Business Financing for a Small Business
Business financing can be critical to getting a new business off to a fast start. Most people think of investors or a bank loan. Here are two other alternatives.
Credit Card Financing
Let’s face it, almost every entrepreneur has used credit cards to purchase an asset for their business or supplies when company funds were low. If your credit is good, you are most likely inundated with offers of pre-approved credit cards. If there is no other way to finance your business and you like living on the edge of disaster, you can finance your company with credit card debt.
Get four of five credit cards, with credit limits between $5,000 to $10,000 each and you’ve put together a source of capital from $20,000 to $50,000. This is expensive debt with interest rates from 15% to 25%. And it’s dangerous. You’ve maxed out your credit lines, so you have no emergency funds for your personal use. Additionally, if you do get an investor interested, your credit card debt may not be recognized as a company debt. Again, the investor will probably not allow his/her funds to be used to pay off your personal debt.
The investor buys a percentage of your company’s revenues in contrast to the more traditional method of buying a percentage of ownership in your company, and therefore profits/income. The investor gets paid regardless of the profitability of the company, and gets paid first, before taxes, debt service, and interest. The investor even continues to get paid if the company declares Chapter 13, a reorganization under the bankruptcy code. If there are sales, the investor gets paid. This is important to keep in mind when considering this type of financing.
There can also be an equity contingency: if the company is sold or goes public, the investor may have warrants or options that allow them to purchase, at below market rate, shares in the company. So the investor gets the best of both worlds, a regular stream of payments based on a percentage of sales of the company and the opportunity to buy very cheaply the stock of the company under advantageous terms.
Obviously this kind of financing is only appropriate for companies that have a high gross margin or low cost of goods sold. It’s also easy to oversubscribe the company’s revenues. And it can make obtaining more traditional debt financing or an equity investor much more difficult.
Royalty financing is a little harder to find than more traditional financing. Start with your accountant and attorney. Ask your Small Business Development Center. Try your Chamber of Commerce and your bank. Search your local newspapers or business paper.