Down Payments On Business Loans And Where You Can Get Yours

All small business lenders – banks, private lenders, alternative financing companies, SBA, etc. – have one major thing in common. They require some form of down payment.

Let’s say that you are requesting an unsecured business loan from your bank. And, you are asking for $80,000 that you want to use to purchase some inventory and supplies as well as to bolster your marketing efforts.

And, your bank approves that request. However, they only approve 80% of your requested amount or $64,000. What?

Or, your business is in need of a new routing machine to handle your ever increasing customer load. The equipment costs $50,000. Your lender approves your request but will only fund $40,000 or 80% of what you need. Huh?

Or, your business has $100,000 in outstanding invoices just waiting to get paid by your customers. Yet, you have new orders coming in everyday that you just do not have the cash on hand to start or complete. Therefore, you approach an asset based lender or accounts receivable factor and ask for an advance on those invoices that will pay within the next 30 days. However, the lender will only fund 80% or $80,000 against those invoices – even though they take control of 100% of their face amount. Really?

Down Payments

Why do lenders require down payments? It all started with banks centuries ago. They determined, through trial and error – mostly error – that if a borrower were to put at least 20% down – have 20% of their own money attached to the loan – then they are 80% less likely to just walk away from that loan should the going get tough.

Thus, they determined that 20% in a down payment was both enough to better ensure that their borrowers will repay those loans – the one thing they want the most – and that 20% was enough of an amount (high and low) that only serious borrowers would and could be able to raise that amount.

In fact, when the government got involved in the banking and lending industries, this down payment figure of 20% was one of the first things that they agreed on as a standard practice and now hold these lenders to that standard.

Bottom line is that having a down payment in nearly all lending – mortgage loans as well as business loans – is now the standard and is already calculated in their underwriting process. Thus, you request a business loan for $100,000 – the lender already marks it down by 20%.

Now, leave it to the SBA to throw a wrench into this discussion. The SBA has a business loan program – their 504 loan program – which helps local small businesses finance commercial real estate or business equipment in their local areas. These loans are secured – 100% – by the real estate or equipment. Thus, with this specific loan program – this secured loan program – the SBA lowered its down payment requirement to 10%. Still a down payment but less of a burden on the borrower.

Types Of Down Payments

Now, there are essentially two forms of legitimate down payments.

1) Simply cover the 20% with your own cash. You need $80,000 for your equipment purchase, the bank will provide 80% or $64,000 and you cover the other $16,000 out of your own pocket.

2) You have built in equity in the item being bought with the loan. Here, you are buying a commercial property to expand your small business (and quit paying outrageous rents). The purchase price is $250,000. Yet, that price is only 80% of its market value – the market value is $312,500. Thus, the difference between the purchase price and the true value of the property is the 20% – 20% equity in the property.

Where To Get That Down Payment

There are several ways that you – the business borrower – can get that required down payment as most small business owners either do not have that kind of cash on hand to cover the 20% or just do not know where to obtain it.

Don’t Pay It:

1) Negotiate with the lender. While this does not provide you the equity to put down – it can alleviate that requirement all together. If your business is strong enough and the lender really wants to work with you – then negotiate that requirement away – and get that lender to cover 100% of your needs.

2) Negotiate with the seller. If you are buying a physical asset like equipment or commercial real estate then negotiate the price to 80% of the asset’s value. Kind of hard to do these days with property values being as low as they are and that most equipment vendors do not have control over their prices – but, if the person wants to sell as bad as you want to buy – then they will find a way to work with you – they always do. MSRP prices are more wish lists then actual prices.

Find The Money:

3) Personal loan. Do you have equity in your home or other personal assets? Can you get a personal loan based on the personal income you do have? Can you tap some other source of personal income or equity – that 1) does not relate to your business and 2) does not put an additional burden on your company?

Most lenders will find out about all of your business debt and most of your personal debt during their approval process. Know that with the business debt, they will include that in their underwriting process when approving your business loan request. And, if they find out that you took another business loan to cover your down payment – they tend to frown on that. But, if they find out that you have a personal loan – even if they know that you did that to cover your down payment – it is still a personal loan and something that ties you personally to that new loan request – means you might get away with it.

Or, try to get a personal loan from a friend or family member. This way, it is not reported anywhere and very hard for the new lender to find out about it. This could be a loan or even an equity injection for stock or ownership in the company. Either way, it should not directly affect your new loan request.

The idea here is simple. Let’s say that you need a business loan for $100,000. You request that amount at 8% for three years. This would set your monthly payment at $3,134. But, if the lender will only approve and fund 80% or $80,000 – then your required payment would drop to $2,507 – leaving the difference of $627 to cover that personal loan you need for the down payment ($627 is more then enough to cover the $20,000 personal down payment loan for the same term at the same rate).

