From the WHY Vault*

Dry Finance: Raising capital when you’re low on funds

There comes a time in the life of many small businesses when you have to make a big decision: Should I invest more money into this project? According to the U.S. Small Business Administration (SBA), there are four key sources to consider when looking for financing:

Personal savings: The primary source of capital for most new businesses comes from savings and other personal resources, such as personal lines of credit or credit cards. It’s great if you’ve got it and can spare it, but know that there’s a possibility you won’t be able to pay that money back (but, then again, there’s a possibility you will). Also, keep in mind that many credit cards carry high interest rates for partial payments and stiff penalties for late payments, so running up your personal credit accounts may not be a wise strategy.

Friends and relatives: The benefit of borrowing from friends and relatives is that often the loans you secure are interest-free or at a low-interest rate (because they love and trust you). The problem is that you may not feel so obliged to pay the loan back, since, after all, it’s your dad. For this arrangement to work, you need to treat this as a business arrangement—call your dad “Mr. So-and-So,” if you have to. And use an amortization calculator to schedule repayment of the loan and to figure out monthly payments and interest that is amenable to both parties.

Banks and credit unions: The most common source of funding, according to the SBA, banks and credit unions will provide a loan if your business proposal is sound. Terms of loans may vary from lender to lender, but SBA lists two basic types of loans: short-¬term and long¬-term. Generally, a short¬-term loan has a maturity of up to one year and includes working-¬capital loans, accounts-¬receivable loans and lines of credit. Long-term loans have maturities greater than one year, but usually less than seven years; they are used for major business expenses, such as purchasing real estate and facilities, construction, durable equipment, furniture and fixtures, vehicles, etc. Interestingly, one of the benefits of seeking the assistance of a financial institution is that writing a business proposal forces you to take a good, hard look at your company and your market. In the end, you may discover that the answer to the question of whether you should invest more money into your business is a no, and better you learn that now than after you’ve taken a chunk of change from your savings account or your dad’s.

Venture capital firms: Companies that help expanding companies grow in exchange for equity or partial ownership, if you’re willing to give that up.

--This article ran in the may/june 2008 issue of WHY, sponsored by EcoVixen.com.

*From time to time, I'll present info from past WHY magazine articles or WHY Xtras in case you missed them the first time around. :)