Latest / Let's Talk Small Biz Finance with CIC Tucson / How to Fund Your Business and the 5 Cs of Credit | Coffee Chats with Caroline Nelson
Transcript
- Caroline Nelson: Thank you so much for joining us today for this coffee chat. My name is Caroline Nelson. I am the Chief Operating Officer and Head of Lending at Community Investment Corporation. We are a nonprofit located in Tucson and we serve the entire Southern Arizona community. Organizationally, we focus in the areas of education, homeownership, and entrepreneurship. And today I am here representing our entrepreneurship programs. We provide ⁓ both education and access to capital for small businesses. This is the first of a coffee chat series we are starting. Thank you so much for joining us and for sending in your questions ahead of time. to get started, we had quite a number of... questions that really centered around how to obtain funding for startup businesses. So I'm going to take a few minutes to go over some general ⁓ information around ways to fund your business and how to tell when you are ready to take on funding and what type of funding might be best for your business. So to start, there are a number of ways that you can fund your business. This circle here represents many of the most common types and so we're going to break these down so that you can determine what makes the most sense for you. Sometimes we hear these words used interchangeably and so I do think it's important to understand the differences in each. So the first is savings, friends and family, and credit card. This is how most businesses start. Because you do not have a track record yet, it can be hard to obtain funding from anyone else. So you're either ⁓ using what you have set aside or you're borrowing from someone close to you who is willing to support your idea. The next option is crowdfunding. So crowdfunding is a mechanism to raise money from a large number of people. We often see this when someone is needing funds for an emergency or a health situation, but this mechanism can also be used to raise money to support your business, both through equity or debt. We'll talk about this a little bit more later. Grants are another option. Grants are largely for a reserve for nonprofit organizations. So someone has an interest in supporting a specific ⁓ idea or group of individuals in a community. And so they ⁓ will ask someone to do work to support that and in turn will give them funds to do it. grants are most commonly ⁓ by nonprofits. We did see an increase in grant dollars available for businesses. ⁓ during the pandemic as a way to keep small businesses open during first couple years. ⁓ grants are not available ⁓ commonly for small businesses. So do want to make you aware of that. ⁓ get a lot of questions around grants. That's one of the first questions anyone asks when they call is, what grants are available to support my business? ⁓ then while there may be some out there, they are not as common. ⁓ as probably everyone would like. So, want to make sure that we are all just aware of how to find them. The next is angel investors, venture capital and private equity. This refers to someone investing in your business. And the last is loans and revenue-based financing. ⁓ And is what the areas that CIC focuses on and what we'll spend a little more time talking about. So we're gonna take a few minutes just to break down some differences between the funding options we just talked about. So dilutive versus non-dilutive capital. Dilutive capital refers to funding you receive in exchange for giving up a portion of your ownership. So you're selling shares of your company to an investor. Non-dilutive refers to funding that does not require you to give up any ownership. So debt financing. Dilutive funding is also known as equity. This focuses on your growth and potential. Debt financing is referred to as non-dilutive. someone is lending you money, right? They're not investing in your company. ⁓ This focuses on past performance and your ability to repay. ⁓ So what is to keep in mind between the two, when you're looking for an investor, this person is going to invest in your company. they see growth potential ⁓ and looking for a return on their investment. So they're more forward looking. ⁓ Debt funding more focused ⁓ on past and your ability to repay. ⁓ And while capital lenders ⁓ do want business to grow and we do hope that you have a really bright future, ⁓ they're focused in the moment and what is possible. So when you talk to you know, an investor versus a lender, it's important to understand what they're looking at so that you can tailor your conversation appropriately to their goals, but also to determine when you might be ready to take on financing. So we're going to break this down one step further. I love this ladder, the capital continuum ladder, mostly for the visual representation ⁓ kind of the life cycle of a business and where funding is available to you. based on the stage that you're in. So when we start a business, we are here at the bottom of the ladder. If you remember from that very first circle slide, most businesses start using personal savings, borrowing money from friends and family. And even this is where you could potentially obtain an investor, right before you have any track record. As your business continues to grow, you're going to unlock additional funding options. So here in this middle section, we have alternative institutional lenders. This is where you may be able to access online loans, merchant cash advance, factoring things along those lines. These transactions are typically more expensive. Oftentimes you can get decisions real very quickly. So like an online loan right here, get a decision in 24 hours. While that may be great from a funding perspective and not having to provide a lot of paperwork, the transaction is typically more expensive. So make sure you are aware of the cost of any product that you are signing up for. As we continue to move up the