Most small businesses are started or expanded with money from one of seven readily available sources. They are in order of frequency:

1.The savings of the person starting the business

2.Money from close friends and relatives

3.Scaling back cash requirements and substituting creative cost-cutting for financial equity

4.Selling or borrowing against equity in other property

5.Money from supporters or others interested in what you are doing

6.Bank loans

7.Venture capital.

I recommend never financing a business with only borrowed money, even if it’s possible. If you’re starting a new business and use your own money or sell equity, you can make your inevitable start-up mistakes cheaply and survive to borrow money later, when you know how better to use it. My general rule is that you should borrow less than half of the money you need, especially if you’re starting a new business. If you’re expanding an existing business, make sure that you can handle the cash payments necessary to repay the loan even if business isn’t as good as you hope. In other words, it’s usually more dangerous to borrow too much than too little. If you have to raise nearly all the money from others, I recommend selling equity instead of borrowing. Now let’s look at each of the most likely funding sources for new and expanding businesses in more depth.

Venture Capitalists banker in New York, the term often connotes a group of businesses that look for hot companies in which they can make large profits. Typically, this group won’t consider any investment smaller than $500,000 and prefers companies specializing in the emerging technological fields, where a lot of money is needed to get started and where it’s possible to achieve enormous returns. Computers, genetic engineering and medical technology are familiar examples. Most readers of this article will be interested in starting or expanding small- or medium-sized service, retail, wholesale or low technology manufacturing businesses. Large-scale venture capitalists traditionally do not invest in these areas. Fortunately, relatives, friends, business acquaintances and local businesspeople with a little money to invest can all be pint-sized venture capitalists. Many do very well at it.

Example: Jack Boots loved to ride dirt motor bikes on the weekends. He was frustrated that no retailer in his county carried either a good selection of off-road bikes or the right accessories. He and his friends sometimes had to drive 200 miles to buy supplies. Eventually, it occurred to Jack to quit his job and open a local motorcycle store. He talked to several manufacturers and was encouraged. The only problem was, he would need $50,000 to swing it. As he only had $20,000, he was about to give up the idea when some of his biker buddies offered to help raise the cash. Jack found six people willing to invest $5,000 each in a limited partnership. Each of these friends was, in reality, a small-scale venture capitalist, betting a portion of his savings on the notion that Jack would succeed and they would participate in his financial success. Jack’s Cycles opened for business and is doing well. All the limited partners were paid back their initial investments plus the agreed-upon return set out in their limited partnership agreement, and Jack is now the sole owner.

The only sad part of it is that Jack is too busy to ride much anymore. Many cities have venture capital clubs, comprised of groups of individual investors interested in helping businesses start and grow. These clubs often serve as an introductory service—you receive a few minutes to discuss your business at a club meeting. If any investors want to pursue the discussion further, they make an appointment with you privately. You can use these groups to expand the list you are making of investment prospects. You may also be able to obtain computerized lists of venture capitalists and investor magazines in which you can advertise your proposition. Often, these clubs are formed and disbanded rapidly; ask the local Chamber of Commerce or your local bankers if there is an active club in your area. When thinking about raising money by selling a share in your business, it’s important that you have a hard-headed picture of what you’re getting into. Amateur venture capitalists or equity investors gamble on your idea for your expansion or new venture. They invest money hoping that you’ll make them rich, or at least richer. If you intend to look for equity investors, your business plan needs enough economic and marketing research to show investors that your idea has the potential of making a substantial profit. You’ll also need to show potential investors exactly how they’ll profit by investing in your business.

Example:Jack Boots spelled out his profit distribution plans in his limited partnership document: Investors received 50% of the profits paid monthly according to their relative share of investment after he paid himself a nominal, agreed-upon salary for running the store. In addition, they qualified to buy merchandise at a substantial discount. They also owned a share of the assets of the business. Jack estimated that a $10,000 investor would receive a monthly cash flow of $200 for an annual return of 24%. When added to the partner’s investment share in the inventory of the shop, this would make a $10,000 investment worth $20,000 in three years.

