How To Obtain Small Business Start-Up Loans

How To Obtain Small Business Start-Up Loans

You've had a brilliant business idea and have decided to pursue it. However, regardless of how simple your business model is, getting it off the ground will require hard cash, and obtaining small business start-up loans appears to be the only option.

Raising capital is common, with around:

  • 46% of businesses attempting to seek capital at the debut
  • 72% requiring additional capital after launch

Small Business Start-Up Loans

Even in Australia's booming fintech lending industry, you can find it nearly impossible to obtain small business start-up loans as a start-up. However, it does occur. But it does happen. 8.2% of start-ups receive a business loan.

Even the most lenient unsecured business loan lenders will require at least 6 months of trading history and proof that your idea is a money-spinner before they will take a chance on you.

However, if you have personal assets, particularly real estate, you may be able to obtain a secured business loan to fund your venture. But keep in mind that if you use your home to secure a loan, you risk losing everything, including the roof over your head, if your business fails and you can't repay the loan.

You'll also need to think about how you'll make your loan payments until your company takes off. To qualify for a loan, particularly one from a bank, you must show that you have sufficient income to meet your obligations. This implies that you must have a steady and ongoing source of income. Calculate loan repayments.

  • Lending Pro Tip 1: If you open a merchant account with your bank and accept credit and debit card payments, you can apply for a merchant cash advance.
  • Lending Pro Tip 2: As you start invoicing customers, you can "sell" these invoices to a lender, who will advance you a large percentage until the entire invoice is paid. This is referred to as invoice financing, and it can assist you in improving your cash flow.

Sweat Equity

No matter how versatile you are, you will require assistance in getting your business off the ground. The most successful entrepreneurs recognize their strengths and weaknesses and rely on others to fill skill gaps.

You may be an expert in financial planning, but you will require assistance in developing your prototype, designing your website, and overseeing your marketing.

Of course, expertise is rarely cheap, and hiring the necessary professional help can be one of the most expensive expenses for a start-up. If your idea is compelling, you may find that people are willing to contribute their time and knowledge in exchange for an equity stake in your company rather than monetary compensation.

They'll become your partners and share in your venture's risks and rewards, so you can count on them to be as invested in its success as you are. If you choose this path, you must carefully select your team, looking for individuals who fully understand your strategy and share your vision for the business.

Calculating the Value of Sweat Equity

If there is disagreement among your team members, your budding start-up could be soon destroyed. How to evaluate each person's contribution and choose how much equity to distribute is the other important topic.

Do you estimate how much money they could have made working on your project at that time? Or how much would you have paid a third-party professional to complete their task? or the significance of their contribution to your company's success?

You must address these issues upfront, find solutions, and specify the level of input that each team member will have when making strategic, creative, or budgetary decisions.

Locate a Qualified Investor

Many funds ('venture capital funds') and individuals ('angel investors') make money by investing in emerging businesses and providing up-front capital in exchange for an equity stake.

Some will provide direct capital, while others will provide convertible debt, which functions similarly to a traditional interest-bearing loan but gives the investor the option to exchange it for stock at a later date. Professional investors fund 32.6 percent of all start-ups.

If you've ever watched an episode of Shark Tank, you'll be familiar with the fact that angel investors are frequently experienced business owners or executives who carefully consider any potential investment.

They will anticipate you to have done in-depth market research, precise financial and strategic planning, and present a strong (and passionate) business case before they will consider investing in your start-up.

Previously, angel investors were often friends or family of aspiring entrepreneurs, but there are now numerous websites that can help you attract the attention of potential angels.

Convertible Notes

A convertible note is a loan-structured investment that converts to equity. The investor lends money to a start-up and, instead of receiving a cash return, receives equity.

They are frequently used when determining a valuation is impossible. It can be difficult to value a new start-up, so instead of negotiating a valuation, raise funds today and postpone valuing the business until you have more to base a valuation on.

This is how it works: The investor provides funds to the start-up on the condition that they receive a share discount when a predetermined trigger occurs, typically when a 'Series A' round of funding occurs. The convertible note will convert into shares at the discounted rate once a Series A pre-money valuation has been established. In most cases, the discount ranges from 20% to 40%.

A convertible note is a simple and inexpensive way to raise capital. A standard market agreement can be used to avoid paying lawyers to draft an agreement.

Venture Capitalists

Venture capital trusts are professionally managed funds in which investors pool their resources and an investment decision is made by a professional fund manager. Each fund will have a different focus and set of rules for the types of businesses it will fund, and not all will be interested in start-ups (here are some that are).

