Business Start-Up Packet

Step 6: Identify Ways to Finance Your Business

When starting a business or expanding an existing business, the owner needs money to pay rent and utilities; acquire inventory, equipment, and fixtures; pay employees’ salaries; make payments for vehicles; market/advertise products and services; pay taxes and needed insurance; and most importantly, pay his or her own salary.

There are several options available for obtaining money to start a new business or expand an existing one. Most businesses begin with the owner’s own capital or loans from friends and family. Some are successful in obtaining bank financing or using a government sponsored loan program. Regardless of the path you choose, it is wise to take time out to put together a credible business plan.

• Equity Financing
• Debt Financing
• State Loan Programs

Equity Financing

Equity means ownership. Equity financing means that you give an ownership share of your business to your investor. Your new "partner" expects to share in the profits of your business. Equity financing differs from debt financing in two ways:

1. Lenders expect to get their money back plus interest. The amount of your obligation is fixed. There is a repayment schedule and that's it. Once a lender is paid off the relationship is over.

2. Equity investors don't expect to get their money back in the same way as lenders. They expect to get a stream of income out of the profits of the company. There is no payment schedule and the stream of income can vary over time. This is a riskier situation for the investor, so the hope is for an even higher return than a lender would get. Of course, investors are interested in more than the stream of income. They'd like to be able to sell their share in the business if they ever need to. That's the return of capital, similar to a lender's getting back the principal amount of a loan, but the amount is not fixed. Instead, it depends on what a buyer would pay for the ownership share.

There are two common types of equity financing:

1. Venture Capital

A venture capital fund is used for very narrow or niche equity financing. It is professionally managed money that seeks to make a high rate of return for its investors by taking high risks in investing in early-stage businesses. These businesses must demonstrate the possibility of extremely rapid growth (i.e. $50 million a year in sales after 5-7 years). Venture capital is equity money (money for stock) that is repaid by capital gains through the sale of stock. Venture capital investors are typically short to intermediate-term investors (1-7 years) who generally invest over $1 million in a company. 

The following are South Dakota Venture Capital Firms:

Bluestem Capital Co 122 S. Phillips, Suite 300  Sioux Falls, SD 57104        (605) 331-0091       www.bluestemcapital.com

Genesis Group        444 Mt. Rushmore Road, Suite 204 Rapid City, SD 57701          (605) 394-1706 or 1-888-662-2880 www.genesisofinnovation.org   www.genesisequityfund.com

2. Angel Investing

An angel investor is a person who invests in a business venture, providing capital for start-up or expansion. These individuals are looking for a higher rate of return than would be given by more traditional investments (typically 25% or more).

Usually, an angel investor is looking for a personal opportunity as well as an investment. Often such an investor has business experience as well as money, and will want to play some sort of active role in managing the company. 

Because he or she is interested in adding value to the company, it's important for any business person thinking of accepting investment from an angel investor to be very clear about what the angel investor is bringing to the deal besides money, and to develop an understanding of what the angel investor would be like to work with.

 

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Debt Financing
Short-term financing/credit sources are usually grouped into two basic categories: unsecured and secured. 

Unsecured credit is obtained without the borrower’s pledge of specific assets to serve as collateral. Examples include:

• Personal credit cards, savings, stocks and bonds, and/or cash value of life insurance policies. Funds borrowed from family members and/or friends.

• A short-term, unsecured transaction loan is a direct, single payment financing arrangement with a bank.  The maturity on this type of loan is usually between one and six months, but may extend up to a year.

• A company’s line of credit is a commitment from a bank to its regular credit worthy business customers to provide a stated maximum amount of short-term financing for a specified time period. The credit line is often granted with a compensating balance requirement, and the floating or variable-rate method of interest payment is used.

• Trade credit is credit extended by one firm to another in conjunction with the sale of goods or services that are used in the normal course of business. For the purchasing firm, using trade credit is the equivalent of a consumer charge account at a department store – goods are purchased but payment can be delayed to the extent of the specified credit terms.

• Accruals are services that are provided for a business on a continuing basis but are not paid for at the time the services are rendered. For example, employees provide services to the business each day they work, however, they are not paid until some specified future payroll date.

 

Secured short-term credit for new/existing businesses, businesses with a marginal credit rating, or businesses that have exhausted unsecured collateral may offer a financing opportunity that would otherwise not exist.  The primary sources of secured short-term financing for business borrowers are:

• Commercial banks

• Commercial finance companies


• Factoring accounts receivables
• U.S. Small Business Administration (SBA) “guaranteed” loan obtained through  a private lending institution, (The SBA rarely makes a “direct” loan to an  individual or company.)

