Funding Your Small Business Startup
How to fund your small business startup with Henry Lopez, serial entrepreneur and host of this podcast. This episode is about helping you determine how you will fund your small business startup. It costs money to start a business, so where will that money come from?
Nothing happens in business without first having money to invest. Depending on your business idea and plans, it may take very little money, or a large sum from multiple sources. But even the smallest of businesses will require some investment of money – and a portion of it will likely need to be your own cash. And your ability to borrow money will be almost completely dependent on your personal credit and your available collateral. On this episode of The How of Business podcast, Henry shares his guidance on how you can get the capital to start your small business.
Join Henry Lopez for the next Financial Projections Workshop. By the end of the workshop, you will have completed the first draft of your financial projections for your business!
Funding Your Small Business Startup – Topics and questions covered on this episode include:
- How are small businesses funded?
- The most common sources of capital for a small business include:
- Your own resources (including cash, investments, IRA, 401k, home equity, margin accounts, credit cards, etc.)
- Friends and Family
- Investor Partners – you may bring in small business partners who will also contribute cash.
- Bank Loans (Conventional or SBA loans)
- Micro Lenders – You can find Micro Lenders, backed by the Small Business Administration (SBA) in each state.
- Angel Investors
- Other sources source of capital for your small business.
- The most common sources of capital for a small business include:
- Common misconceptions about small business funding:
- It’s easy to get a bank loan for your first start-up business. (It’s possible, but it may not be easy.)
- Your credit does not matter. (Your credit score is what’s most important.)
- You won’t have to personally guarantee the loan. (You will almost certainly have to personally guarantee your small business loan.)
- You can finance the entire amount required and don’t have to invest any of your own cash. (It will be highly unlikely that you will be able to secure a 100% loan for your small business. You, or you and your business partners, will have to contribute some cash.)
- Where to start: How much do you need?
- Every business has different capital needs, and every situation is unique.
- Can you start smaller? – It’s usually better to start smaller, and then grow your business over time.
- Once you have calculated how much startup funding you will need, you can begin to determine where you will get it…
- Self-Funded (Your Money) – Sources of self-funding for small business start-up may include:
- IRA or 401k (You must be cautious if considering borrowing from you retirement savings!)
- Credit Cards (Not highly recommended, but it may be an option for some of your start-up expenses.)
- Margin Loans (Borrowing against your investments.)
- Home Equity Loans
- The benefits of self-funding your small business include the simplicity of the process – there is no approval process or need for strong credit. You also won’t have debt service to worry about (unless you borrow against your retirement accounts of take out a home equity loan.)
- Some the challenges include: depleting your retirement and emergency savings and not having enough extra cash to cover your personal and household expenses or if you need additional working capital for the business.
- Other People’s Money
- Consider the value of leveraging other people’s money. If you do the math, although it may seem counter-intuitive, the return on investment is always better if you borrow a portion of the required investment.
- Definition of an Entrepreneur by Harvard Business School Professor Howard Stevenson, “entrepreneurship is the pursuit of opportunity beyond resources controlled.”
- You should also consider opportunity cost – they cash you don’t invest in the business can potentially continue to grow where you have it invested now.
- If you do leverage other people’s (or the bank’s) money You will likely have to come up with some portion of the start-up expenses yourself.
- Friends & Family
- Most commonly in the US, people start a business using their personal capital, the contributions of family and friends, or a combination of both. When you borrow money from family and friends, the terms may be quite flexible, or there may not be any specific terms at all. Of course, a major benefit of borrowing from friends and family is that you typically won’t have to provide extensive documentation or put up the collateral required with most bank loans.
- On the flip side, these types of loans can carry the greatest risk and impact if your business fails.
- Taking money from friends and family can potentially damage your relationships with them if the business fails, or if funding terms are not clear or were never discussed.
- Consider borrowing from friends and family very carefully. Ask yourself this questions, what happens to my uncle financially if I lose all of his investment? And if you do take money from them, be sure to document it in a note so that every one is clear as to when and how you will pay them back. You also want to be clear as to what their involvement, if any, will be in the operations of the business.
- Business Partners
- Angel Investors
- Angel Investors are people or groups who invest in the start-up of a company.
- May also be referred to as a Venture Capitalist or Venture Capital – but this term usually refers to investments made in an existing early-stage business, and the second and subsequent rounds of funding before a business may go public.
- Investors normally give you money in exchange for an ownership share – also called equity – and perhaps an active role in the management of your company.
- You will need to determine if you are seeking silent or passive investors, or equity investors who will likely demand an active role in your business.
- Investors are usually interested in…
- High-growth companies
- Equity, rather than debt (it’s not a loan)
- Higher risks in exchange for potential higher returns
- May or may not be “patient” money depending on the type of investor and the investment.
- Control! Be prepared to give up some portion of both control and ownership of your company in exchange for their money. Of course, you will also hopefully get their expertise to help you launch and grow your small business.
- Most important is usually You and You Team!
- High-level steps for securing investor funds for your small business:
- Find potential investors
- Your network
- Angel investment networks
- Share your Business Plan or Pitch Deck
- Due Diligence
- Investors will review your management team (including your backgrounds), the market, your products and services, legal structure, business model, and your projected financial statements.
- Negotiate Terms
- If they decide they want to invest, the next step is to agree on a term sheet that outlines the terms and conditions for the investment. You will need legal counsel to help you negotiate and finalize the terms of the deal for their investment in your small business.