Venture capital funds, like angel investors, will demand detailed business plans and convincing financial projections, as well as a lengthy evaluation and due diligence process. However, there appears to be a rapidly growing appetite for investment in emerging businesses in Australia, so if you have a compelling idea and a thorough business plan, now appears to be an excellent time to seek venture capital funding.

The most significant disadvantage of accepting investors into your company is that you will most likely have to cede some control to someone who may not share your goals, vision, or risk tolerance. However, in exchange, you may gain access to invaluable knowledge and contacts that will help you advance your firm (not to mention the cash).

Borrow from Family and Friends

If you can't persuade professional investors to invest in your company at this stage, or if you don't want the loss of control that comes with a venture capital injection, you could turn to the people who already believe in you.

If you have family or friends who have money to spare and it appears that you have a winning idea, they may be willing to support your efforts and share in your success.

According to a US survey, up to 38% of businesses are founded with funds provided by family and friends. According to a 2016 Australian survey, 28.8 percent of start-ups received funding from friends and family. It can offer a variety of benefits, including lower interest rates and more flexibility in terms of when and how you repay the loan.

However, there are risks if an informal loan is not handled carefully. Mixing money and friendships frequently ends in disaster - and can destroy relationships. If you choose this option, you must take a professional approach and draft a clear legal agreement outlining the terms of the loan and your repayment plan.

Regardless of how enthusiastic and determined you are as you launch your new business; it is critical to consider what you will do if it fails and you are unable to make the loan payments as scheduled. Include clauses in your loan agreement that address their options if you must default. This will reassure your friend or relative that their valuable savings are safe in your hands.

Personal Loan

If a business loan is out of your price range, a personal loan may be an option. Many lenders are hesitant to lend money to a new business, as previously stated, but this does not mean they will not lend you money, especially if the amount you want to borrow is small and you have a good credit history.

Many personal loans are not secured by collateral. Personal loans are given to individuals; the lender will consider your personal credit history and financial situation when determining how much you can borrow.

If you intend to quit your day job to work on your new business, you must declare this when applying for a loan, which means the lender will deduct your earnings from that job when calculating serviceability. If you've already quit, you may find it difficult to secure even personal funding unless you have income from another source, such as investments or rent.

Crowdfunding

Crowdfunding is another way to tap into the generosity of your family, friends, and random well-wishers. This entails going online and soliciting small contributions to help you get started.

It can be extremely successful, and if enough people believe in you or your idea, it can be a great way to raise a significant sum without requiring any one person to risk a large sum of money. However, there are no guarantees that you will raise the necessary funds.

You can use several platforms, each with a slightly different focus - as well as several fees, terms, and conditions. Before you choose one, do the following research:

  • Payment Options: Some platforms only accept credit card contributions. People are more likely to donate when it is simple for them to do so, so choosing one that allows one-click payment through a trusted system like PayPal may increase your chances of raising the funds you need.
  • Fees: Both the platform and payment system providers profit from commissions on the funds you raise. Some will charge your donors a fee on top of their contribution, which can cause resentment, whereas others will take a percentage of each gift, leaving you with less. These are the most recent rates published by some of the most popular crowdfunding websites. Payment processing fees typically add an additional 2.5 to 3 percent to the total.
  • Rewards: Some platforms enable you to create incentives for people to donate a certain amount. Rewards can range from early product access to discounts, free accessories, and VIP status.

Peer-to-Peer Lending

Peer-to-peer lending is becoming more popular as an alternative to seeking professional investors. Fintech sites like Society One, MoneyPlace, and Harmoney aim to bypass banks and "connect investors seeking a higher return on their investment with creditworthy individuals and businesses seeking a simple, competitive loan."

While these websites appear to connect lenders and borrowers, they actually serve the same purpose as a bank. The relationship is not direct; the platform acts as an intermediary, charging both parties fees.

To borrow from a peer-to-peer lending platform, you must first apply for a loan and pass a credit check, just like you would with any other finance provider, to demonstrate your ability to repay the loan. You'll also need to make a compelling pitch for your company, as these investors want high-potential investments to compensate for the risk they're taking.

However, the application process will be much faster than with a traditional lender, and you will almost certainly be offered lower interest rates than with a bank.

If you choose to go this route, make certain that you thoroughly review the terms and conditions of any loan, as well as the fees and any other hidden charges, before committing to anything. Peer-to-peer lending is not subject to the same stringent regulation as financial intuitions, so it's important to understand exactly what you're agreeing to.

