Capital Access: Methods to Build Lasting Wealth

Capital Access: Tools for Wealth Creation

?In the past, some viewed debt as a negative—a burden to avoid if at all possible. However, this perception is shifting as seasoned business owners recognize that debt can be a powerful tool for building wealth. Access to capital allows businesses to invest in growth opportunities, manage cash flow, and navigate unforeseen challenges effectively. While you may have experience with various financing options, it’s essential to stay informed about the nuances and implications of each choice. Let’s explore the types of capital available and why, in many cases, banks can be your best option.

Types of Access to Capital

1. Foundation of Capital Access - Personal Investment

The most common form of a capital infusion is a personal investment from you, and any business partners within the enterprise. Using your own savings, or seeking funds from family and friends, demonstrates commitment to your business and builds trust with potential lenders, creating a solid foundation for future financing while reducing reliance on external debt. The negative to involving family, or friends is with the inability to repay-or being forced to surrender ownership shares in lieu of repayment.

2. Investors

While seeking out investors may seem appealing, it’s crucial to recognize the long-term costs involved. Investors often require equity stakes in your business, which means they’ll take a percentage of future profits. For example, if you give away 5% of your business, that percentage grows with the business’s future value. In contrast to a fixed loan, this can lead to a significantly higher cost in the long run, particularly if your business experiences substantial growth. The question is, should I pay a percentage of a loan, or a percentage of my [future] business? An investor is tied to the success of the business, meaning if the business fails-their investment is lost. Whereas a loan seeks to have return only on what was lent. No more, no less. While investors care less about the ability to repay the loan, they are not necessarily regulated to ensure it either.

3. Partnering with Financial Institutions

Bank loans remain one of the most reliable sources of financing for established businesses. With regulated lending practices, banks offer structured repayment plans and fixed interest rates, providing a predictable cost of borrowing. Key benefits include:

• Regulated Environment: Banks operate under stringent regulations, ensuring accountability and stability.
• Fixed Rate of Return: A bank loan typically comes with a fixed interest rate. For example, a 5% interest rate on a $100,000 loan means you’ll pay $5,000 in interest, regardless of future growth.
• Structured Terms: Clear repayment schedules help you manage cash flow effectively, that don't change with investor demand.

At the end of this article is a detailed comparison of investor vs. financial institution. Understand first: Banks will need to be able to prove a reliable ability to repay the loan. It's important to understand that banks are not investors looking to get into a new venture, rather, looking for a return on the money used for the loan. Think of it as purchasing the money as a product. How will the business pay for this product?

4. Hard Money Loans

Hard money loans are short-term loans secured by real estate or assets, typically used by businesses in urgent need of cash. While they provide quick access to funds, they often come with, Higher Interest Rates: Due to the increased risk, hard money loans can be significantly more expensive than traditional bank loans. Shorter Terms: These loans usually have a term of a few months to a couple of years, requiring quick repayment or refinancing. While you avoid the time it takes to prepare financials for a bank, or surrendering equity in exchange for capital, it is one of the more costly approaches. Often costing more than the stated cost in relation to how annual percentage rates are calculated.

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5. Unsecured Loans

Unsecured loans may also be an option for businesses looking for funding without collateral. However, they tend to be expensive because they pose a higher risk to lenders, unsecured loans come with higher interest rates and stricter repayment terms. Further, they tend to be more difficult to obtain. Some lenders typically require strong credit histories and financial statements, making them harder to qualify for. Some banks do not offer unsecured loans.

Preparing Ahead of Time

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Regardless of your financing strategy, preparation is key. Here are some steps to take before the need for capital arises:

Maintain Accurate Financial Records: Ensure your financial statements are up to date and reflect the true state of your business. Understand that banks are required to obtain any and all financials that they've asked for. If they ask for it, ensure that you follow through with providing the documentation.

Build Relationships with Lenders: Establish connections with banks and financial institutions. Having a bank that understands your business can lead to better terms and quicker access to capital when needed. When you have a partnership with lenders, the loan turnaround time is significantly reduced.

Create a Business Plan: A comprehensive business plan demonstrates your vision, strategy, and potential for growth, making you a more attractive candidate for financing. If nothing else, have answers to tough questions from lenders. Answers to questions like, "What happens if...".

Know Your Credit Score: Regularly monitor your credit score to ensure it aligns with the requirements of your desired financing options. Don't apply and get surprised. Monitor your credit closely.

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?Understanding the various types of access to capital is crucial for any seasoned business owner. While alternatives to bank loans may seem appealing, the structured nature of bank financing, along with the regulated environment and predictable costs, often makes them the most prudent choice. By preparing in advance with a Certified Public Accountant, and fostering relationships with financial institutions, you can position your business to thrive in any economic climate.

Example: Investor vs. Loan

?Let’s say your business is currently valued at $100,000. You have two options for funding: taking out a loan or bringing in an investor.

Option 1: Investor

?If you decide to bring in an investor and give away 10% of your company, you’re effectively selling a portion of your equity. Here’s how it breaks down:

Current Business Valuation: $100,000

Equity Given: 10%

Value of Equity Given to Investor: $10,000

Now, fast forward a few years, and your company grows to a valuation of $10 million. The investor still owns that 10% stake, which is now worth:

?Investor’s Stake at $10 Million Valuation: 10% of $10,000,000 = $1,000,000

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Option 2: Loan

?Now, let’s consider the alternative of taking a loan instead of giving up equity. Suppose you take out a $100,000 loan at an interest rate of 5%. The cost of the loan would look like this:

Loan Amount: $100,000

Interest Rate: 5%

Total Amount Paid Over Time: Assuming a 10-year term and simple interest for simplicity, you would pay back a total of $150,000 (this is a simplified calculation; actual repayments would depend on the loan structure).

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Summary Comparison

?If You Take on an Investor:

You give up 10% of your company today worth $10,000.

If your company grows to $10 million, that 10% is now worth $1,000,000.

If You Take a Loan:

You repay $150,000 over time, which is a fixed cost regardless of how much your company grows.

That's an expensive loan!