- The Investment
- Depending on the terms agreed to, this may come all at once or in specific rounds tied to certain milestones in the start-up of your small business.
- Related episodes of The How of Business podcast:
- Episode 377: Start-Up Funding with Hall Martin – How to seek and secure start-up funding for small business owners with Hall Martin, an entrepreneur and angel investor. Hall Martin is an entrepreneur and the Founder & CEO of TEN Capital – TEN Capital helps startups and growth companies everywhere raise venture funding. He shares tips and advice on how to find and pitch investors.
- Episode 382: Business Plans – and the Business Plan Outline free download.
- 395: Financial Projections for Small Business Startup and the Financial Projections Spreadsheet free download.
- Find potential investors
Crowdfunding allows you to leverage small amounts of investment capital from a large number of individuals to finance your new business venture. Leveraging the internet, Crowdfunding platforms allow you to leverage a virtual network that brings investors and entrepreneurs together. There are essentially two types of crowdfunding: Gift Based and Equity Based Crowdfunding. Crowdfunding websites such as Kickstarter, Indiegogo, and GoFundMe attract hundreds of thousands potential investors and supporters. And there are even platforms focused on creative businesses, including Patreon and Substack.
- Bank Loans:
If you want to retain complete control of your business and not part with any equity (ownership of your small business), but you don’t have enough cash yourself to invest in your business start-up, then you should consider a small business loan. Traditional banks are a good source of business funding, however, you may be surprised to know how difficult it can be to get loans from banks, particularly for first-time small business owners and start-ups.
- The types of loans available for small business start-ups include:
- Conventional Loans
- SBA Loans
- Micro Loans
- An SBA loan is more common for small business loans. Many people think an SBA loan is a direct loan from the government. You actually obtain SBA loans from banks or credit unions, and the SBA, or federal government, guarantees these loans for the bank up to a certain amount. This minimizes the risk for the bank, and encourages them to lend money to entrepreneurs who will in turn contribute to their local communities by creating jobs and other opportunities. The Small Business Administration supports several types of SBA loan programs. The most common SBA financing program is the SBA 7(a) loan, a general-purpose loan that can be used to cover most major business expenses. The SBA 504/CDC loan is a more restrictive type of funding available to small businesses that promise to create economic growth in their communities. The SBA also offers microloans for businesses that need smaller loans, and they also have programs for veterans. As you might understand, the federal government doesn’t like to take on risk, which makes SBA loans among the most difficult and time-consuming to obtain. The place to start if you are considering an SBA or Conventional loan is with your local bank or credit union. Have a preliminary conversation with a representative at your bank to begin exploring your lending options.
- Episode 235: Mandy Kuxhausen – SBA Loans
- The types of loans available for small business start-ups include:
- Micro Loans
Microlenders are non-profit organizations that receives federal funding from SBA. In turn, the Microlender makes small loans (typically under $50k) to very small businesses in the community, and they also provide assistance to the small business owner. Search for Micro Lenders in your state, to investigate this potential lending option. Often these loans may carry a higher interest rate and some fees, but they may be more willing to work with you if you have low or poor credit.
- What do lenders want:
- Credit worthiness – credit score & ability to repay
- The Five Cs of Credit
- Capacity – ability to repay
- Capital – your cash portion – skin in the game
- Collateral – as a source of remedy in case of your default
- Conditions – the market and industry
- Character – including your educational background, business experience and personal credit history.
- Personal Guarantee
- Business Plan with Financial Projections
- If you don’t have good credit now (probably around 700 or above), then that should be your focus over the next year or so. It may be that you have to delay your launch until you get your credit score to where it needs to be.
- Episode 240: Gerri Detweiler – Personal & Small Business Credit
- The Five Cs of Credit
- Credit worthiness – credit score & ability to repay
- Minimum start-up investments to consider:
- Legal & CPA advice – estimate between $500 and $1000 at a minimum if you don’t partners in the business.
- Entity Creation – if you do it yourself, then it will be a few hundred dollars. NOTE: If you will have partners or investors, you need to engage an attorney!
- Start-Up Expenses
- Working Capital
- Key takeaways from this episode include:
- Before you go find the money to start you small business, you must first complete your financial projections to calculate how much you need.
- Consider starting as small as possible, niche down and take the MVP (Minimal Viable Product) approach, then grow by reinvesting your profits. Even if you have the money, start small to validate that your idea and business model are indeed profitable.
- The most common options for small business funding, and that you should perhaps explore first, are your own resources. At a minimum, you will need some of your own cash to start a business regardless of the other sources of capital.
- It’s not easy, but you may well be able to get a loan. You just need to be well prepared and have the credit worthiness the lender will require.
- If you really want it bad enough, you will find a way to make it happen! You may have to delay your small business launch, and adjust your short-term vision for your business, but you will get there!
- Join Henry Lopez for the next Financial Projections Workshop for Small Business Startups!
The following is a full transcript of this episode. This transcript was produced by an automated system and may contain some typos.
0:00:11.3 HENRY LOPEZ: Welcome to The How of Business. This is Henry Lopez, and this episode is all about helping you determine how you will fund your small business startup, it costs money to start a business, obviously, so where will that money come from? To receive more information about the halo business, including the show notes page for this episode, which will include all the free downloads and other resources that I will reference in this episode, please visit the how business dot com. And I want to announce that I’ve just set the date for my next financial projections workshop, so please visit TheHowOfBusiness.com for that next workshop, date and time, and the registration link, I have once again limiting the number of participants to this next workshop to 10. So be sure to register today for the next financial projections workshop.
