While many businesses have been slammed by recession, some entrepreneurs are using the downturn as a time to prepare for better times ahead. And a big part of that is not only getting your current balance sheet in shape, but lining up funding sources to support future growth.
It starts with understanding the different options, and that alone can be challenging. When American Express surveyed a group of small business owners recently, it found that many were having trouble separating financial fact from fiction.
For example, Amex found that 34 percent of business owners surveyed believed, incorrectly, that a business “term loan” (funded immediately for a set term and amount) and a “line of credit” (which you open and tap as needed) are essentially the same. And nearly 40 percent believe it’s a good idea to apply to as many lenders as possible when seeking a loan, when the opposite is true. Multiple applications can tarnish your credit rating.
Here are five things you should know about financing that can help position your business for future growth:
1. Reinvested profits are perfect. The best source of “venture capital” for an existing business is money your company is already generating. Many entrepreneurs miss growth opportunities by spending profits in unproductive ways. Others take the opposite extreme, pumping every penny into the business while taking nothing for themselves. Both can backfire. If you do need to seek a loan, bankers will prefer that you pay yourself a reasonable salary. They want to know the business can be profitable even if those running it get paid.
Reinvesting profits in your business is a key to successful long-term growth. This is “patient” capital that builds value in your business without debt and without giving up shares to others. About 46 percent of business owners surveyed by American Express said they planned to finance their growth by reinvesting profits.
2. Tap into trade credit. “Trade credit” describes the process of delaying payment for goods and services your business purchases from various suppliers and vendors. You may find vendors more than willing to sell on credit to a growing business – and even to a startup – if you can strike a long-term deal to buy from them.
And from your perspective, trade credit is also one of the safest forms of business borrowing. Bank debt is dangerous because payments are still due even if sales drop. But if sales drop so will your orders, so your level of trade credit will drop too.
Right now, trade credit may be more readily available than bank or other types of loans. And it lets you spread payments over months or even years with little or no down payment and generally favorable rates.
3. Line up credit lines early. The time to establish a line of credit is when you have the ability to qualify for one – not later on when you need it. Having a line of credit can help you growing by providing ready financing when opportunities arise. A line of credit is also vastly preferable to using corporate credit cards that generally carry much higher interest rates and increasingly onerous terms. But avoid using a credit line to bail yourself out of trouble. Lines are meant to be tapped as needed, then paid off so they are available again the next time.
4. Expand banking relationships. If you have accounts with only one big bank, consider opening additional accounts at a regional or community bank. That will give you more options when it comes time to look for loans, lines or other credit to support your growth plan.
5. Consider alternative loan sources. A few options include credit unions you may be eligible to join, accounts receivable financing (also called factoring), and so-called “peer-to-peer” lending. Peer-to-peer (or person-to-person) lending has taken off in the recession as traditional loan sources have dried up and new Internet sites have made it easy to apply for and obtain this type of financing.