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Getting Smart Money To Fund Your Startup

Small businesses tend to face obstacles securing loans. What do lenders look for before they part with their money? Most small businesses are established without financial assistance from outside investors or lenders. An entrepreneur armed with a big idea for a small business typically gets established with personal savings.

More commonly, he gets monetary help from family and friends. Many small business owners don't know where or how to obtain outside backing. And many owners believe that lenders won't consider their small companies good investment risks.

Traditionally, small businesses have more trouble getting small loans than large companies have borrowing much greater amounts. Most lenders consider small firms risky because for every business that starts up, two or three close down. Another major obstacle most small businesses face is a lack of collateral.

Few have tangible assets like inventory, buildings or equipment to offer as security. And even if a business does own property, it may not be able to get a loan if it cannot demonstrate an ability to repay the borrowed funds from future profits. A number of lenders will not consider investing in an endeavour if that ability is not substantiated. But, for the business owner with a sound idea and a convincing presentation, financial assistance is available.

Small businesses usually need more than just cash: they need "smart" money. This means, financing that helps your business in the way that you want it to, where the financier provides not only capital, but also support and expertise for the business. Smart money could be a guaranteed loan that allows you to keep your ownership interests intact until your business reaches the stage at which you want to sell shares of the business.

On the other hand, money that comes from letting your brother-in-law become a partner in your business because you need his $5,000 before the end of the week might be far more costly than you ever imagined. Locating "smart" money presents difficulty for the entrepreneur because the capital market for small businesses is imperfect and consists of a great variety of under-publicised and poorly organised financing sources.

Whether you are trying to locate a bank that is willing to lend money to your small business or whether you are looking for a business "angel" who will contribute needed equity capital, your quest for financing will require that you devote the same attention to obtaining capital as you give to decisions involving the business's basic product or service.

The Kind Of Financing You Need

Commercial and inventory loans, lines of credit, and accounts receivable financing are sensible financing methods for small businesses that don't have cash on hand. These short-term loans are often granted to borrowers who don't have substantial amounts of collateral. As inventory is sold or payments on accounts received, the business pays money back to the bank. It's true, however, that businesses with larger requirements need longer term loans, which often require collateral.

For example, the substantial expenses required for start-up, real estate purchases, major expansion or acquisition, are usually met with loans written for five years or more. Some banks believe personal assets should provide much of a business' financing for start-ups, expansion and acquisition, and may require a business owner to get a personal loan using personal property as collateral. Real estate loans or second mortgages are borrowed against the value of business-owned property.

In 1996, Singapore's Productivity and Standards Board (PSB) was established, and tasked with helping small and medium-sized enterprises. Its Local Enterprise Finance Scheme (LEFS) is one such initiative. The LEFS provides low cost, fixed rate loan to help companies finance industrial facilities, machinery and equipment.

It also provides short-term loans. Entrepreneurs may also apply for Special Interest Rate (SIR), which charges only 3.5 per cent per annum. These loans may be used to establish a new business, to modernise and improve infrastructure, to expand manufacturing capacity or to diversify into other product lines.

To secure venture capital, a firm with a viable product and service may seek assistance from the Economic Development Board (EDB), which has established EDB Ventures Pte. Ltd, for investments in local enterprises with good potential.

Entrepreneurs who have problems borrowing money from banks to fund their business expansion because their companies do not have track records or sufficient collateral will soon have access to even more assistance. The PSB will introduce next month a new $200 million credit guarantee programme for the small and medium enterprises (SMEs).

What Lenders Are Looking For

Regardless of how successful your enterprise or idea looks on paper, lenders want to know where you will get the money to repay their loans. You must build the lender's confidence in your ability to repay your loan - demonstrate your stability and your solid reputation among associates and customers.

Most lenders whether they are banks or financial institutions base the decision to back your company on factors that include: Examinations of credit reports on your company, your loans and your fulfilment of their terms; information from your suppliers about how much credit they give you, how much of it you use, and how you have performed on your credit line; examination of your company's financial statements, especially how closely your assets' valuations reflect their true values; and your written business plan. Lenders also want to see that you have invested a substantial amount of your own money in the firm, which means, you should have put in roughly half the amount needed for start-up - before seeking investors.

Venture capitalists look for big opportunities, especially those with IPO potential. Contrary to popular belief, most modern venture capitalists do not make money by investing and building great long-term businesses. Many venture capitalists today sell shares in their ventures as soon as they can once the company goes IPO. So, unless your company has IPO potential, and you wish to take your company public, most venture financing is realistically unavailable to you.

Some angel investors can also contribute tremendous business insight and experience. But, be especially careful to do "due diligence" on your angel investors. Be sure they can afford to make aggressive investments in your business and that they understand the risks. Agree, ahead of time, what, if any, non-investment involvement the angel will have with your company. Angels should be labelled as "accredited investors," which is a fancy way of saying they are rich enough and smart enough to make aggressive investments.

With either angel investors or venture capitalists, you will need to give up partial ownership of your company. Very few angels or venture capitalists will invest without equity upswing potential. If you wish to retain full equity (ownership) of your small business, you will only have debt financing available to you. This means, if you are lucky enough to get a loan, you will be required to pay back interest and principal, but you will own 100% of your company.

"This article was contributed by Christopher Lai, Director-Head of Business Development, Small Business Services, CSG, American Express International Inc."

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