0:00:58.3 HENRY LOPEZ: So let’s talk about funding options for your small business, nothing happens in business, obviously, without first having money to invest, depending on your business idea and your plans, it may take very little money or large sums from multiple sources, but even the smallest of businesses will require some investment of money, and a portion of it will likely need to be your own cash, and your ability to borrow money, if you are going to borrow money will be almost completely dependent on your personal credit and you’re available collateral. So let’s explore how you can get the capital to start your small business first or start with the most common sources of funding for small businesses in the United States, and this is somewhat in order of most common, with the most common being your own sources of capital which might include cash investments, your IRA or 401K money, home equity loan, margin accounts, credit cards, those types of things, the cash and the resources that you currently own, it might also include money that gets led to you or given to you by friends and family, or an investor partners that you might bring into the business who are going to bring capital as well, of course, there’s traditional lenders, bank loans, especially spa type loans, but there’s also micro-lenders that you may want to consider, and then there are…
0:02:20.5 HENRY LOPEZ: Would typically refer to as angel investors, people that we don’t know necessarily, or maybe not very well, who you might pitch your idea too, for them to invest in the business. And of course, there are other sources, and I’ll touch on a couple of those here on this episode, but let me start with a few common misconceptions about small business funding, the first one that I have on my list is that it’s easy to get a loan for your first business startup, now it’s certainly very possible, and you should definitely explore it, if that’s one of the ways you believe that you can fund your business, but just be prepared that it won’t be easy, and there are very specific things that the lender is going to look for that, I’ll share with you in this episode. So it’s not easy, but it is possible. The second misconception is that your credit, your personal credit doesn’t matter, in fact, if you’re going to borrow money, your credit perhaps is the most important single factor in determining if you’re going to get that loan, even with an SBA load.
0:03:20.9 HENRY LOPEZ: Another misconception is that you don’t have to personally guarantee the loan, again, this is in the case of you getting a loan from a bank, even an SBA load, the reality is that you will have to personally guarantee that loan, and what that means is that if the business goes bust if you have to shut it down, that does not forgive the loan, you personally are still responsible for paying back that loan, and then the final one that I have my list of misconceptions is that you can finance the entire amount of what you need to get started, and the working capital that you’ll need in those first critical months and that you won’t have to invest any of your own cash, that’s simply typically not the case. There was going to be at least a portion of the capital required, that’ll have to be your own cash or perhaps one of your partners, so where do you start with getting the money that you need to start your business? My recommendation is the first place to start is to determine how much money do you need, so that means that you have to develop your idea to a enough of a level where you have a plan of some sort and a business model, and you calculate…
0:04:31.3 HENRY LOPEZ: You do the financial projections to calculate how much money you’ll need to get started, including the working capital that you’re going to need to get to break even. So how much is that? And so those calculations are critical because then once you know how much you need, you can better determine where will that money come from, and as I always recommend related to any business startup, I encourage you to think about starting as small as possible to niche down and start with the smallest version of your business possible, this is regardless of whether you have all the money that you would ever need or you have very little money, in fact, that sometimes is one of the advantages of not having as much money when you start a business, because it forces you to start small, and the reality is that that’s often the best way to start, because that allows you to validate, to take an MVP, a minimum product approach to your concept, to your business model and validate Without investing too much money yet that there is a market for your product or service? I did an episode on this topic, episode 351 called niche down to grow your small business, and I encourage you to listen to that episode, if you haven’t already, I explore this concept of starting smaller, of niche down, of starting with the smallest possible version of your idea, and then growing it over time.
0:05:56.7 HENRY LOPEZ: But once you’ve done that, once you’ve determined what that business is going to look at, like to start, then it’s about calculating how much start of funding you will need, so that again, you can determine how you will get that money. Let’s talk a bit more about self-funding your business using your own money, and this can include all kinds of resources that you might have control over, I’m talking about primarily cash, the cash you might have in savings, for example, maybe it’s an emergency fund or maybe a savings that you’ve accumulated specifically to start this business, which is fantastic, but when some people also do is they might type into their retirement savings or IRAS or 401Ks, and while that certainly has tremendous risk associated with it, it’s also a possibility there are programs that exist that you may want to look into that facilitate with no penalties, no, no IRS penalties to borrow against your retirement accounts and essentially invest in yourself and in the business that you’re starting.
0:06:59.0 HENRY LOPEZ: I think that this approach makes sense for some people.
0:07:02.2 HENRY LOPEZ: Certainly what I recommend, if you’re considering that, is that You don’t borrow against the entire amount of your investments, of your retirement investments, in case things don’t work out into business fails, you at least have a depleted… Your entire retirement savings. So that’s another source of self-funding, you might explore margin loans or loans against your investments for higher net worth individuals, that might be an option, you might tap into the equity that you have in your home… Again, that comes with the risk, so you have to be very careful, but it could be that it makes sense for you to leverage that money that you’ve built up there, that value that equity in your home and use a portion of that as the funding to start your business, and then there’s even credit cards, as outlandish as that sounds, and again, not certainly something I highly recommend, but I’ve done that when I started first business back in 1991. Part of how I financed it, it was just a part of it that I call both together, was I put a lot of the expenses, the start-up expenses initially on a personal credit card, so there are all of these abilities and sources of you, all of your personal sources of funding that you need to explore, the benefits of self-funding of using your own resources, your own cash and other resources to start your business includes the simplicity of course of the process, there’s no approval process by a bank and you don’t need any credit or any strong credit, or certainly any credit at all, you’re the one funding yourself, and you also don’t have to worry about paying back a loan to a bank that would take away from the money that you can pay yourself from the business.
