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Draw the Law: Capital for your Start-up, Part III


Hey everyone, today’s Draw the Law will be brief, in anticipation of your 4th of July weekend!  Remember to enjoy yourself, be safe, and that the next post will be for Social Media and the Law on Tuesday, July 5th. Anyway, let’s get to it!

In the last post, I discussed raising capital from private sources such as institutional lenders, banks, or wealthy individuals or organizations, such as angel investors.  Today, I will discuss some of options through the government.

US Government Programs

The United States government does not lend money to small businesses.  Instead it has designed guarantee programs to encourage banks and other financial institutions to lend money to small businesses.  The main organization responsible for this is the Small Business Administration (SBA).  There are three main loan programs that the SBA offers to small business owners.

7(a) Loan Program

The 7(a) Loan Program provides financial help for businesses with certain special or unique requirements.  For instance, funds are made available to businesses that operate in underserved communities, in the export business, or operate in rural areas.   In general, the 7(a) Loan Program has a variety of sub-programs designed to promote very specific kind of businesses.

Microloan Program

The Microloan Program is exactly as it sounds.  It is made to provide small, short-term loans to small businesses and not-for-profit child-centers.  The maximum loan is for $50,000, but the average tends to be $13,000.  The monies received under this program come with certain restrictions.  Mainly, it cannot be used to buy real estate or pay off existing debt.  The money can be used for the following purposes: 1) working capital; 2) purchase of inventory or supplies; 3) the purchase of furniture and or fixtures; or 4) purchase of machinery or equipment.  Finally, the intermediary lender (the bank) is required to put you, the business owner, through certain training programs.

CDC/504 Program

The CDC/504 Program has the purpose of acting as an economic development tool for communities.  It basically operates through a Certified Development Company (CDC), a private, nonprofit corporation, which in turn works with the SBA and private lenders to provide financing to small businesses in the area.  It selectively targets businesses and then injects them with fixed-rate financing to acquire major fixed assets for expansion or modernization, thus insuring there is investment in infrastructure and development for the community. The funds must be used for fixed assets, for example: 1) purchase of land (including with buildings); 2) improving the area, such as grading, streets, utilities, parking lots, and landscaping; 3) the construction of new facilities or modernizing, renovating or converting existing ones; and/or 4) purchase of long-term machinery and equipment.  The funds CANNOT be used for working capital, inventory, or for the consolidating/repaying of debt, or financing.

*Please note I could spend dozens of posts talking about the variety of other loans and grants from other governmental departments and agencies.  Those tend to be heavily industry-specific types of programs, such as the US Department of Agriculture’s Farm Loans Program, designed for family-sized farmers and ranchers.  Today’s post is about very general small businesses.

Office of Hawaiian Affairs Programs

The State of Hawaii, as with many others states, has some unique funds or programs to help foster community and business development.  Those with Native Hawaiian ancestry have a couple of programs to look towards to help starting or growing a business.

Mālama Loan Program

First off, there is the Office of Hawaiian Affairs (OHA) Mālama Loan Program.  In this program OHA partners with First Hawaiian Bank to provide lending services to Native Hawaiian consumers and businesses.  Loan approval goes through the Native Hawaiian Revolving Loan Fund Board of Directors.  Some of the features of the loan are a 5-year, 5% fixed rate up to $75,000 for eligible businesses.  Typically, the business is used for business growth.  For more information, visit OHA at their website.

Kau Inoa Small Grants Program

The second program that I would like to mention is the Kau Inoa Small Grants Program.  This grant is dedicated to providing monetary incentive to encourage individuals and organizations for the purpose of nation-building. OHA suggests activities that grantees could participate, such as registering Hawaiians for Kau Inoa, conducting/hosting educational presentations, and/or the staffing of informational sites.  In general, this type of program is specifically geared toward events or short-term projects.  There is no non-profit or residency requirement.  The award amount is dependent on the type of event and hours of work required.  In certain cases, the award can be made on an accumulative and ongoing basis for a defined period of time, instead of singular events.  If you are interested please check out this link.

An Injection of Cash:  Not a Long-Term Financing Relationship

If you notice some these government guarantee-backed loans and grant programs are intended to be just quick shots of cash, especially like the SBA’s Microloan or the Kau Inoa Small Grants Program.  However, may be that is all you need to get over the expensive startup requirements your endeavor requires or that’s all you need to get your idea out there to gain supporters, customers, or clients.  For those with the entrepreneurial spirit, you might want to view your capital raising strategy as a three-legged stool with injections of money coming from all three sources.