4) Sell off unneeded or unused assets – personal or business. This way you get needed money from assets that you don’t need or want and you don’t have to pay that money back – it is free and clear for you to use. Thus, while you are only getting 80% of your requested loan amount – you only have to pay for that 80%. And, the $627 difference – outlined above – is money that you now don’t have to pay to any lender – it is added money in your pocket or for your business.

5) Lastly, use your business. Let’s say that your business needs a $100,000 to expand. Now, it could get a loan now or it could save up its own money – its own profits – for the next 3 years (your business has to be generating some form of profits for you to be able to afford the loan payments in the first place – thus, it can just save that money itself).

But, not wanting to or not seeing it as a viable option to wait 3 years – your business can just save that money (profits) for that down payment only – save for 7 months or so to get that needed 20% – then request the loan. This would have the same benefits of selling off assets for that needed cash without losing the use of those assets. The only requirement here or burden on the business is time – the 7 months.

The Main Reasons For The Growth Of The Home Based Business Industry

“Opportunity does not knock, it presents itself when you beat down the door.” – Kyle Chandler

What is the Home Based Business Industry?

An entrepreneurial business is mainly operated from home, mostly by the business owner himself. Some people refer to it as micro enterprises, working online, or small businesses. A small or micro business may not necessarily be a home based business.

It is important for the development of our home business opportunity to achieve financial independence in the global economy of the 21st century, to have a view of the total size of this industry and some views on possible future development and growth. This evaluation of the trends of the industry will help to dream-it-plan-it-do-it.

Very reliable statistical information is not freely available because these businesses are not well defined and are not part of governmental statistical planning and strategic information data. Some research and other information are available and will help us to get a broad view of the importance and trends of this industry.

Some general trends of and comments on the Business Industry:

The prospect of working from home has gained credibility over the years. It is no longer seen as a kind of part time job that the wife is doing from home while caring for her children. Take into account that most companies, about two-thirds of all companies, begin at home. That includes big companies like Apple Computer, Baskin-Robbins ice cream, Electronic Data Systems, Hallmark cards, the Lillian Vernon catalogue, and Purex.

In the USA, the average income generated by the home based business is substantial, as indicated by the following:

“Plus many home businesses do generate substantial revenue. About 35% have revenues of more than $125,000 and 8% more than $500,000. The median household income is $50,233 for households in general and roughly $75,000 for home entrepreneurs. The income for home based business owner is thus substantially higher than it is for the population as a whole.”

The home entrepreneurs business employs about 13.2 million people in the USA. It is estimated that about 50% of these are home based businesses. The assumption is that the home based businesses employs about 6.6 million people in the USA.

The home business industry is developing fast and becomes more important due to the following:

• The growth in the internet and the people connected to the internet. Two billion people are connected via the internet and this number grows by 200 million each year.

• Growth in the availability and lowering of the costs of broadband communication and connections worldwide has a positive influence on people connecting to the internet.

• The internet, increased online purchasing, money transfer mechanisms (notably PayPal), reliable global shipping, the decline in informal trade barriers and networks created through immigration have all made it easier for small businesses to serve global markets. The internet has been particularly important in enabling small businesses to cost effectively serve small market niches (the ‘long tail’ phenomenon).

• The development of computer technology, software, printers, dedicated telephone lines, and mobile phones creates new opportunities for the home based business and makes it more viable to operate a business from home. Affordable and powerful new technologies will continue to create new opportunities for the home based business. These technological developments will help to keep this industry growing.

• New innovations like:
o Express parcel delivery, distribution, cloud based IT services.
o Outsourcing, freelancing, communication technology, and the availability of skilled people in foreign countries makes it possible to not to have to perform all tasks at the premise of the home based business. It is easier to operate from a small premise at home.
o New business models have created new job opportunities for the development of home based business. Two examples are the network marketing industry, or multilevel marketing, and franchising.

• The growth of the knowledge and service based industries requires little office or working space and economies of scale does not apply.

• People are making lifestyle changes and prefer to work from home as it gives them flexibility, it saves time, and it eliminates commuting costs.

• The computer home business is not exclusively dependent on the local market to generate income, or for its financial existence; that makes this kind of business less vulnerable to economic cycles.

• Many people do need an extra source of income due to debt or other financial reasons and start their own home based business part time to generate a second income stream.

• With employer benefit packages being cut and the chances of losing a corporate job increasing, many view starting a home based business as no more risky than traditional employment. Job and income security drives people to start looking for and to develop an extra source of income for them.

• Due to demographic and social shifts. Aging baby boomers, women, Gen Y and others are all seeing home based business ownership as an increasingly viable work option. An interest in achieving work/life balance, flexibility, the opportunity to pursue a passion and working for your self are some of the reasons given for starting a home based business.

• There is a lack of corporate jobs. Large corporations have been battered by the recession. Even if the economic recovery is strong, it is unlikely that these companies will dramatically increase hiring. Instead of hiring full-time staff, they will stay flexible and lean through the increased use of technology, contractors, partnerships, and outsourcing. As a result, starting a home based business will be the best, and in many cases, the only option for corporate refugees.