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State Loan Programs
There are a variety of financing programs available to aid South Dakota businesses with start-up, growth and expansion. With the help of professional loan officers, financial packagers, and development specialists companies can move from blueprints and business plans to bricks and mortars.  The state offers a range of programs from revolving loan funds to work force development grants.

Bank financing is usually the least expensive source of funds therefore you should begin your search for financial assistance with your local bankers. However, you should not approach your banker or any other financing organization for assistance until you have developed a business plan.

Revolving Economic Development and Initiative Fund (REDI)
The main objective of the REDI Fund is to create “primary jobs” in South Dakota.  Primary jobs are defined as “jobs that provide goods and services which shall be primarily exported from the state, gain market shares from imports to the state, or meet an unmet need in the area resulting in the creation of new wealth in South Dakota. Primary jobs are derived from businesses that bring new income into an area, have a simulative effect on other businesses or assist a community in diversification and stabilization of its economy”

Eligible Applicants

Any for-profit business or non-profit business cooperative that is either a start-up business, an existing business or the relocation of an existing business from out-of-state which will create primary jobs in South Dakota or any for-profit or non-profit economic development corporation which will create primary jobs in South Dakota, is eligible to apply for a loan from the REDI Fund.  Regardless of the industry, in accordance with the goals of the REDI Fund, the business should:

• Create NEW, quality, primary job opportunities.
• Create capital investment in South Dakota.
• Diversify the local and state economy.
• Not be in direct competition with existing local businesses.

Costs eligible for participation may include:

• The purchase of land and the associated site improvements.
• Construction, acquisition or renovation of buildings.
• Fees, services and other costs associated with construction.
• The purchase and installation of machinery and equipment.

Costs which are NOT eligible include:

• Refinancing of existing debt.
• Short-term, interim financing for the construction or acquisition phase of a project.
• Trade receivables.
• Inventory.
• Other working capital needs.
• Preliminary design stage costs which include, but are not limited to, market research, written cost estimates, development of business plan.
• Preliminary product development costs.

How the Program Works

The REDI Fund may provide up to 45% of the total project cost and requires the applicant to secure the matching funds before applying to the Board of Economic Development (BED) for the REDI Fund, including a 10% minimum equity contribution.

Interest rates are determined by the BED.  Each loan has a fixed rate of interest over the term of the loan.  The loans are amortized over a period of time, up to 20 years for real estate and 10 years for equipment, with a balloon after five years.  The reasoning is twofold: 1) To keep the fund revolving and continuously available, and 2) To lower debt service during the critical first five years when cash flow is limited.

The BED encourages interested parties to discuss their projects with a Governor’s Office of Economic Development (GOED) representative prior to completing a full application to determine if the project satisfies the requirement of the REDI Fund.  This will be helpful to the applicant when completing the full application and will allow the GOED the opportunity to give suggestions on how to make the application stronger.

REDI Fund participation is proportionate to the number of new jobs created and economic benefits to South Dakota.  Each application is considered individually, according to the quality of the jobs created, wages to be paid, economic conditions of the area and the quality of the business.  Generally, within 30 days after the completed application is received, the board will make a decision on the loan.

How to Apply

You can view and print the application as a PDF file using Adobe Acrobat Reader 5.0. Please note that while you may type your information onto this application and then print it, once you leave this site the information will not be saved.  Go to  www.sdreadytowork.com and click on Financing/Incentives, then click on REDI under Low Interest Loans, then click on Governor’s Office of Economic Development Financing Application (PDF). For more information visit the web site listed above or please contact the Department of Tourism and State Development at 711 E. Wells Ave, Pierre, SD 57501-3369, 1-800-872-6190.

Other Revolving Loan Funds
South Dakota has several communities around the state that offer financing through local revolving loan funds.

SBA 504 Loan Program
South Dakota Development Corporation

The SBA 504 Loan Program offers subordinated, fixed rate financing to healthy and expanding small businesses.  Long-term, fixed rate financing (10-20 years) and reasonable rates (near long-term US Treasury bond rates), make the 504 Program an attractive and effective economic development financing tool.

Criteria
The 504 Program is available for fixed asset purchases only on: land, building and equipment with a useful life of 10 years or more.  No working capital, inventory, venture capital or refinancing are eligible.

SBA 504 financing is “permanent” take-out mortgage financing.  Interim or construction financing must be utilized to complete the project.

Eligible borrowers are for-profit businesses.  Ineligible businesses include not-for-profit, passive investment and real estate companies, financial institutions, developer/landlord arrangement, ventures, private recreation facilities and unregulated media firms.