0:08:46.2 HENRY LOPEZ: But some of the challenges with self-funding include what I’ve mentioned already, if you borrow, for example, against your retirement account, then you may be at the risk of depleting that and not having enough money for retirement, if you take the money you have in an emergency fund well, of course then, no, you don’t have that, and you have to be very careful that you leave yourself enough cash and resources to cover your own personal expenses and your household expenses for a period of time until the business starts generating enough of an income for you. To pay those expenses. And what if the business needs more working capital because it didn’t ramp up as fast as you’re projected and you need to inject more cash, well, if all of your cash, all of your resources are already in the business, then it’s gonna be a challenge to find where you’re gonna get that additional money that you need to get the business to profitability, but on this topic of using just your money to fund the business is important to also think of the flip side of it, and the value of leveraging other people’s money as the saying goes, if you do the math, although it may seem counter-intuitive, your return on investment is always better if you borrow a portion of the required total investment to start your business.
0:10:04.6 HENRY LOPEZ: My favorite definition of entrepreneurship that relates to this is by Harvard Business School Professor Howard Stevenson, and he defines entrepreneurship this way, entrepreneurship is the pursuit of opportunity beyond resources controlled. Us.
0:10:21.6 HENRY LOPEZ: It’s very simple, but there’s a lot in that short sentence, The Pursuit of opportunity to build something, to create a business beyond resources controlled, and that includes a lot of things that word resources, but what it includes is the money, the capital required to launch that business. Related to this is also the consideration of opportunity cost, so if you put all of your cash into this business and you’ve taken it out of, for example, other investments, well, now you’ve lost that opportunity to continue to grow that money where it’s invested now, of course, regardless of whether you’re gonna use your cash or leverage somebody else’s cash, you will have to come up with some portion of the startup expenses yourself.
0:11:12.3 HENRY LOPEZ: Let’s explore friends and family a little bit more as a source of funding your business.
0:11:16.6 HENRY LOPEZ: Most commonly in the US, people start a business using their personal capital, as I mentioned, and often also the contribution from family and friends, or a combination of both, and when you borrow money from family and friends, the turns may be quite flexible, they may not be… There may not be any specific terms at all.
0:11:33.9 HENRY LOPEZ: And of course, a major benefit of borrowing from friends and family as with investing your own money is that there’s also no extensive documentation process or any collateral typically that’s required as with bank loans. On the flip side, these types of loans can carry the greatest risk and impact of your business fails, taking money from friends and family can potentially damage your relationships with them if the business fails or if funding terms are not clear or never discussed at all. My recommendation is to consider borrowing from friends and family very carefully.
0:12:08.2 HENRY LOPEZ: Ask yourself this question. What happens to my uncle financially if I lose all of his investment, what would happen to him financially, would it be detrimental or would it just be painful, but not the end of the world… And if you do take money from them, be sure to document it in a note very clearly so that everyone is clear as to when and you will pay them back. You also want to be clear as to what their involvement, if any, will be in the operations of the business and return for their investment. Now, let’s consider partners, and of course, partners may also be friends or family, but let’s talk about it from the perspective of investing or funding, helping you fund your business partners are often… One of the reasons people will partner with someone else is that person might be bringing in the bulk of the cash, that can get tricky, and you have to be very careful, and certainly if you’re partnering with anyone in a business other than your spouse, then you do want to get the advice of an attorney and make sure that you draft a proper operating or Partnership Agreement that spells out all of the terms of that partnership, one of the most popular episodes of The how businesses episode to F9 and the previous versions of this topic, of business partnerships.
0:13:23.7 HENRY LOPEZ: So if you’re thinking about partnering with someone again, either because that’s the way you’re gonna run the business, or in part because that’s how you’re in part going to fund the business, I encourage you to listen to that episode and also download the free memo of understanding that will serve as a checklist to help you at least begin to have the conversation, and then as I said, have an attorney help you put into an operating agreement, the terms of that partnership. I am not a big fan of bringing in partners exclusively because they have money, I’d rather you bring in that person as an investor that is not involved in the day-to-day operations of the business. It usually creates an imbalance that creates problems down the road, now that’s not the same as you’re gonna partner with one or more people and you’re each gonna put in a percentage of the capital and you’re gonna own that equal percentage in this business, that is how it’s often done. And that’s great, just keep in mind that if you’re not putting in the higher percentage of the capital, then typically that results in you not having majority ownership of the business, it doesn’t have to be that way, but that’s typically the way it’s structured.
0:14:36.3 HENRY LOPEZ: If I partner with you and I put in 51% of the money that’s required, then I typically would own 51% of the business, which means I’m the majority owner, and I get to make the big decisions. So be aware of that. Again, the biggest word of caution is to bring in a partner exclusively because they have the money and nothing else to offer, instead bring in that person as an investor that does not participate in the day-to-day decisions of the business. Now, let’s talk about investors, and it’s called multiple different things, but I’ll use the term angel investors, and that term is used to represent people or a group of people who invest in the startup phase of a company and are usually… They’re usually referred to as Angel Investors, that first round of investors… You may also hear the term venture capitalist or venture capital, but that term usually refers to investments made in the later stages of an existing business, the second or subsequent rounds of funding, and usually that’s related to businesses that the goal is for them to go public or to be sold at significant exponential return on that investment, so typically what you’re looking for when we say investors for small business startups fall in this category of angel investors or just call them investors, and investors normally give you money in exchange for an ownership share.