“Nevertheless, owners are much more satisfied with their quality of life than other small business owners. However, the majority of owners do not appear to have made a financial trade-off in order to secure this quality of life.”

The number of people connected to the internet is growing very fast. Broadband is becoming more available in the world. The internet support technology and mobile applications of communication is growing at an astronomical rate. These developments create new opportunities for the internet related businesses.

It is being considered by some researchers that these developments will have a greater influence on the world economy than any economic revolution in history.

Selling A Share of Your Business to an Employee

Selling a share of your business (or the entire business) to an employee is often overlooked as a strategy, yet it can be very beneficial for both the owner and employee. There are many different ways this can be achieved and different situations where it might be beneficial. It is also possible that the owner can negotiate a better price as the employee may not have the capacity to purchase the business without the owner’s added assistance.

How does it Work?

One of the reasons why this strategy is attractive is that you can tailor it to meet the requirements of the business, the owner and the employee. There are no fixed rules, work out what both parties need for the deal to be beneficial and it’s a negotiation process from there.

The essential part of the transaction is that the owner will be entitled to receive a payment in return for giving the employee ownership or part ownership of the business.

The following variations can exist

  • If the employee does not have the funds or the capacity to borrow the purchase price, then
  • the purchase price can be paid over a number of instalments
  • the owner can personally guarantee the loan (in the employee’s name) and a separate agreement which entitles the owner to retain ownership of the business sold if the guarantee is activated
  • If the employee does not have the capacity to establish their own business premises then the employee can pay a rent and administration fee to the owner
  • The employee may purchase only one income stream of the business (and the owner continues to operate and own the remainder of the business)
  • The employee may purchase a share of the entire business (which could be Stage one of a number of stages to acquire the whole business)

What situations would it be beneficial?

Some examples which would suit this strategy:

1. The owner requires cash for personal reasons and financing is not an option

Example

Peter owns 3 toy stores which are trading very well. However Peter borrowed heavily to invest in an Aged Care Venture recommended by a friend. The Aged Care Venture has filed for bankruptcy and Peter is struggling to meet his debt obligations personally. The business operated an overdraft and the bank is not willing to lend any additional funds.

Paul has been a store manager for 5 years, and has previously spoken with Peter about purchasing the business or part of the business, but Peter had declined as he felt he would sell the entire business when he plans to retire in 5 years.

Peter and Paul negotiate for Paul to purchase 20% of the business for $50,000.

2. The business is largely dependent on the owner and therefore difficult to sell to an “outside party”. However, through a staged process, the business and its value can be transferred from the owner to the employee

Example

Neville provides engineering consulting services to large mining companies. Almost all of the income is from 4 mining companies that he has consulted to for over 10 years. Daniel is a qualified engineer who has been an employee for 5 years assisting Neville on these contracts (the business also employs 1 engineering undergraduate and 1 administration staff member). Neville wishes to retire.

It is unlikely that this business is saleable to anyone except Daniel. It is also likely that Daniel would not be awarded the contracts himself without Neville’s assistance.

Daniel agrees to purchase the business effective immediately – the deal is

  • 50% of the purchase price is paid now
  • 50% of the purchase price is payable in 12 months if the mining companies agree to maintain the contracts after Neville’s departure
  • Neville agrees to continue in the business for 12 months and is paid a salary

3. The owner wishes to offload part of the business to allow another part of the business to grow OR an excellent employee will leave without being rewarded with ownership.

Example

Annette owns a business that distributes cleaning products. The business has 3 distinct income streams

  • Wholesale of cleaning products to 3 large corporate clients. Annette has known these clients and has been distributing to them for 15 years. Profit on these products is high.
  • Retail of cleaning products to restaurants within a 200km radius. Carol is the manager who looks after this division, and whilst sales growth has been good, profit margins are lower as there are a number of competitors in this market.
  • Annette has developed an innovative cleaning product which is suitable for hospitals. This product has significant potential but Annette will have to invest a lot of time to commercialize, trial and distribute the product.

Carol works long hours and has done a great job with the retail division. Carol is enthusiastic about new products that could be sold through the retail network and has some other ideas to increase profits. Annette however does not have the time, nor the interest to invest money into this division, especially when the same time and money spent on the hospital product could produce much higher profit. Carol is frustrated at this lack of interest and is deciding whether she should approach a competitor to employ her. Carol has been repaying her university debt and does not have much money.

Annette and Carol agree as follows

  • Carol will purchase the retail division for $200,000, payable immediately
  • Carol is unable to obtain finance for $200,000 by herself, so Annette agrees to personally guarantee the loan. They sign an additional agreement which states that if the personal guarantee is called upon then Annette will be entitled to retain the Retail business. The loan term is for 4 years.
  • Carol will pay a Rent and Administration charge to Annette of $2,000 per month for the use of the office, staff and equipment.