3 questions entrepreneurs should answer before borrowing money

 
08/13/2018

At first, starting and growing a business is exhilarating. You have an idea, you’ve tested the concept, written a business plan, developed a product or introduced a service. The dream is big and starting to take shape. Then, you put together a budget and list everything it will take to grow the business.

For most entrepreneurs, expenses exceed income, especially when the business is young and growing.  You’ve put all that you can into funding the business, but it’s clear the business will need more cash to get to the next level. 

There are many ways to fund a business: “friends and family,” angel investors, private equity and venture capital among many others. Credit unions and banks finance the majority of small businesses in this country and have traditionally offered significant and meaningful support for economic growth by doing so. Each source of capital has a place in the funding life cycle. Knowing what to access, when and how depends on the answers to a few questions.

1.    Does the business have revenue?

All successful businesses begin with an idea.  Some quickly generate revenues, cover expenses and show a profit, but most do not.  Turning a great idea into a profitable business requires capital and the belief and support of funders with a high tolerance for the risk of very early-stage investing.  

In most instances, that funding comes from the entrepreneur and her friends and family; people who have a personal interest in the business, a belief that it will succeed and a desire to provide support.  Businesses that are “pre-revenue” are generally not ready for traditional financing. 

2.    Does the business show a profit; more importantly, is the business cash-flow positive?

The phrase “cash-flow positive” comes up often in episodes of Shark Tank, and there’s a good reason.  Businesses use cash to pay bills, not profits. This reality becomes clear to entrepreneurs the first time a client pays late and a vendor expects payment on time. The mismatch between the two is the difference between the cash you have and the cash you need. Some businesses are growing so fast and consuming so much cash that they grow right into oblivion.

Financing rapid growth before the business is profitable generally requires investment, not debt. Best sources are angel and private equity investors who are willing to take more risk in exchange for ownership. For the entrepreneur, raising capital this way can be a smart decision if that investment helps the business scale more quickly, creating more value for everyone.

3.    Can the business demonstrate the ability to repay debt?

Fundamentally, credit unions and banks are lenders, not investors. All lenders evaluate the ability of the borrower to repay the debt, whether the loan is to a business for working capital, or to an individual buying their first car.

If you have a track record that shows you can repay the loan, you’re ready to talk to the credit union about how traditional financing can help your business succeed. Generally, financial statements that show at two to three years of favorable trends are required. 

Regardless of where you are in the funding cycle, advice and support can be found throughout the entrepreneurial ecosystem. Establishing relationships with business lenders in local credit unions and banks can be especially helpful. You’ll know right away whether someone is connected, interested and willing to help your business succeed.

SOURCE: http://www.bizjournals.com



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