0:16:09.8 HENRY LOPEZ: They want a piece of the business, or what we call equity, and perhaps they may also require or want in return for their investment and active role in the management of the company, they want to have some say so on how you run the business. That could be good, that can be bad, but you will need to determine if you’re seeking a silent and passive investor or an investor who’s gonna take an active role in the business, now that could be a positive, especially if that investor has expertise as knowledge is an entrepreneur with lots of experience, and you’re going to leverage that person as a mentor as well as helping you make those decisions in the business, so that could have positive, but it can also have to realize that you’re giving up some control and be ready to accept that again, you’ll want to clearly define what those roles are and what the expectations are upfront, before you start the business, investors are usually interested in a few things, a few key things, they usually look for high growth opportunities that are looking to invest in companies that allow them to make a handsome return more than if they just left their money in a typical investment, a safer investment, so they’re looking for a significant opportunity for growth and for return on their investment, they’re not typically looking for an investment that do make…
0:17:34.1 HENRY LOPEZ: And maybe they’ll make their money back 20 years from knowledge, usually a shorter horizon. They also usually, as I mentioned, one equity, they want a piece of the business rather than it be treated as a loan, although there are those types of investors are out there that are just looking for the cash flow of a loan that they might offer you, so that is something to explore, but typically, they want a piece of the business in exchange for this investment of money, they are looking again overall for taking a higher risk in exchange for a potential higher return.
0:18:10.4 HENRY LOPEZ: And again, this is not gonna be patient money here, it depends on the type of investor, but usually they want to see performance within a relatively short period of time, and their expectation might also be that they’re gonna be on a cash out either because you will sell or some other event that will happen that will allow them to recoup their initial investment plus their return.
0:18:33.6 HENRY LOPEZ: A lot of this is about control, so you have to be very careful about what control you’re willing to give up by giving up a portion of the equity of your business and whatever role they’re going to play, the investor is going to play in your business. So you have to be prepared to give up some portion of both control and ownership of your company in exchange for the investor’s money, and as I mentioned, you will also, hopefully, if they are going to be actively engaged, you’ll gain their expertise to help you launch and grow your business, but the most important thing that investor is typically going to consider, certainly experienced investors, is they’re gonna consider you and your team, and you’re gonna make a bet because that’s really what it is, it’s a high risk bet that you… And your character and your resourcefulness and your abilities are gonna get the business through launching and to profitability.
0:19:28.5 HENRY LOPEZ: So at a high level, those are the things that investors are looking for, I think that seeking investors is a great option, of course, it’s easier said than done, to find investors, if you’re considering investors, let’s talk about at a high level how you might go about getting an investor for your business.
0:19:46.2 HENRY LOPEZ: First is to, of course, find those potential investors, and that’s not easy, if in particular, you’re not in that circle of people or they’re not in your network, that’s typically where we find these investors, is in your network… The network of people that you know or someone who you know who knows an investor that might be able to make an introduction, but there are also Angel Investment networks that you can find online and learn about their application process and how to potentially get in front of them to pitch your business idea on episode 377 of the holiness, I interviewed how Martin… On that episode, we talked about how the seek and secure startup funding for small business owners from angel investors, how is an entrepreneur and the founder and CEO of 10 capital and 10 capital helps startups and growth companies everywhere raise venture funding, and he shared on that episode tips and advice on how to find and pitch investors, so these investor networks are out there and they’re looking for people like yourself who have ideas for businesses that are looking for funding now again, some of them are specialized in venture capital, where you have to have an existing business that’s looking for an infusion of cash to take that business to the next level and others, and it might be other sources like an incubator, the type of situation that do look for startups that delivers in to get that business launch again, typically in return for a portion of ownership of the business, by the way, you’ll find links to all of these previous episodes that I’m referring to on the show notes page for this episode, so if you just go there to the show new space with this episode, I’ll have all of the links to these other episodes that I’m referring to here throughout this episode, so after you’ve found a potential investor or an investor network or an incubator, that is certainly the hard part, but then it’s about sharing with them, of course, you’re a business idea and you usually do that through a business plan, or often it’s called the pitch deck, unlike with friends and family, where they may well just give you the money for your business without any plan or projections, most investors are going to want to see a plan and financial projections.
0:22:02.1 HENRY LOPEZ: They want to understand your business model, how will you make money, and most importantly for them, how will they make a return on their investment? For those of you have been listening to the how a business or some time, I’ve released numerous episodes on this topic, most recently, episode 382 on business plans, and that episode and that show notes page includes a free download on a business plan outline. So if you haven’t listened to it and you haven’t downloaded that, and that’s where you’re at here in your planning process, I encourage you to go to that episode, episode 382, and then most recently, I did episode 395 on financial projections for small business startups. And there’s a download there of a free financial projection spreadsheet, so I encourage you to listen to those two episodes if you haven’t already, and as I mentioned at the beginning of this episode, I’m excited to announce new dates for the next version, the next iteration rather of the online workshop, financial projections for small business owners, so go to the how abuses dot com for that next date in time. I’m limiting that to 10 participants. So it’s gonna go fast.