Additional Money Sources for an Existing Business

If you’ve been in business for at least three or four years and can show a history of profitable operations, a whole new world of financing options opens up to you. The major advantage you have over a start-up is that you can prove what you say, whereas a start-up can’t. Be careful if you’ve been in business for less than three years or can’t show a profitable history—financing sources may consider you a start-up and put you in a higher risk category. (Funding sources for start-ups are covered in Section C, above.) Take your latest two or three years’ financial statements with you as part of your business plan when you talk to any financing source. That way, the lender or investor can see where you’ve been and where you’re planning to go. Here is a list of readily available financing sources for expanding your small business. Consider each potential source of money carefully—each has unique advantages and disadvantages as they apply to your business. Approach whatever source makes the most sense for your business first; you can try others if the first one doesn’t work.

1. Trade Credit After you establish a reliable record of prompt payment with your suppliers, normally they will consider extending additional credit for your expansion plans. Let them know of your plans well in advance; if you begin delaying your payments to finance your expansion without notifying them, they may get annoyed. They have an interest in seeing you grow; after all, you’ll be buying more from them in the future. Sometimes they will even introduce you to their bankers and investors if you approach them with a well-thought-out business plan.

2. Commercial Banks Remember those banks that were so hard to get money from when you started your business? Well, once you can show a profitable history, they become a lot more friendly. As an established businessperson you can often secure flexibility from banks that you might not expect. For example, they may lend you money and take a security interest in your accounts receivable. Or they may take a security interest in your inventory, equipment or other business assets.

3. Equipment Leasing Companies Leasing companies own equipment that they rent to businesses and individuals. Some leasing companies are similar to rental yards in that they have a supply of equipment on hand that they rent out. Sometimes these companies offer repair and trade-in privileges in addition to short-term rentals. Other leasing companies—called full finance leasing companies—do not take physical possession of any equipment. You find the equipment you want, and they buy it for you. Full finance leasing companies have no equipment inventory and offer no return or repair services. They borrow money from a bank, so you’ll have to pay back the equipment cost plus interest and a leasing company service fee over a fixed time. Normally, you have the option of buying the equipment for an additional price at the end of the lease term. Full finance leasing companies base their credit decisions on your company’s financial condition. They will want to see lots of financial records from your company and may request that you pledge some of your personal assets to guarantee the lease. Of course, make sure you understand what you agree to before you sign anything.

4. Accounts Receivable Factoring Companies Factoring companies—also called factors—buy your accounts receivable at a discount. Then, they collect your accounts at full face value. This can be a very expensive way to raise cash—I only recommend it as a last resort. Some factors require that your accounts pay them directly instead of paying you. This can cause problems with customers, who’ll assume that you are having serious cash flow problems. Approach factors with caution and make sure you understand the implications of the agreement before you sign it. Factors can buy your receivables with or without recourse—that is, your guarantee of payment to the factor. Factoring with recourse means that the factor pays you a higher percentage of the receivable in cash and makes raising cash less expensive. But you can be seriously damaged if a big account fails to pay its bill and you have to make good on your guarantee.

5. Venture Capitalists Some venture capitalists specialize in funding businesses after they have a track record and are willing to take a smaller return as a result. The industry is changing, and more venture capitalists are looking at a wider range of possibilities and client companies. Often a venture capitalist will specialize in a market area and company size or stage of growth. The possibilities have increased, and so has the work involved in finding just the right backers. (Also, see the discussion on venture capitalists for start-ups in Section C7, above.)

6. Money Brokers and Finders Money brokers and finders develop and maintain lists of investors and lenders interested in businesses. For a fee, they will circulate your financing proposal to potential money sources. A legitimate broker or finder can look at your business plan and know if he has a good chance of finding money for you. Finders simply introduce you to possible backers; they cannot negotiate on your behalf, and they are not licensed. Money brokers are licensed and can negotiate on your behalf. Fees for both finders and brokers are comparable. I recommend that you work with people who work on a contingency fee basis only and do not require up-front fees. While some worthwhile finders and brokers require an up-front fee, there are some non-legitimate people who take the up-front fees and disappear. Also, I recommend that you obtain references from any broker or finder and that you verify the references. Total fees, including both up-front and contingency, can range up to 10% or 15% of the money raised, so be cautious and remember that everything is negotiable. You can contact finders and brokers in the financial section of your newspaper’s classified advertising section.