Credit Cards

Using a credit card to cover start-up costs may appear to be an easy solution, but it is extremely risky. With interest piling on top of your borrowings every month, your balance can quickly spiral out of control if you're not careful.

Credit cards were used by 14.9% of start-ups to help cover expenses. If you go this route, make sure you pay off as much as you can each month.

If you frequently switch credit cards, you may be able to take advantage of 0% interest introductory deals on purchases and transferred balances - but if you've given up regular work to start your business, you may find it difficult to obtain new credit facilities when the interest-free period expires, leaving you paying higher interest.

While this is unlikely, you should be aware that most credit card agreements state that the lender has the right to withdraw the facility at any time, without notice, and for any reason, potentially leaving you with a large debt and no way to repay it.

Home Equity Loan

If you own a home and have built up equity over time, you may be able to sell it and use the proceeds to fund your business.

In practice, this means you'll be taking out a mortgage on your home, or extending an existing mortgage. It is similar to obtaining a secured, long-term personal loan. Mortgage rates are typically lower than those of most other types of finance, making it a cost-effective way to obtain a large sum of money over a long period of time.

There are three important factors to think about:

  1. You won't be able to access the equity in your home if your lender doesn't believe you can make the payments. You'll need to present proof of a consistent, dependable source of income in order to be qualified.
  2. In many cases, mortgages are long-term loans that cannot be repaid early without incurring significant penalties. This suggests that you can still be forced to pay interest on a long-term loan even after your business starts to turn a profit and you are no longer in need of the money.
  3. If you put your house up as collateral for a loan and something goes wrong, you run the danger of losing it.

Grants

As part of its National Innovation and Science Agenda, the Australian federal government is actively working to encourage entrepreneurship and grow small enterprises.

Along with several tax benefits and initiatives to entice investment in creative and high-potential start-up businesses, they are funding and supporting "incubator" services that "allow imaginative entrepreneurs to rapidly turn their ideas into internationally competitive businesses."

The incubation support initiative is part of the Entrepreneurs' Programme, which also provides small incorporated businesses with accelerated commercialization grants. These grants provide "expert advice and up to $1 million in matched funding to cover eligible commercialization costs to assist them in bringing novel products, processes, and services to market."

Applying for an accelerating commercialization grant can be a time-consuming and difficult process. There are numerous requirements to meet, such as the intent to trade outside of your state or territory and ownership of a sufficiently "novel" product or service that will not be suitable for many businesses.

It's also worth noting that this is matched funding, which means you must demonstrate your ability to cover at least half of the project costs yourself.

There are numerous other government grants available to small businesses for a variety of purposes, including market research and testing your business model, hiring employees, and assisting with start-up or expansion costs. Many of these are grants from state or local governments that are limited to specific regions or types of businesses.

Savings

This could be the opportunity you've been looking for all these years: to turn your nest egg into a thriving business and secure your financial future. Savings interest rates in Australia are currently extremely low, hovering around 3%, so using your savings to fund your start-up could yield a much higher return.

And, because any type of business loan is almost certainly going to have a much higher interest rate than you can earn on your savings, it makes perfect sense to start your business with the money you already have rather than borrowing.

However, be cautious because the start-up costs of a business can quickly add up, and there will always be unexpected costs. If your company fails, you may quickly deplete your savings and be left with nothing (but you will not be saddled with debts).

Poor cash flow is one of the leading causes of small business failure in Australia, so if you're going to rely on savings as a backup rather than a loan facility, you'll need to manage your working capital carefully.

 

R&D Tax Incentive Funding

The R&D Tax Incentive program may be available to some Australian businesses. We saved this one for last because refundable tax credits require you to spend money before you can receive them.

If your company engaged in eligible R&D activities during the fiscal year, your accountant can include the R&D expenses when filing your tax return for that year and receive a 43.5 percent refund (38.5 percent for businesses with a $20 million or higher turnover).

Conditions apply, and the R&D activity must first be registered with the Department of Industry, Innovation, and Science for approval. It is suggested that you hire a specialized R&D consultant to help you with your submission in exchange for a percentage of the refund.

Treadstone is a registered R&D Tax Agent and a member of AusIndustry's R&D Tax State Reference Groups. We spoke with Peter Nolle of Treadstone to get his advice for businesses interested in participating in the program.

Looking to Obtain a Small Business Start Up Loan?

Whatever funding method you choose, remember that money isn't limitless! Until your business is well-established, it is critical that you make prudent spending decisions and avoid unnecessary expenses such as renting your own offices.