ladder, the next option alternative community lenders. This is where CIC fits. ⁓ Other community lenders, CDFIs, SBA, credit unions, ⁓ compared this middle online sector, ⁓ alternative lenders typically have lower interest rates, but they do require more paperwork. ⁓ So means it will take a little bit longer to obtain funding. And then at the top of the ladder, we have our conventional banks. This is my hope is for you all to be able to unlock bank financing ⁓ at one point in your future. Something to keep in mind is the banks are ⁓ highly regulated and do require more financial history. So looking at typically two to three years worth of history before you're able to unlock bank funding. Compared to anyone else on this list, banks often have the best interest rates and the best terms. So if this is an option for you, this is definitely something to consider. But hopefully this chart will help you understand where you are in this journey and what funding options are available to you. I do think it's important just from an expectation setting perspective to understand how the different products work and what's possible. That way you don't prepare a huge presentation and go to the bank expecting them to fund your startup. So just knowing that that might not be possible for two or three years can help you reset expectations and start in a different place where you're going to have better access to funding. So the next question is around how do lenders make their decisions? I prepared a few slides. think it's important to understand how funding decisions are made. ⁓ so that you can be prepared when go to meet with a lender so that your chance of being approved is much higher. So lenders use the five Cs of credit to make their decisions, capacity, capital, credit, collateral, and conditions. ⁓ Many lenders use all of these or a portion of these in their decisions, but I think it's helpful just to understand what each of them means and really what lenders are looking for. So the first one is capacity. This refers to a borrower's ability to repay their loan. Lenders want to make sure that the business can afford to take on the payment. So to do this, we're looking at historical financial documents like your tax returns, your profits and loss statement, balance sheet, things along those lines to make sure there's enough cash flow. Capital refers to the amount of money that you have invested in your business. If you are wanting someone else to invest in your business, you need to have some of your own funds already invested or be willing to invest some of your own funds. refers to the lender's opinion of the general credit worthiness. So ⁓ some tools we're looking at ⁓ are a credit How have you handled your in the past? Are you making your payments? do you have a lot of debt? ⁓ you have a reasonable amount of debt? Things along those lines. ⁓ Also comes into play are your interactions with lenders. Really what this refers to is ⁓ you providing documents When we have a conversation with borrowers, we're asking lots of questions about the business. Then you're providing documents that also tell that story. As the business owner, does your understanding of the match with what we're seeing? ⁓ we're not necessarily comparing that, right? But if you're telling me your business is profitable and I look at your financial statements and I see a different story there, ⁓ maybe that means that... there's some work to do, right, in understanding what these statements are telling us and how that works for your business. So credentials, on what industry you're in, credentials may be important. ⁓ lenders do ask for a resume and then some also ask for references. Collateral refers to assets that are used to secure the loan. So if the business cannot repay, these assets can be sold to repay the loan. Some common things that can be used are property, vehicles, and business assets. And even depending on what you're using loan funds for, like if you're purchasing assets or you're purchasing a vehicle, the use of for the loan can be used as collateral. Conditions refers to Things related to the loan and some of these are outside of your control. So, you know, how long you've been in business, how is the industry that you're in doing? Is this a industry? Is this an industry that ⁓ is very susceptible to economic changes? ⁓ You that is out of your control. Economic factors, what's going on in the world around us that may affect your business? So these are things that lenders are considering when they're reviewing your application. So I do it's important that you understand what's going on around you and how that might impact your ability to obtain funds. on what's going on in the world, lenders tighten their requirements, ⁓ right? If a lot of concern, if we're going into like a recession or there's concern about, know, just what's going on forward looking, ⁓ it may be little harder to obtain capital than in a time where we have less concern. So I put together an exercise which I think is really helpful for anyone, really anyone who is running a business or thinking about running a business to go through. It's really a checklist to figure out where you are in your ability to access capital. These are really all things that best practices, really good things to keep in mind. ⁓ if you're thinking that you might want to take on capital at some point in the future, I would highly recommend going through this checklist, figuring out where you are, and then you can work on improving those areas that may not be as strong now. That way when you do want to take on capital, you are ready and you have a strong application. the first one ⁓ capacity. Can you afford to make your loan payment each month? ⁓ you know how much extra cash flow you have? So if your answer to this is no, a good starting place would be to start keeping track of your finances. How much are you making and how much are you spending? So this is a great place to start here. If you want to