Slide 10: Sources to Help Start Your Business SCORE Counselors to America’s Small Business SBDC Small Business Development Centers Women’s Business Centers Local and National SBA websites including one on disability information Part Three- Sources of Help in Starting your Business: SBA provides funding to several organizations that can assist you in starting or operating a small business. The first is SCORE, Counselors to America’s Small Business. SCORE is a nonprofit association dedicated to educating entrepreneurs and assisting in the formation, growth, and success of small businesses nationwide. SCORE has 489 chapters throughout the United States and its territories with 10,500 volunteers nationwide. Both working and retired executives and business owners donate their time and expertise as business counselors. SCORE can help you in several ways. They offer email advice online, face-to-face small business mentoring, and low cost workshops at chapter offices nationwide. And, they offer online how-to articles and business templates as well as online workshops and learning, all of which are available on their website at www.score.org. You can also find the SCORE location nearest you at this website. The second resource available to you is Small Business Development Centers, or SBDCs. SBDCs provide management assistance to current and prospective small business owners. The SBDC program is a cooperative effort of the private sector, the educational community, and federal, state, and local governments. SBDCs offer one-stop assistance to individuals and small businesses in central and easily accessible branch locations. They offer a wide variety of services including training, counseling, research, and other specialized assistance. The SBDC staff often have established contacts with local loan officers and representatives at local banks making them an ideal source of referrals and information as to what each bank is looking for from their prospective loan applicants. A national SBDC Clearinghouse website at www.sbdcnet.org also provides extensive information on all aspects of starting or operating a business as well as a SBDC locator tool. Another resource is Women’s Business Centers. Women’s Business Centers are national network of educational resource centers. They’re designed to assist women in achieving their dreams and improving their communities by helping them start and run successful businesses, regardless of social or financial disadvantage, race, ethnicity, or business background. The mission of the centers is to level the playing field for women entrepreneurs who still face unique obstacles in the world of business. A list of Women’s Business Centers is available at our website, [www.sba.gov]. Type Women’s Business Centers into the search box. Our national and local websites also offer an extensive repository of tools, checklists, tutorials, and guides to assist you in starting and operating your business. The national website address as mentioned before is www.sba.gov. Local websites for each SBA office in the country are available by clicking on the local resources tab on the national homepage. Local websites can tell you about upcoming training and network events in your area; provide contact names and phone numbers for local SBA lenders, SCORE, the SBDCs and Women’s Business Centers and offer highlights of local, successful entrepreneurs. One non-SBA website of interest to Americans with disabilities is [ww.disabilityinfo.gov]. It provides quick and easy access to comprehensive information about disability programs, services, laws, and benefits. I wish you the best of luck in your efforts to join the 25 million other American small businesses. Small businesses are the strength of our nation’s economy. They account for 50 percent of the country’s private non-farm gross national product, create between 60-80 percent of the net new jobs and are 13-14 times more innovative per employee than large firms. Good luck to you. Slide 11: Web Resources The following are websites that Ford Scott mentioned throughout the presentation: • Americans with Disabilities online resource (www.disabilityinfo.gov) • Credit reports (www.annualcreditreport.com) • DOL Small Business and Self-Employment Service (www.jan.wvu.edu/sbses) • National SBDC clearinghouse (www.sbdcnet.org ) • NewWell Fund (www.atlfa.org) • New Visions, New Ventures (www.nvnv.org ). IDA information • SCORE (www.score.org) • Small Business Administration (www.sba.gov) • Virginia section (www.sba.gov/va) • Social Security Administration (www.ssa.gov), PASS information • Virginia Department of Business Assistance: www.dba.state.va.us/financing/crd)