Small Business Financing; What I Learned from My Father
I bet it would be very hard to find anyone to disagree with me that financing your small business is hard. Even if you are established and need capital for an expansion, new equipment, or new staff, getting more funding is hard. Often, it could mean the difference between growing or not. To make matters worse, I'm going to go against what my MBA Finance Professor said, Having some bank loans in your portfolio will make you more well rounded. Which might be true if you we're a very large corporation and trying to diversify where your money sits and how it might be affected by tax laws. Yet for the small business, I'm going to tell you that a bank loan to fund your business could spell disaster. I say this with the understanding that there often is no other choice, and you have to take the risk. Lets look at some of the reasons why I'm glad my business has never used a bank loan as a main funding source.
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Not completely unlike today, the 1980 business scene was a disaster zone. Our country was in a deep recession and business bankruptcies easily grew over 50%. The federal funds rate was about 11% in 1979 and grew to over 20% by 1982, as well, the prime interest rate went over 21% by that same year. Therefore, bank rates we're moving up over 22% to cover the costs they had with borrowing money from the federal government. That left many business owners holding loans they could not afford and banks pulling loans. My family had an industrial business then, they felt the crunch and had loans pulled out from under them. The times we're bad, and it took a long time for the family to recover but what was learned from that was that loans for a small business could be disastrous. And we are seeing it today, rather we saw it two years ago when the mayhem started hitting streets. Banks became tighter in how they lend, and they re-filtered who were worthy of getting loans, resulting in many pulled loans. At least this is the feeling I got through speaking with Sergey from , whom I strongly recommend.
When the recent events that led to our current recession (or Depression if you will) in the US and the world, we pared down a few positions in the company and put a freeze on raises and hiring. Other than that we didn't do much, besides wait it out. Our main industry is the construction industry and with products that lag about a year and a half behind the market. Meaning, it took a year and a half for us to feel the effect of the downturn. When it did hit, we did feel it; business dropped off about 40%. We regressed in sales back about 3 years, thankfully we we're profitable then and would be again today. What really saved our rear ends was a lack of bank loans. We didn't have anyone to pull our funding, unlike many of our customers who used banks to expand with millions of dollars. Without loans, we didn't have interest rates creeping up and eating away at our profits. I firmly believe if we did have a bank loans we might not have done so well or at least it would have been a very tense time.
So now you are asking; how am I supposed to fund my business then if I need to shy away from bank loans? Because of my past experience I may shy away from bank loans forever but there really are some sound reasons as to why you would want a loan and some very sound strategies for offsetting the interest of loans (i.e. investment in bonds and such, not really what small businesses do). Here are some sound places to look for startup and maintaining finance needs:
- Venture Capital and Angel Investors: Venture Capital types have a business plan of their own, it's all about investing and getting out so unless you are in a high growth market with enough to grow quick inside 5 years, they may not be interested. Angel Investors on the other hand tend to be in it for a while and will be more forgiving when it comes to when they can cash out on their investment. (Where to look: National Venture Capital Association NVCA)
- SBA Loan: Its low interest but high collateral, meaning they will want much of what you have in personal and business assets to secure the loan. But it's not a bad way to go, let's say you need to build a building, a low interest rate loan backed by the government is not hard to see. Although we have seen the real estate market drop lately, it's still a great long term investment so long as it doesn't drag you down. (SBA Loan Site)
- Equity Investors: There are many equity investors out there who would love to be a part of the action, much like Venture Capital investors but differing in that they also help to structure investor buyouts and family restructuring. Family restructuring and Equity Investors is a topic we will cover really soon as great ways for owners to get out of a business and get the rest of the family into it. (Example: Main Street Capital Corporation)
- Dont overlook friends and family, granted it's hard to be in business with friends and even harder with the family but this blog is all about making the family and small business work and with some 60% of small business be owned by families, don't forget Uncle John as a potential funding source.
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The moral to the story is, be very careful where your hard earned money goes and be sure that when you need funding that it won't vanish one day. Commercial bank loans can spell disaster in a bad economy, but sometimes you have no other choice, and you shouldn't let it stop you if you have to get a loan. But don't forget other avenues like venture capitalists, angel investors, SBA loans, friends and family. Maybe Uncle John wants to build you a building and charge you rent, a win for both of you.
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Posted in Law Post Date 12/21/2014