0:23:10.8 HENRY LOPEZ: It’s gonna fill up fast. Like the last one did. And during this live online workshop, I’m gonna guide you step by step through the process of creating your financial projections, or often it’s called to perform for your proposed new business, and you’ll be what to ask a question because it’s a live event. And at the end of the workshop, you have completed your first draft of your financial projections for your business.
0:23:31.6 HENRY LOPEZ: And again, as I’ve mentioned here, and I’ll mention it several times, that’s the key component, that’s where you have to start, is by determining how much money you need and then if you go to either investors or a lender, they’re going to want to see that as well, so it’s a critical step in getting your business launched, especially if you’re gonna use other people’s money, but
0:23:53.7 HENRY LOPEZ: Even if you’re using just your money, I really encourage you and challenge you to put together financial projections to at least validate that the business model that you’ve developed for this business is or has the potential to be profitable and by win, so go to the holiness dot com and click on the registration for the next financial projections workshop for small businesses.
0:24:17.3 HENRY LOPEZ: Alright.
0:24:17.7 HENRY LOPEZ: So continuing with how it a secure investors, I talked about finding them, I just shared about sharing what they’re gonna want to see your business plan or a pitch deck, and then the last three steps that happen typically in the process is if they are interested in your idea of an investor, an investor group is interested in your idea, then the investor will review your management team, including your backgrounds, your market and products and services, the legal structure of your business, your business model, all of this is called due diligence, and of course, they’re gonna look at your financial statements, so they’ll check you out and vet you and make sure that it all adds up, and that what you’re projecting makes sense, and that you are who you say you are, and they’ll look into your background and make sure that they believe in you and your team, then you’ll negotiate terms, if they decide they want to invest, the next step is usually to agree to what’s called a term sheet that outlines the terms and conditions for the investment, and of course, if you get to this point, if you’re considering bringing in an investor, you need to get legal counsel to help you negotiate the deal and also to finalize the terms of this investment deal, and then ideally, if everything goes well and all that works out and you’re able to agree to terms and you get that money and typically, it may not be all at once, it just depends on the terms, it might be that there are rounds of funding as certain milestones occur in the launch of your business.
0:25:43.0 HENRY LOPEZ: So far, we’ve talked about using your own resources, your own cash, leveraging friends and family that might allow you to borrow money from them, and I just walk through bringing in an investor partners or investors, and the whole process that that typically looks like at a high level, now, I wanted to quickly about crowdfunding, you may have heard of crowdfunding as a way that people have started their businesses or funded ideas to get started in a business. Crowd-funding allows you to leverage small amounts of investment capital from a large number of individuals to help you start your business venture, you’re leveraging the Internet on these crowdfunding platforms like Kickstarter, for example, that allow you to leverage a virtual network of people, and they bring together investors and entrepreneurs, there are essentially two types of crowd funding, I’m not gonna get into deeply on the details, if this is something that you wanna explore, then I encourage you to do more research, but there’s either a gift-based crowd funding, which has been the traditional form of crowdfunding or in return for someone giving you some money, they don’t get a piece of the company, they get some level of a reward.
0:26:57.9 HENRY LOPEZ: And I’ll give you an example here in a moment, and then the other type is equity-based crowdfunding, which became legal several years ago that does allow people to invest and take an equity position in your business. So crowdfunding websites as an example, or as I mentioned, Kickstarter, India, Go, Go, Go, Fund Me, and they attract hundreds of thousands of potential investors and supporters that you might be able to tap into, there’s also even platforms focused on creative businesses like Patreon and sub-stack, I’ll give you an example, when I was curious about this ever, years ago, I invested in a product called a huge cube, and if you’re interested, you can still find that campaign on Kickstarter, it’s one of the… Were probably one of the most successful campaigns, I suspect on Kickstarter. They started with seeking a goal, the goal they had was for 15000 and to date, they have raised more than 6 million dollars through the Kickstarter platform. Now, they’re an anomaly here. They’re a unicorn certainly, but it shows you that there is this ability now by leveraging the Internet and these platforms like Kickstarter and others to perhaps use a very unique unconventional compared to what we’ve done historically and then conventional way to start your business.
0:28:26.7 HENRY LOPEZ: As I was doing research in preparation for this episode, I just did a search on Kickstarter, for example, for different restaurants, which are another common category of businesses, it’s not the only category, but it’s a common one, and I found one, for example, an entrepreneur that is wanting to start a wine bar and cafe in California, and they set up a Kickstarter campaign, and your goal was to raise 50000, and they’ve done… So they’ve raised 50000 from 107 backers as they’re called individuals, and what they’re getting… What these 17 people are getting is no equity in the company, they have no ownership, they’re getting prizes and gifts, and maybe a the gift card that they can use at this restaurant, those types of incentives, what they’re doing, what you’re doing when you leverage these platforms is you’re connecting with like-minded people that want to support this idea that you have, or this business or this mission, and so crowdfunding might be another source of capital that you might want to explore. Now, let’s talk about loans, if you want to retain complete control of your business and not part with any equity, but you don’t have or you don’t want to use all of your own cash, all of your own resources, and of course, you should consider a small business loan everybody knows, of course, the traditional banks are a good source of business funding for these loans, but which you may be surprised to know is how difficult it can be to get loans from banks, particularly for first-time business owners and startups, but it’s not impossible, and you should definitely explore it.
