There are many sources of debt financing: banks, savings and loans, commercial finance companies and government agencies are most common. State and local government have developed many programs in recent years to encourage the growth of small businesses. Family members, friends and associates are all potential sources, especially when the capital requirements are small.
Typically, banks have been the major source of small business funding. Their principal role has been as a short-term lender offering demand loans, lines of credit, and single-purpose loans for machinery and equipment. Banks generally have been reluctant to offer long-term loans to small firms. The SBA guaranteed lending program encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available.
In addition to the traditional term loans and revolving lines of credit most often provided by commercial banks, other types of debt financing arrangements, such as asset-based financing from business financing companies, lease and equipment financing and sale and leaseback arrangements, have gained popularity.
Historically, it is extremely difficult to start a business with 100 percent debt. Private lenders and government loan programs often require 20 to 50 percent equity participation by the owner. The exact percentage depends on the project, the financial resources of the owners, the type of industry the use of funds and the financial institution’s general loan policy. In addition to equity considerations, lenders commonly require the borrower’s personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business.
Most traditional lenders prefer manufacturing or industrial operations where funds will be used to purchase fixed assets, i.e. land, building, or production equipment. These items offer the type of collateral often required to secure the debt.