For example, if you are one of those fortunate to qualify and receive a government-backed loan you could combine that with your personal money to get you past the startup phase. After you purchase all your equipment (usually the most expensive) part you can then use investors or private lending to get your company to the next stage of growth.

Last Word

The programs discussed today by no means represents an exhaustive list of everything that exists.  You should be aware that many loans or programs are hard to obtain given the overall problems with the economy.  However, remember sometimes the best times to start a business is during downturn, especially with commercial spaces very low, the cutting of valuable government services, and learning lean strategies to survive.  If you are seeking government-backed loans it is best to be prepared for some of the extensive requirements of the programs (i.e. lots of paperwork!).   It is best to have experts help you by developing strategies, processes, or general advice to address your concerns or compliance issues.

Next time I will discuss starting a business through “faster” methods.  Namely, buying an existing business or into a franchise.

See you on the next draw!

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.   No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.   Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

Draw the Law: Capital for Your Start-Up, Part I

Draw the Law” is a weekly short post where I try to visualize a legal concept.  It is designed to be helpful to small business owners and give them a quick overview of various aspects of the law that affect them.  For the next couple of posts I will detail how to finance a start-up.
In the prior post of this series we finished up with the variety of entity organizations, namely, sole proprietorship and partnership.

Now, that we have a business drawn up and have its “skeleton” outlined we will talk about the “blood” of the business or the financing of it.  What we need now is money!

Sources of Capital

There are a variety of methods of funding your business.  I like to divvy up those sources of money into three distinct categories.  They are as follows:

  1. Personal – what can you leverage on your own to raise money?
  2. Private – lenders and investors
  3. Government

Today, I will solely focus on personal methods of securing capital and then in Part II, I will discuss Private and Governmental sources.

Personal Sources

Let me list the personal methods first and I will turn to each one and briefly discuss them.  They are as follows:

  • savings
  • life insurance
  • retirement plans
  • home equity
  • stocks and bonds
  • credit card debt
  • loans from family friends

All of these represent the variety of personal sources that you could go to for money needed for starting your business.  I will now handle each one.

Savings

Savings is one of the easiest methods.  You just take what you have and spend it on the business.  All your cash in the bank use it on purchasing equipment, supplies, etc . . .  and it is as simple as that.  However, the reality is unless you are starting a business that has very little capital needs you are going to need to turn to other sources that draining your checking and savings accounts.

Borrowing Against Various Assets

In the case of life insurance, certain types of retirement plans, home equity, and stocks and bonds many people end up borrowing against these assets to raise the cash they need.  While, it is true you could cancel your life insurance policy, sell your home or condo, or sell your stocks and bonds most people would like to keep these assets for the long-term.  Instead they opt to borrow against the value of the item.  Typically, the loan that you are get will not be the full value of the item being borrow against, but some percent.

For the life insurance loan you would need to contact your insurance company.  For a home equity loan the bank that you owe your first mortgage on would be the first to turn to.  To use any stocks or bonds you own as collateral contact your broker.

Credit Cards

This method is as close to using your own savings to generate the buying power you need for equipment and the like for your business.  However, everything that goes on credit generally faces high interest rates if you cannot pay the balance of immediately.  In general, a credit card for the business is a good thing to purchase office equipment, make quick small payments, and emergency purchases, but should not be the primary method of financing the business as the interest rates will drain you over the long run.

Family and Friends

Here in Hawaii, we generally have a good family system where mom and dad, aunts and uncles, grandparents, and even calabash cousins will loan us some money to help our dreams come true.  While we like to trust in our family and friends, and hope for the best, it is also smart to just put the terms down in writing.  It should not be taken as an insult, but help avoid the creation of two different stories and future conflict should the business be unable to pay back the loan.  In addition, by having a promissory note, your relative or friend is in a better position to tell tax authorities that the money given to you was really a loan and not a gift, which have differing tax consequences.

Promissory Notes

These  are simple legally binding documents.  All they need to do is outline the terms of the loan, which includes the following parts:

  • identifies the parties;
  • how much money will be received;
  • what the interest rate is;
  • the amount of time you have to repay;
  • and the rate at which you will repay.

You can draft a promissory note yourself, so long as it has all the above components.  Just be sure to sign it, make a copy (to remind yourself of the repayment), and have the appropriate family member or friend hold onto the note.

If you are either party, the business owner or the family member or friend, and really concerned about such a loan you can always speak to attorney to make sure everything is in order. In addition to seeing a lawyer, for any method of financing you will probably want to meet with a financial adviser and accountant to make sure you have a firm grasp of how you will raise the money, expend it, and any debt obligations attached to it, as you get your business off the ground.

See you on the next draw!

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.   No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.   Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.