Thinking of a business loan?

TO START your business, you must purchase licences, pay for permits, engage professional services (e.g., legal, accounting, insurance), do leasehold improvements, and buy furniture, fixtures and equipment. You may require initial retail inventory – an opening stock of repair parts, accessories, or office supplies such as business cards, letterheads, envelopes, staples, etc. Once you start operating, you must replenish these retail or parts stocks and pay the day-to-day wages of your employees (working capital requirements). There are financial strategies to satisfy these needs and to approach the various sources of this financing (lenders and investors).

Money that finances a business is called capital. Bank loans approved for day-to-day business operations (working capital) have characteristics that make them different from those approved for equipment purchases (long-term capital or capital assets). A bank loan officer can often assist you in finding a workable combination of these different types of capital. Using loans for purposes other than those for which they were approved is considered an abuse of your loan privilege.

NOT ALL MONEY IS THE SAME

There are two types of financing: equity and debt financing. When looking for money, you must consider your company’s debt-toequity ratio – the relation between dollars you’ve borrowed and dollars you’ve invested in your business. The more money owners have invested in their business, the easier it is to attract financing.

If your firm has a high ratio of equity to debt, you should probably seek debt financing. However, if your company has a high proportion of debt to equity, experts advise that you should increase your ownership capital (equity investment) for additional funds. That way, you won’t be over-leveraged to the point of jeopardising your company’s survival.

Equity funds come from personal monies of the partners (such as savings, inheritance, or personal borrowings from financial institutions, friends, relatives, and business associates) and from stockholders of the shares in a corporation. These funds are normally unsecured and have no registered claim on any of the assets of the business, freeing those up to be used as collateral for the loans (debt financing). Higher equity creates increased leverage. Leverage reflects the business’ ability to attract other loans and investments. An equity position of $30,000 may enable the business to obtain debt financing of up to three times that amount, $90,000. A fully leveraged business has no further ability to borrow money.

Most small or growth-stage businesses use limited equity financing. As with debt financing, additional equity often comes from non-professional investors such as friends, relatives, employees, customers, or industry colleagues. However, the most common sources of professional equity funding are venture capitalists. These are institutional risk takers and may be groups of wealthy individuals, government-assisted sources, or major financial institutions. Most specialise in one or a few closely related industries.

Venture capitalists are often seen as deeppocketed financial gurus looking for start-ups in which to invest their money, but they most often prefer three- to five-year-old companies with the potential to become major regional or national concerns and return higherthan-average profits to their shareholders. Venture capitalists may scrutinise thousands of potential investments annually but only invest in a handful. The possibility of a public stock offering is critical to venture capitalists. Quality management, a competitive or innovative advantage, and industry growth are also major concerns.

Different venture capitalists have different approaches to the management of the businesses in which they invest. They generally prefer to influence a business passively but will react when a business does not perform as expected and may insist on changes in management or strategy. Relinquishing some of the decision-making and some of the potential for profits are the main disadvantages of equity financing.

DEBT FINANCING

Traditionally, banks have been the major source of small-business funding. Their principal role has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. Banks generally have been reluctant to offer long-term loans to small firms. The Jamaica Business Development Centre (JBDC) assessment programme encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available. The JBDC’s programme has been an integral part of the success stories of many firms nationally.

In addition to equity considerations, lenders commonly require the borrower’s personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. For most borrowers, this is a burden but also a necessity.