take on a loan, what a lender is doing, they're looking at your cash flow, right? If you want to take on a loan and the payment is going to be $500 a month, you need to have at least $500 a month extra cash flow to cover that payment. Now that's a really simple way of looking at it. but just so that you understand what we're looking at. Capacity, have you invested any money in your idea? If yes, in what way? You'll need to be able to explain that. And if no, how do you plan to do so? So if you have a newer business or you're looking to start a business, if you are able to obtain financing, a lender will typically require you to invest 10 to 20 % of the project, use your own money and invest 10 to 20 % of it in the project. So for example, if you are looking to start a business in the idea cost $100,000 to get off the ground, ⁓ should have 10 to 20 percent, so 10 ⁓ $20,000 ⁓ your own money ⁓ contribute to this idea. ⁓ you are able to obtain a loan, the maximum amount you would likely receive is $80,000 or $90,000. ⁓ The next one is character. How have you handled your in the past? If you're not sure, I would recommend pulling a credit report. We all have the ability to pull free credit reports every year. ⁓ pull a credit report. I wouldn't focus as much on your score, but I would look at your history. ⁓ How many outstanding items do you have? Do they all belong to you? Sometimes fraud happens, unfortunately, and so it is important that we're checking our credit regularly to make sure that everything belongs to us. ⁓ But yeah, if you have items out there, is everything paid? Do you have any delinquencies? Is there any cleanup that needs to happen? The best time to start working on this is now when you do not have a need for capital. That way when you do, you'll be in a better position. ⁓ you do have past two items or collection items you can start. bringing those current so start making payments. Lenders are looking at how you've handled your relationship with other lenders and so if you have a lot of items that are behind lenders may wonder what's different about this transaction so this is ⁓ what we're considering when we're looking at credit reports. ⁓ The next one is collateral. Do you have any assets that can be used to secure a loan? This, I think, is also helpful from an expectation setting perspective. we don't all have assets, especially if you have a new business, you might not have had time to build, an asset base. And so this also helps us understand what we may be able to obtain from, a loan. So if you're needing $50,000, but you don't have any assets that can be used either the business or personally, a $50,000 loan may not be possible. Now there are some lenders out there that do not require collateral, but it is harder to find. So more commonly in business world, you will need to provide collateral. If you find an option that doesn't require collateral, that's awesome. But just in mind that you will likely need some kind of collateral. We've seen a of businesses take out smaller loans really as building blocks. rather than trying to do everything at once, ⁓ starting with the really to purchase that first piece of equipment, right? And then once you taken that on and you pay that off, you're for the next building block. This can be a really effective way to grow your business and to really grow your asset base. And then the fifth C ⁓ is And so think through what factors outside of your control may affect your ability to get a loan. What's going on in the economy behind us? How is your industry doing? What may a lender want to know? Tariffs is one that ⁓ there's a lot of talk about. So a lender ask you, you know, where does your product come from? How are you affected ⁓ by this? you had to raise your costs? Are your costs like to obtain your product going up? ⁓ So these are things that ⁓ you should have to and that you might need to convey to someone else when you are talking about obtaining funding. So the next question is how do I finance my startup? So as we've talked about, debt is harder to obtain for newer businesses, especially if you're pre-revenue. And if we remember back to the slides about equity versus debt, dilutive versus non-dilutive capital, ⁓ is looking at your history, right? We're looking at now and behind us, and at your historical cash flows. So if, as a brand new business, if you don't have any historical cash flow or you personally have the cash flow to support that idea, it can be harder to obtain debt financing. So just something to keep in mind. Some options for you to explore. can borrow money from friends or family. ⁓ could take out a personal loan. Credit cards ⁓ something we see a lot of people use. I will caution you. ⁓ can get out of hand really quickly. mean, if you are taking out debt, I would just caution you to start out small. Don't take on too much debt too early. Sometimes our ideas don't work exactly as we have planned or we need to pivot. ⁓ And if we've taken out a lot of debt really early on, it can be hard to pivot in the way that we need to support a growing business. when we talk about credit cards, ⁓ all spend money differently. We all look at money a little differently, but sometimes credit cards can feel like free money. I don't know what it is about that. I don't know if you all feel that same way, but we're willing to just swipe that card because it's not coming out of our checking account. We may be making purchases. ⁓ larger purchases than we would if we actually had the cash in hand. So keep that in mind if you are using credit cards to start your business. We see a lot of people max out all of their credit cards or take out a lot of credit cards to start a business. Credit cards these days are running, regularly seeing 25 to ⁓ % annual interest. That is ⁓ high and that is a lot of money. ⁓ a lot, all that interest is money that's not in your pocket. ⁓ if you can do this, without taking a lot of credit card debt, you will have more money in the end