Learn which small business financing option may be most appropriate for your business.

Headshot of Amir Madjlessi

Amir Madjlessi, Executive Vice President, Managing Director of Business Banking for Santander Bank

Raising seed capital or growth funds for a business can be thrilling. But if you’re unfamiliar with the small business financing options available, choosing the right one can be daunting.

The loan products suited to a seasoned company with a solid customer base and increasing profits won’t likely be available to a starting business. But even if you have the financial track record to prove your creditworthiness, not all options will fit your particular level of cash flow or business goals.

The key, says Amir Madjlessi, Santander Bank’s Executive Vice President and Managing Director of Business Banking, is to get up to speed on the various lending solutions available and their requirements. “Any good banker would be willing to partner with you to help you make an informed choice,” he explains.

We asked Madjlessi for his insights for businesses deciding which type of financing to choose and how to get better educated on the various loan types available. Here’s what he had to say:

Q: What’s the most important thing for small business owners to consider when financing the start or expansion of their company?

A: Put yourself in a position of knowledge. Get to know the factors that drive lenders to offer capital. This will help you understand just how creditworthy you and your business are.

In commercial lending, there are four Cs of creditworthiness: character, capacity, capital access, and conditions:

  • Character speaks to the size of a business, the location, the number of years in business, business structure, number of employees, media coverage, online reviews, and the business owner’s appetite for sharing information about themselves.
  • Capacity assesses the ability of business to repay a loan. The bank looks at cash flow, corporate debt (secured and unsecured), whether the company has a line of credit, and if that line is used prudently. A cash flow positive business will likely have the leverage to get the best loan rate and structure possible from its bank.
  • Capital access refers to whether the company has the financial resources to repay creditors. With newer businesses that have yet to demonstrate consistent performance, banks focus on the owner’s personal credit. With more established businesses, banks pay attention to business credit factors like how timely the company pays their vendors.
  • Conditions are the external factors surrounding a business, like industry growth and market fluctuations.

Lenders use these four Cs to determine whether they can extend credit to your business, what rate to give you, and what terms to offer you. A good banker can explain how to improve these factors.

Q: Which financing options make the most sense during your first year in business?

A: Startup firms often rely on personal assets because the business has yet to establish a financial history for a creditor or lender to assess. Startup funding usually takes the form of personal savings, personal credit cards, supportive family members, and any other personal resources the entrepreneur can bring to the table.

Business founders have more options available today than 15 years ago. Crowdfunding and nonbank online lenders now offer alternative financing options to new businesses.

Q: Which business financing options should you consider two to five years down the line when purchasing new equipment, property, or otherwise expanding?

A: The credit instruments available to established business owners fall into three categories: a loan, a line of credit, or an equipment loan. The type of expansion you undertake will determine the right financing option.

Buying property versus leasing can provide long-term benefits. A real estate mortgage with a 25-year term enables you to build equity, pay down the mortgage over time, and reduce the outflow of cash. In today’s sustained low-interest rate environment, it’s possible to buy and pay off that mortgage at a lesser charge than leasing property.

When financing new equipment, match the useful life of that piece of equipment to the loan timeframe. Many business owners want the longest repayment term to increase cash flow, but the longest possible term may not make sense if the equipment needs to be upgraded partway through the life of the loan.

A line of credit addresses the seasonal cash flow gaps that are prevalent in so many industries. Consider the consultant who puts a lot of up-front costs and labor into a project but doesn’t get fully paid for months. Meanwhile, the employees must be paid. A line of credit can provide the flexibility needed to cover the cash flow problems caused by this situation.

A line of credit can also be used to gain more favorable terms by taking advantage of vendor discounts. Many suppliers will offer discounts if full payment is made within 30 days. The vendors often agree to do this because they’re trying to increase their cash flow too.

Q: What are some of the biggest mistakes business owners make when weighing financing options?

A: One big mistake we see business owners make is picking the wrong financing instrument for the business activity they want to pursue. Another mistake we see is owners failing to compare the terms of the available financing options, be it interest rate, fees, renewal rate, or prepayment penalties. It’s really important for people to evaluate packages side by side. Don’t just pick the first available option.

Also, in more established businesses I sometimes see business owners failing to consider unusual sources of financing. For example, some manufacturers offer financing programs to help facilitate sales of their equipment or vehicles. Business owners would be wise to consider what assets can be creatively financed in these ways.

Q: When, if ever, should an entrepreneur consider taking a personal loan to seed or grow their business?

A: It depends. People should consider the risk that they’re taking, the rate that they’re getting, and what they’re using the proceeds for. If a personal loan helps you exploit a new opportunity in the business community or solve a problem for customers, it may be a risk worth taking given the potential payoff. But if you’re considering a personal loan to sustain an ongoing cash flow gap or maintain an operation that isn’t showing great signs of success, you may have to face the reality that it’s time to cut bait and move on.

As for taking out a second mortgage on your home to help seed or grow your business, I’m not sure that I would encourage that. However, taking out a second mortgage to seize a market opportunity is a much better scenario than doing so to inject cash into a business that hasn’t been solvent for a sustained period of time.

Q: What emerging changes have you seen in small business financing in recent years? 

A: Access and speed come to mind. Historically small business owners would have to engage a broad group of people in the business community to understand and access the financing options available to them. But now the internet brings very creative alternative financing tools like OnDeck, Kabbage, and Lending Club right to their doorsteps of young companies. You can visit a website that uses algorithms to analyze your checking account activity and immediately determine your capacity to repay a loan. That is an extraordinary change for the financial industry.

The caveat is that some alternative financing options are very expensive. So new businesses looking for seed funding and companies looking for expansion loans have to be cognizant of the associated costs.

Q: Any additional tips for helping small business owners navigate the sea of financing options?

A: Build a professional team around you that has the expertise you lack. You need an accountant, an attorney, and a banker. An accountant will help you understand the implications of depreciation and tax obligations. An attorney will help you stay on the right side of the law, protect your interest in your business, and take the appropriate amount of risk when investing in your personal or business assets. A banker will pore over your and your company’s financial data and advise you on the best financing options available based on your objective. 

The professionals on your team don’t have to be pricey. But they do have to be trusted, objective parties who can explain why you should or shouldn’t pursue a particular financing option. A good professional team can make all the difference in your business surviving, succeeding, and thriving in the future.

Santander Bank does not make any claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained in this article.

Readers should consult their own attorneys or other tax advisors regarding any financial or tax strategies mentioned in this article. These materials are for informational purposes only and do not necessarily reflect the views or endorsement of Santander Bank.

  Equal Housing Lender. Santander Bank, N.A. is a Member FDIC and a wholly owned subsidiary of Banco Santander, S.A. ©2018 Santander Bank, N.A. All rights reserved. Santander, Santander Bank, and the Flame Logo are trademarks of Banco Santander, S.A. or its subsidiaries in the United States or other countries. All other trademarks are the property of their respective owners.

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