0:30:07.9 HENRY LOPEZ: There are essentially three or so types of loans that I’m gonna touch on here in this conversation, first is very lightly I’ll touch on because it’s not as common and harder to get as a conventional loan, then there are SBA loans and there are micro loans, conventional loans are more common for smaller amounts of money and come with more restrictive terms and are almost entirely based on your credit worthiness.
0:30:34.6 HENRY LOPEZ: So let’s talk about silos because that is the more common form or type of small business loans for startups.
0:30:42.9 HENRY LOPEZ: Now, depending on who you ask, you might have heard or been told that the SBA doesn’t lend to startups, and that’s not entirely true, although the reality is, when you look at the numbers… When you look at the statistics of SBA loans issued on an annual basis and you look at the loan amounts, they’re mostly larger loans, which tells me it’s for larger business start-ups or it might also be for existing businesses, but it does happen. I have gotten sought and gotten several business loans, SBA loans for several of the businesses that I have launched or have launched with my part.
0:31:17.3 HENRY LOPEZ: So
0:31:17.5 HENRY LOPEZ: It is possible. It’s just challenging, but you should explore it again, also one of the misconceptions, as many people think an SBA loan is a direct loan from the government, what you’re actually doing is you’re obtaining an SBA loan from a bank, your local bank or a credit union, and the SBA or essentially the Federal Government is guaranteeing those loans for the bank up to a certain amount, and so that minimizes the risk for the bank, and it encourages the bank to lend money to entrepreneurs who will hopefully in turn contribute to their local communities by creating jobs and other opportunities. So the Small Business Administration, the SBA supports several types of SBA loan programs, with the most common SBA financing program being the SBA 7A load, which is a general purpose loan as it’s called, that can be used to cover most major business expenses, including most start-up expenses, then there’s the SBA 504 CDC loan, which is more restrictive, a more restrictive type of funding, but it’s available to small businesses, they promise to create economic growth in their communities, and the SBA also funds what are called to micro loans for businesses that’s need smaller loans and I’ll speak to that in just a moment, as you might understand that the federal government doesn’t like to take on risk, which makes SBA loans among the most difficult and time-consuming to obtain.
0:32:44.5 HENRY LOPEZ: So the process of obtaining an SBA loan and my experience and people that I’ve talked to, it might take three months, might take six months, so you have to consider that… It might take some time to see curable the place to start, if you’re considering an SBA or even a conventional loan, is with your local bank or credit union where you do your banking now, is often a great place to start, so have a preliminary conversation with a representative of your bank, and begin exploring what they’re lending options and what you might be able to qualify for and what they’re gonna require from you, and typically that’s gonna be… They want to see some type of a business plan with financial projections, and they’ll have at least a preliminary application that you’ll have to complete
0:33:29.6 HENRY LOPEZ: On episode 235 of the hour. Business had the pleasure of interviewing Mandy cuts housing, and she is a specialist on SBA loans. So I encourage you, if you want to learn more about SBA loans to listen to Episode 235.
0:33:45.0 HENRY LOPEZ: So as I said, related to the SBA, there are these things called micro loans, and they’re provided by micro-lenders who are non-profit organizations that receive money from the SBA and turn… The micro-lender makes smaller loans, typically under 50000 to very small businesses in their community, and they also can provide assistance to the small business owner, mentoring to help you get started, to help you put together your planning and an ongoing guidance sometimes to help you grow your business, so if that’s something that you might consider, especially if you’ve niched it down and you’ve identified that smallest possible way to start your business and it’s under 50000, and that combined with some cash that you have will get you there to get your business started and properly funded. Then I encourage you to search for micro-lenders, every state has different micro-lender, so search, just do a Google search for micro-lenders in your state and investigate this potential lending option. Often, these loans might carry a higher interest rate and some fees, but they may be more willing to work with you and often do if you have lower or poor credit scores, so speaking of credit scores, what do lenders…
0:35:02.2 HENRY LOPEZ: Regardless of the type of loan. What are they looking for from you? Well, a great place to start is what you may have heard of, and if you’ve spoken to any lenders, they may have shared with you what they call the five Cs of credit, and those five Cs of credit are capacity, capital, collateral conditions and character. Capacity is essentially your ability to repay, do you have the resources and the income or other sources to pay back that loan if the business fails, does the business have a business model and financial projections that show that you can cover that debt service to pay back that loan, the next is capital, so your cash portion, your skin in the game, as I’ve mentioned now, any lender is going to… For that matter, probably any investor is going to want or require that you put in some portion of your own cash so that you’re invested in it, if for no other reason, then there’s collateral, and that is the collateral that you’re going to have to put up in the case of a loan, certainly in the case of an SBA loan, it’s a source of remedy in case you default on the loan, so you may have to put up property investments, maybe even your personal home, so you have to be very careful about that, but that will be a requirement is that you have the collateral to support the loan that you’re asking for, and then I’ll be conditions, depending on the market, the type of business, the industry, there’s gonna be certain conditions that apply, there may not even be a program available for your type of business.