to grow your business or in your pocket personally as the owner. Small Business Administration, ⁓ issue loans for newer ⁓ Typically, they require that you have prior business experience. ⁓ So is also an area ⁓ for you to gain some experience. If you don't have it and you're wanting to get into an industry, ⁓ now would be a great time to maybe get a part-time job or to get a full-time job in that industry so that you can gain that experience. That way when you're ready to start your business, you have that experience, you will have a better chance at gaining funding and even growing your business. As we talked about in the very beginning, crowdfunding. ⁓ We have a really cool option here in Southern Arizona and actually it's available to anyone globally, it's Kiva. Kiva is a crowdfunding platform. you share your idea with the world. So it starts with you sharing your idea with your personal network. You explain your business, what you need funding for, ⁓ then you share this with your personal network. ⁓ make loan amounts of $25 to this. Everything happens through the Kiva platform. And then ⁓ once network starts to invest in this, then the project opens up globally. ⁓ It's really cool to see how many people come together so quickly. Hundreds to thousands of people come together to fund projects. Kiva is a 0 % loan, no collateral is required. So this is a great option for you if you're looking for amounts of up to $15,000. We do have a Kiva Hub here in Southern Arizona that CIC manages. So feel free to reach out if you would like to learn more about that. And then your bank may be an option for you if you have a strong relationship. with them. Banks tend to be relational. They're looking at your whole deposit history. So that could potentially be an option. Everyone know your banker. It's really helpful. is. These days it's a little bit harder because we do so much ourselves. But if you have a relationship, see if there's a way you can build one or also maybe focus on the community banks. We have a lot of great community banks ⁓ and that be an easier way for you to build a relationship. ⁓ than with a large institution who maybe doesn't have a strong presence or doesn't have as many individuals for you to connect. have a couple more questions for you ⁓ that were sent in. The first ⁓ ⁓ does your personal immigration status matter if you have an LLC? Immigration requirements are when lenders are looking at both where the business is registered, where business is organized and registered, but they're also looking at the owners of the business. So immigration requirements are lender specific. So I would definitely check with banks, credit unions, lenders, and you can ask that question. question we received is, are you seeing right now is the biggest disconnect between what founders think and financing partners care about and what they actually care about? ⁓ This is a really great question. you so much for sending this in. ⁓ I would say the biggest disconnect see ⁓ is business owners having readily available information. We work with lot of small businesses and lot of micro businesses and very commonly we talk to individuals who are not keeping track of their finances. So the business is operating out of a checking account, the owner isn't sure how much the business is making, how much they're spending, if they're even profitable. And so that is the basis of any conversation around funding much are you making? What room is there to take on funding? How is your business performed historically? Remember, we're looking backwards. How has your business performed? then also, right, what are you expecting to do in the future? ⁓ this is backwards looking and also forwards planning. So I think that is the number one issue we run into and what ⁓ slows down obtaining financing is just having readily available financial information. And this next question really ties into this and this is how do you track your finances or know your profit? ⁓ So at a basic level, we should be keeping track of what our business makes and what it spends. The difference between the two is your profit or loss. ⁓ If you, you should have a separate account for both your business checking account and your personal checking account. I realize businesses sometimes start intentionally, sometimes start. unintentionally, you're just doing something, people love it, people start buying it, next thing you know you have a business and you didn't intend to start one. ⁓ whenever you realize that you have a business, definitely separate your business and your personal finances. So one, have a separate account. ⁓ Step is just start tracking everything that you're making. If you can truly keep that separate, it's gonna be a lot easier for you to know going on. We see lot of transfers between accounts, which makes it hard to really understand by quickly looking at, right, like your ins and your outs, because those numbers are going to be really inflated. So if you can, keep your transfers to a minimum and really try to just stick to business activity in your business account. So that's step one. This is a foundation for you. I taught a class a couple months ago around how to create basic financial systems. So if this is where you're at, if you're not keeping track of your financials and you would like to, we will include a link for this class. It's on our YouTube page, but we'll also include a link for it in the caption. And this is around how to create basic systems. So how do you download your transactions, categorize them, start creating basic profit and loss statements? ⁓ we have a foundation, we can start to level up. I know finances are not comfortable for everyone. ⁓ really overwhelming if numbers aren't your thing. I personally love numbers. You want to create a budget, call me anytime. That gets me really excited. But if that doesn't excite you, then let's start really basic. Start keeping track of things, start creating really basic calculations. Once we're