All businesses require funding or capital. There are a number of ways to fund your own business. One of the most common sources particularly with new businesses is equity. This can come from personal savings, friends, family or investors. The benefit of this source is that it generally allows for the most flexibility in terms of repayment. Your own savings account can be replenished over time and may not require any return of interest. As for other sources, that all depends on what kind of terms you can work out with friends, family and investors. Most third party investors want to see a return on their investment. Don’t think of it as free money, but rather flexible money.
What if my company needs funding and I want to borrow? What kind of loan do I need and what loan is best for my business?
Let’s start with the reason you need the money and what you intend to finance.
- My business is falling short on operating cash. My customers owe me money, they will pay but sometimes I have to wait 45-to 60-days. I also have to keep raw materials on hand and I have some finished product I have yet to ship or invoice.
Solution: You might need a bank operating line of credit. The invoices you have sent to customers represent shipped, finished goods your customer and they have yet to pay. In essence you are acting as their bank. They are using your money. In this case, an operating line of credit may be the right loan for you. You can borrow on the line to provide funds for your business to operate until the invoice is paid by your customer. Keep in mind the receivables need to be current and in good standing.
In addition that raw material in your business and the unshipped finished goods may require funding. In this case an operating line of credit may be a great resource. Not all inventory is suitable for bank funding. Highly specialized materials and finished goods may not be the best fit.
In either case the bank may require that you provide a borrowing base certificate that lists all your current accounts receivable and your inventory. Most banks will consider financing up to 75% of eligible receivables and 50% of inventory. The bank will ask that you at pay accrued interest monthly and may require that you pay the line to 0 during the year. Example: a $100,000 line of credit at 4.50% would cost $4,500 for the entire year if 100% of the balance were outstanding for 12 months.
- Sales are increasing and I need to increase capacity. I need some new equipment.
Solution: This is a great reason to need a bank loan. Adding equipment increases production and capacity for more. However it can be expensive. Coming up with that amount of cash might exhaust your working capital (cash). An equipment term loan may be the best answer. Generally you will need to come up with 25% of the cost and the bank will fund the other 75% required. The bank will then provide you with time to repay the loan, generally 3 to 5 years. Example: $100,000 cost, 25% down payment = $75,000 / 5 years / 4.50% = $1,398 / month or $16,778 per year.
- Sales have increased I have inventory and equipment wall to wall and I have no room to move?
Solution: Another great reason to borrow. Adding space can also increase production, efficiency and sales. Again new construction is expensive as is land. Taking the funds from working capital may hinder the company’s operations. A real estate term loan may be the answer. Example: $500,000 cost for a new building. Bank will require a 20% down payment. Loan amount $400,000. With an initial rate of 4.50%, subject to adjust every 5-years until maturity not to exceed 20-years your monthly payments would be $2,530.00. This keeps much of the cash in the business and allows it to pay for the building over time.
These are just three basic types of bank loans that are available. Each business is unique and we can tailor the loans to fit your needs. We also have the ability to offer SBA loans and we will address that topic in our next blog! Stay tuned!