0:36:38.0 HENRY LOPEZ: So that’s why you want to have that preliminary conversation with your bank, and in the fifth S is character, which includes you might include your educational background, your business experience, but most importantly, your personal credit history, so beyond those five Cs, which encompasses most things I want to touch on a few things that are of primary importance as to what lenders are looking for and want to see before they’re going to give you any money, the personal guarantee is one that I just touched on, which is that you can rest assure that for any type of loan you go get… Certainly for an SBA loan or a convention alone, you will personally have to guarantee the loan, that means that if the business fails, if you have to shut down the business that does not excuse you or forgive the loan, you will personally still be responsible for the loan. And if you don’t make your payments as scheduled, they may go after the collateral that you put up for the loan to begin with, the other thing that banks will want to see, as I’ve mentioned several times, is your business plan and your financial projections, in my experience, you’re not gonna find a single lender out there that doesn’t want to see your plans and your financial projections, and then again, as I mentioned, related to character, you have to have the credit worthiness essentially for an SBA or conventional loan, in my experience, but this is just generalities, you have to explore it yourself if you don’t have good credit, typically above 700 or so, and again, that’s just a generalization, then you’re gonna have a challenging…
0:38:19.3 HENRY LOPEZ: You may not qualify for an SBA or a conventional loan, if you don’t have good credit now, then that should be your focus over the next year or so, or however long it takes you, it may be that you have to delay the launch of your business until you get your credit score back up where it needs to be, but you’ll still get there, it just might take you a little longer, so the important thing though is to identify that now and be realistic about what your current credit situation is, and then focus on improving that if that’s what it’s going to take before you can get a loan… Episode 240 of the Howard business. I interviewed Jerry debt while Jerry has been on the show multiple times, but on episode 240, Jerry and I chatted about personal and small business credit. So if you want to learn more about personal credit and the things that go into that and more details on what banks are going to look for there, I encourage you to listen to Episode 240 of the Halo business. So I have shared with you my thoughts on the primary sources of funding for small business startups, including your own resources, friends and family investors, both people you might know, or partners, or angel investors, people that you’re gonna seek out that might be interested in investing in your business, and then we just talked about loans, in particular, SBA loans, and what a bank is going to look for from you to potentially qualify for a loan.
0:39:48.1 HENRY LOPEZ: The thing to consider is regardless of the sources or combination. Nerve, as I mentioned at the beginning of this episode, you’re going to need some money even if you start very small, so there are some minimum categories of investment that I want to touch on that I think are very important, and then I don’t want you to overlook…
0:40:06.1 HENRY LOPEZ: First is getting legal advice and CPA or accounting advice, depending on whether you’re going to have partners or not, might dictate how much you need from an attorney, and whether you need a properly drafted operating in partnership agreement, but you shortly at a minimum, want to get advice on how to best structure your legal entity for the best tax and liability protection, so you want to get that advice from a CPA for a business where it’s just yourself, my estimate for cost on legal advice and CPA guidance. It’s probably in the 500 to 1000 at a minimum. It’ll be more expensive if your attorney has to draft, help you with drafting and create for you and draft and operating our partnership agreement, and it might be more expensive, you also didn’t have at a minimum, the expense of creating your legal entity. Once you’ve gotten that guidance from a CPA or a tax attorney as to what legal entity makes best sense for you, then you’ve got a couple of options, the cheapest option is to create the legal entity yourself, which you can do in every state, that’s something you do at the state level, and that will cost anywhere from 100 to a few hundred dollars, and my experience, depending on the state, and then you’re gonna have other start-up expenses, so at a minimum, you’re gonna have certain start-up expenses, and this way is so critical to calculate those expenses.
0:41:35.1 HENRY LOPEZ: And then the number one reason that most businesses fail is that they’re under-funded, you cut corners, or you underestimate how much money you need and what we call working capital to get you through that ramp-up time to the point where the business breaks even and starts to generate a profit, and that’s what we cover in this workshop that I just announced, the new dates for the financial projections workshop, that I encourage you to consider signing up for at a minimum, download the financial projections spreadsheet and the business plan outline. You’ll find both of these downloads, free downloads on the show notes page for this episode, and of course, as I mentioned, the related podcast episodes, and educate yourself on how to do that and create your financial projections. Here are my key takeaways for you from this episode, before you go find the money that you need to start your small business, you have to start with calculating how much you need, and that’s all about those financial projections. Also consider starting as small as possible, niche down, taken MVP or minimal viable product approach, and then grow by re-investing your profits, it’s also called bootstrapping, even if you have the money, start small to validate your idea and business model and to validate that people want what you’re offering and that you can deliver it in a profitable way, the most common options for small business funding and that you should perhaps explore first is your own resources, but for most of us, we have limited resources, and so at a minimum, you need to make sure that you have enough of your own cash to contribute, because again, you won’t be able to borrow everything, and no investor is likely gonna give you all of the money to start your business, you’re going to have to contribute some amount of money yourself.
0:43:26.6 HENRY LOPEZ: And while it’s not easy, the other take away is that you may well be able to get a loan, you need to at least explore it, you need to be well prepared and have the credit line… That the lender is going to require. If that’s an option, you’re going to explore, but start by checking with your local bank and at least beginning to understand what the requirements are for potentially getting a loan, if you really want it bad enough, you will find a way to make it happen. To make this business happen, you may have to delay your launch and maybe adjust your short-term vision for your business, but you will get there. I encourage you to join me for the next financial projection workshops for small business startups, just go to the houses dot com, and you’ll look for the registration link there. I wish you the best as you prepare to launch our small business, this is Henry Lopes, and thanks for joining me for this episode of the how of business. I release new episodes every Monday morning, and you can find the show anywhere you listen to podcasts or at my website, the Haines dot com.
0:44:33.4 HENRY LOPEZ: Thanks for listening.
0:44:35.5 HENRY LOPEZ: Thank you for listening to the how of business. For more information about our coaching programs, online courses, show notes, pages, links and other resources. Please visit the how business dot com