Since the beginning is always a good place to start, let us begin with the definition of a small business. In other words, how small is small? To begin with, a small business is a business with a small number of employees. When it comes to business, the definition of size is often related to the number of employees that a particular business supports, though there will be other considerations such as annual turnover and assets value.
While the legal definition of a ‘small’ business may vary by country and industry, in the United States, for example, a small business generally has fewer than 100 employees while in the European Union it has fewer than 50. A small business anywhere in the world is likely to either be a privately owned corporation, a partnership, or a sole proprietorship. Into this group will fall, for instance, the ‘mom and pop’ small businesses that are actually family-owned and operated enterprises, and may even be second- or third-generation businesses.
So what does it take to set up a small business? Funds are the obvious answer, but what kind of funds? The thumb rule is that the small entrepreneur should have access to a sum of money that is at least equal to the estimated revenue for the first year of business in addition to other anticipated expenses. Therefore, if an entrepreneur feels s/he will generate revenue of $50,000 for the first year and incur additional expenses of $50,000, s/he should have at least $100,000 as available capital.
Understandably, that kind of money is not to be pulled out of a hat. So what the potential small business owner does is apply for a small business loan. Make no mistake; it is vital that you have requisite capital when you start up, because the commonest malaise that plagues small businesses is bankruptcy owing to under capitalization. So lack of adequate funding will make the entrepreneur liable for all of the company’s debts should the business end up bankrupt.
Allan Mason, who set up a convenience store five years ago in Greensboro, North Carolina on the strength of a small business loan, recalls how he feared that might not break even in his first year in business. “The problem is that apart from ensuring that the business has enough capital, a small entrepreneur must also remember his gross margin (that is, sales minus the variable costs). To break even, I obviously had to reach a volume of sales where my gross margin was higher than my fixed costs,” Allan explains. “I also had to make sure that I did not under-price my items to the extent that I simply could not break even, and yet offer reasonable prices to customers in the teeth of competition from supermarkets.”
Allan had applied for a small business loan that would enable him to stock diverse products. “I wanted to get as close to the departmental store as possible in terms of items on offer, but I also wanted the intimacy of the shop around the corner,” he says. “My loan was approved on the strength of my business plan, and I think that is crucial for any small business owner. If you do not have a clear business plan and revenue model in mind, your loan application goes in the trash.” In April 2007, Allan opened his third store in Greensboro, and currently employs a staff of 12 across his three stores. “If I’m not careful, I’ll be launching a supermarket chain soon,” he jokes.
Therefore, it is a good idea to have written down a few points about your business and ideas, and have an explanation ready as to why people will buy from you and not your competitors, what your turnover and profits are likely to be over the coming years, and the exact amount of loan that you are looking for. Allan also advises prospective debtors to shop around. “Make sure you get a competitive interest rate on your repayments,” he says. “Loan Interest should also be tax deductible, which basically lowers the net effective rate.” In addition, it is wiser to opt for a lender or bank that allows you to pay off your loan before term if you are so able, and also lets you choose the loan repayment term.
However, at the end of the day, a small business loan is still a loan, so you need to be particular about repayment. Like any other loan, a small business loan can readily give you a bad credit history.