Stages of a Developing Business
Lenders suggest that rather than approaching a bank, owners of businesses in Stages One and Two should seek financing from informal investors. Such sources of funding may include, among others, friends or relatives, partners, local development corporations, private foundations offering program-related investments, universities with targeted research and development funds or through a loan which is guaranteed by the Small Business Administration (SBA).
Lenders say that businesses in Stage Four, and some in Stage Three, are sufficiently developed to approach a commercial bank or another traditional lender for a loan.
If your business is in Stage Three or Four and you intend to approach a commercial bank, lenders suggest that you first submit an application to a bank with which you have an established relationship. If you do not have an established relationship with a bank, lenders recommend that you ask an experienced accountant or lawyer to contact a bank and present your proposal.
Also, keep in mind that you must choose a legal designation-sole proprietorship, partnership, or corporation-and execute the necessary documentation for your small business before approaching a bank or another lender.
Reasons to Borrow
There are three major reasons why businesses borrow; the first and most common reason is to purchase assets. A loan to acquire assets could be for buying short-term, or current, assets-such as inventory-and would be repaid once the new inventory is converted into cash as it is sold to customers. Or, the funds could be for the addition of long-term, or fixed, assets, such as equipment.
The second reason is to replace other types of credit. For example, you may wish to use the funds to pay suppliers more promptly to get a discount on the price of the merchandise.
The third reason is to replace equity. If you wish to buy a partner’s share in your business but you don’t have the cash to do it, you may consider borrowing.