The net worth of an eligible business may not exceed $6 million.  Its net profits after taxes must not have exceeded an average of $2 million during the previous two years.   Should a company fail to meet these standards, the company will still be considered a small business if it meets size requirements, based on the number of employees, which vary among the different industries depending on NAICS codes.

How the Program Works
Typically the 504 loan has a 50-40-10 structure where 50 percent of the project is financed by a regulated lender which receives a first mortgage position on all project collateral.   Forty percent is provided by the South Dakota Development Corporation which sells debentures guaranteed by SBA and receives a subordinated collateral position.  The remaining 10 percent is provided by the borrower in a cash equity injection.  This is the minimum equity contribution and depending on the project, and available personal resources, SDDC may require a larger contribution. (Start-up businesses or single purpose facilities require an additional equity contribution of five percent.  If the business meets both of these criteria a ten to twenty percent equity contribution is required).

At least 50 percent of the project cost must be provided from “non-federal” sources, such as commercial banks, S & Ls, saving banks, insurance companies and equity contributions.  The lender will receive a first position on the assets acquired with the loan proceeds.  The maturity of this loan must be at least seven to 10 years, depending on the amortization of the SBA loan, and have an interest rate which is “legal and reasonable,” fixed or variable, and may be renegotiable.  The renegotiable formula must be stated in advance.

South Dakota Development Corporation
Eligible businesses may borrow up to $ 1,000,000 ($1,300,000 in designated areas) with a minimum of a $50,000 loan being obtained through the SDDC.  The SDDC portion of the project may not exceed 40 percent of the eligible project costs, nor can the SDDC portion exceed the first mortgage amount.  The goal of the program is to create at least one job for each $35,000 of debenture.  Personal/corporate guarantees are required of all individuals or entities having ten percent or more ownership in the business and may be required for managers who occupy key positions that are vital to repayment ability, regardless of their ownership percentages.

The SDDC sells debentures, guaranteed by SBA, with a 10 or 20 year maturity based upon the weighted average of the useful life of the assets purchased with the loan proceeds.  The rate of interest is fixed for the term of the loan and determined at the time of sale of the debenture, which is based on the current average market yield.

There are various one-time fees associated with the 504 loans.  The one-time processing fees total approximately 3.25% and are added to the loan amount.  On-going servicing fees are added to the interest rate and include fees to the Central Servicing Agent, the SDDC and SBA.  In addition, a 0.5% fee is payable by the first mortgage lender to the SBA.

How to Apply

You can view and print the application as a PDF file using Adobe Acrobat Reader 5.0. Please note that while you may type your information onto this application and then print it, once you leave this site the information will not be saved.  Go to  www.sdreadytowork.com and click on Financing/Incentives, then click on SBA 504 under Low Interest Loans, then click on Governor’s Office of Economic Development Financing Application (PDF).  For more information visit the web site listed above or please contact the Department of Tourism and State Development at 711 E. Wells Ave, Pierre, SD 57501-3369, 1-800-872-6190.

Bond Financing
Another financing option is the pooled loan program through South Dakota's Economic Development Finance Authority. This loan program, designed for more capital intensive projects, provides small businesses access to larger capital markets for tax-exempt or taxable bond issuances. The program can fund projects individually or pool them to help lower the cost of the bond issuance. One of the biggest advantages of this program is a long-term loan with a fixed interest rate.

A major benefit to borrowers is South Dakota's "A" rating by Standard and Poors. By maintaining an "A" rating, South Dakota is able to offer a lower interest rate to the applicant.

All for profit businesses that are engaged in the operation of an industrial, processing or manufacturing business may apply for bond financing through the South Dakota Economic Development Finance Authority.

How it Works
The bonds can be either taxable or tax-exempt. To qualify for tax-exempt financing the borrower must be a manufacturer. Bond proceeds can be used to finance 80 percent of new construction, and 75 percent of new equipment costs, with no greater than 25 percent of the bond proceeds being used for ancillary activities such as office or inventory space.

How to Apply
You can view and print the application as a PDF file using Adobe Acrobat Reader 5.0. Please note that while you may type your information onto this application and then print it, once you leave this site the information will not be saved.  Go to  www.sdreadytowork.com and click on Financing/Incentives, then click on Bond Financing, then click on Governor’s Office of Economic Development Financing Application (PDF).  For more information visit the web site listed above or please contact the Department of Tourism and State Development at 711 E. Wells Ave, Pierre, SD 57501-3369, 1-800-872-6190.


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