This chapter helps your writing process because it gives you an idea of what lenders and investors want to see in a finished plan. Your ability to understand your financier’s motives can mean the difference between getting a loan or investment and coming up empty-handed. If you already have financial backing, you can skip this chapter.
Many people and institutions are looking for sound loans and investments. From their side of the fence, it can often seem extremely difficult to find a good one. Many potential financiers have been frightened by news stories about small business financial problems, con artists selling phony tax shelters, business bankruptcies, and so on
Ways to Raise Money
A loan is a simple concept: Someone gives you money in exchange for your promise to pay it back. The lender could be a bank, friend, family member, or anyone else willing to lend you money. The lender will almost always charge interest, which compensates the lender for the risk that you won’t pay back the loan. Usually, the lender has you sign some papers (called a note and loan agreement) spelling out the details of your loan agreement. (See Chapter 10 for examples.)
While these basic concepts are simple, not everyone seems to clearly understand them. For example, some people put a great deal of energy into arranging to borrow money but think little about the hard work that goes into repaying it. The important thing to understand is that the lender expects you to pay the money back. It’s only fair that you honor your promise if you possibly can
Lenders often protect themselves by taking a security interest in something valuable that you own, called collateral. If you pledge collateral, the lender will hold title to your house, your inventory, accounts receivable, or other valuable property until the loan is paid off. Loans with collateral are called secured loans
If you don’t repay a secured loan, the lender sells your collateral and pockets the unpaid balance of your loan, plus any costs of sale. Not surprisingly, if you have valuable property to secure a loan, a lender will be much more willing to advance you money. But you also risk losing your house or other collateral if you can’t pay back the loan
Loans without collateral are called unsecured loans. The lender has nothing to take if you don’t pay. However, the lender is still entitled to sue you if you fail to repay an unsecured loan. If he wins, he can go after your bank account, property, and business.
Lenders typically don’t make unsecured loans for a new business, although a sound business plan may sway them. Remember, the lender’s maximum profit from the loan will be the interest he charges you. Since he won’t participate in the profits, naturally he is going to be more concerned with security
An equity investor buys a portion of your business and becomes the part-owner. The equity investor shares in your profits when you succeed. Depending on the legal form of ownership, she only shares in your losses up to the amount of her initial investment. Put another way, most equity investors’ risk is limited to the money they put up, which can be lost if the business fails