What You Really Need to Know About Startup Financing

Jumping the Gun

Unfortunately, entrepreneurs are so obsessed with financing, they often neglect details like critiquing the business plan. Even a banker may not uncover flaws in the strategy, particularly when the borrower is a strong contender in terms of credit history and collateral. "If people have good credit and are willing to put up their house, they will get the loan," says Therese Flaherty, director of the Wharton Small Business Development Centerin Philadelphia, "but they may not be able to generate the payback."

There was no danger of Jamila Payne, 26, falling into that trap. Payne was a recent college graduate when she launched a mail order clothing business, Milla by Mail Direct. Without collateral, traditional credit sources were out of reach. But instead of plunging headfirst into a frustrating credit search, she planned her business to the smallest detail. By the time Payne needed a loan, she had incorporated her company, drafted a business plan and saved $8,000. Impressed with her initiative, a nonprofit lending group accepted her in its program for entrepreneurs 30 and younger. Payne got $15,000 and completed a 10-week training program, an invaluable experience for the young business owner.

How Low Can You Go?
Entrepreneurs tend to overlook an obvious way to reduce their debt dependence: trimming the fat from their business plans. "One of the biggest sources of financing is not needing to spend the money," says Therese Flaherty, director of the Wharton Small Business Development Center in Philadelphia. "If they can buy used equipment and furniture and not need the money, they're taking much less risk. They should look at their whole operations plan and see if they can minimize the amount of investment they need. It's better not to take out the loan if they don't need it."

It's not uncommon for start-up entrepreneurs to seek credit simply because they believe it lends validity to a brand-new business. "I've seen people who just want a line of credit because they think it makes them look more legitimate," says Flaherty.

She urges start-ups to think of alternatives to credit, especially to fund short-term spending. For instance, a painting business could finance certain operating expenses, such as paint and other supplies, by asking customers for a portion of the payment upfront. "If you can get staged payments, you can avoid the line of credit."

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This article was originally published in the October 2003 print edition of Entrepreneur's StartUps with the headline: Truth & Consequences.

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