ANSWERS: 1
  • Access to credit is vital for small businesses. Start-up, expansion and survival require readily accessible capital. Financial institutions play an important role in providing capital to small businesses, since these companies are generally not in a position to access funds from equity or traded markets. Further, financial information and public information on small firms is almost nonexistent, so their creditworthiness is difficult to ascertain. Therefore, small businesses have to rely on a variety of sources for their capital and credit needs.

    Which Type of Credit Is Best?

    Small business owners have a variety of traditional and nontraditional sources of funding available to them, each with its own set of advantages and disadvantages that are individual to each business and the characteristics of its owner. In evaluating the advantages and disadvantages of specific types of financing, consider the use of collateral (while it may reduce the interest rates and fees involved, it also carries a risk), the use of financing obtained in the business's name (this will not be a possibility for a sole proprietorship) versus financing acquired in the owner's name and whether using credit cards is a practical option. Although capital is gained immediately through the use of credit cards, one late payment could put the account in default, often resulting in interest rates several times the original annual percentage rate. The small business population in the United States consists of only six million employer firms--3.7 million of which employ fewer than five employees--and 20 million non-employer firms. Small business that employ a staff should do well with traditional financing sources, such as banks, and may be able to qualify for certain loans offered through agencies such as the Small Business Association (SBA). These types of lenders require a detailed business plan, and the SBA requires that the business have tried to acquire traditional financing first. Remember that financial institutions are profit-oriented; they opt to lend money only if they believe that it will be repaid on time. The business plan needs to have information and financial analysis that indicate repayment will occur. Of the 20 million non-employer firms, about 65 percent are home-based and provide small incomes (less than $10,000 annually) for mostly part-time owners. This situation is not consistent with a business endeavor providing full-time self-employment income. In this financial scenario, borrowing money from traditional sources, such as a bank, is very difficult unless there are significant assets present, the money is used entirely in assets that retain value and/or there is a high second income in the home. Small businesses of this nature tend to choose to use credit cards (personal or business), home equity loans or mortgages, and unsecured personal loans or borrow from friends and family. Over 30 percent of the 20 million non-employer firms in the United States earn between $10,000 and $50,000. This type of small business has an easier time receiving financing from traditional financial institutions and is also more likely to receive loans through nonprofit agencies such as the Small Business Administration. The reason is that, at the per annum revenue value of $10,000 to $50,000, the proprietor of the business is deemed financially solvent. However, the proprietor may be limited as to the amount he is able to borrow and must show a business plan that indicates how and when repayment will be made. At this level, loans are generally made to the proprietor rather than the business as an entity; the business may not be structured in a way that allows that or may not have had enough time to establish its credit.

    Source:

    SBA, 2009. Small Business in Focus: Finance.

    SBA, 2009. Guaranteed Loan Programs

    SBA, 2009. When You're Ready

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