comfortable with that, then we can start to add more complexity to it. But don't worry about starting all the way at the top. We want to create systems. that you are going to use and keep in place. That is what's gonna be most effective. question we received. What are you seeing in the market? ⁓ That business owners should be aware of thank you for asking this question something we've seen over the couple years, but we're really seeing an increase in recently ⁓ our merchant cash advance and revenue based transactions ⁓ and really what we're seeing is A lot of businesses are taking these on and a lot of businesses are getting in over their head with them. And so they're calling us because ⁓ these transactions are constricting their cashflow and they are wanting to refinance them. ⁓ without spending too much time diving into this topic, it's probably ⁓ could be a session all on its own and maybe we'll do that one day in the future. The way these transactions work, it's not alone, right? may look like a loan, but it's not a loan. So it's important whenever we are taking on capital, we understand what we're taking on, we understand how the fine print works. So with these transactions, ⁓ an advance on your sales. So what we're seeing this pop up is a lot of companies that process card transactions ⁓ process sales in general, right? When they see your sales history, they're now offering you an advance. They're sending it to your email. A lot of companies, can't even apply for these. When they see like a pattern, they'll send you a note and say, you're eligible for $10,000. Would you like to take this on? And you say, yes. Money appears in your account. That's great. What happens is the repayment for these is a percentage of your sales, often daily, sometimes weekly or monthly, but a lot of what we're seeing is daily. And this money is taken out of your sales. The merchant is taking your daily payment, so they look at your sales, they say you're paying us 5 % of your sales. They their 5 % and they give you what's left. So they get their payment first and you have no way to change that. ⁓ And if your sales increase, your volume of sales increases, your payment is going to increase. And this is where we're seeing people run into trouble ⁓ is their are really high and it's constricting their cash flow. ⁓ Now the with these transactions ⁓ is ⁓ on loan, you're charged an interest rate. ⁓ Oftentimes if pay off early, you don't have to pay the rest of that interest. ⁓ With these cash advance and revenue based financing transactions, ⁓ you pay a That fee ⁓ is set and is attached to the amount that is advanced to you, you pay that full feedback regardless of how quickly or how long it takes you to pay back. And so the problem in refinancing out of these is you're paying that fee in full and then you're taking on additional capital. So say you refinance out into a traditional loan, you're paying that full fee and now you're adding interest to that. And so this is where this gets really expensive and can really hurt your business. I just want to warn you if you are seeing this pop up, if you're receiving emails for these, don't accept. It's not free money. You do have to pay it back and it can potentially cause problems. So feel free to reach out if you want to talk about this topic further or ⁓ you are considering one of these transactions, I'm happy to talk it through with you and see what makes the most sense, this or maybe a traditional loan. One last question we received ⁓ is do you build more predictability? especially getting into the operating rhythm and pipeline steady enough that financial decisions don't feel like they're made under time pressure? That's a really good question. I think this is something we all struggle with. Regardless of where you are in your business life cycle, predictability is really great. As businesses are starting out, that predictability is a little harder because we don't have a track record. I operate in the finance world, I think financial statements are really helpful. I think numbers are really powerful and they really tell us our story. And at the end of the day, we start businesses for a reason, right? Like we have a legacy, we are trying to build, we to provide income our family, whatever we see a niche in the market we're wanting to fill, ⁓ whatever is, those goals will not be achieved if we don't have money. And so keeping track of our finances is really important to grow our business. And so back to this question, ⁓ do you build ⁓ predictability? ⁓ going to take time, ⁓ also knowing your numbers helps you build that predictability. ⁓ just start keeping track ⁓ how much you're making and how much you're spending. whatever's going on in your business, make notes too. If you launched a new product, mark where that is in your notes so that you can see how your revenue was affected by that. you have enough history, you can look back and see those trends. ⁓ you have that history, then you can say, ⁓ all right, well, I know I'm generating $10,000 every month, right? That's where the predictability starts to come in. If we keep on this path, ⁓ can safely assume ⁓ I'm going to be making $10,000 a month and I'm going to be spending $8,000. Okay? And then we can start to build on that as we go. So really my theme for today is keep track of your finances, prepare financial statements, even at a basic level. And then from there we can build. we have a better chance of meeting our goals if we really start focusing on our finances. All right, that is the last question for today's Coffee Chat. Thank you again for joining. Thank you to everyone who sent in questions. If anyone has specific questions, wants to talk one-on-one, feel free to reach out to our team anytime. We're doing this again next month on March 19th at 9 a.m. So feel free to send in questions ahead of time. We will answer them live and you can visit the show notes for the link to register for that class. ⁓ you so much for joining us.