SMB Archives | Page 10 of 42

Jul

2024

How to Write a 5-Year Business Plan

Having a business plan can help you focus on where you want to go with your company and what it will take to get there.

How far into the future should you be planning? It can be helpful to have a short-term plan for one year, as well as a three-year business plan. But in this article, we’ll look out just a little further to create a business plan for the next five years.

We’ll also look at examples of some of the sections you should include to help you in writing your five-year business plan.

Why Create a Five-Year Business Plan?

Having a business plan can help you see the big picture for your business. It helps you identify your strategy. Why are you in business? What do you want to accomplish?

It can also help you define your marketing approach. You’ll have to do some research into who your clients are for your business plan, and by putting your energy here, you’ll be able to improve your understanding of your audience and how to reach them.

If you’re looking into how to get a small business loan or how to look for investors, you may see that some lenders and investors require a business plan from applicants. Why? They want to see that you’ve carefully thought through your business strategy and have a detailed plan for the money you’re seeking.

So why a five-year business plan? Five years is a good period of time, since it lets you consider both the short-term (the next 12 months) and look forward to the longer term, as well as set goals that you can work toward over time.

Now let’s look at what you need to include in your plan, including some examples.

Recommended: Structure a 3 Year Business Plan

Sections to Include in Your Business Plan

Not sure how to write a five-year business plan? We’ll go through it, step by step.

Your own plan might vary slightly. For instance, you might decide to include your “Management Team” and “Products and Services” as subsections under “Company Description.” But these are the sections that might typically be included in some form in a five-year business plan.

• Executive Summary: A brief overview of your business and its goals.

• Company Description: What does your firm do? Where does it operate and how does it fulfill its goals?

• Management Team: Who runs your company? What relevant background do they have?

• Products and Services: What exactly does your company produce/provide and how much?

• Target Audience: Who do you expect to buy your products and/or services? Are there new audiences you want to reach, too?

• Competitive Analysis: Who are your competitors and how do you compare?

• Market Analysis: How well is your company meeting the needs of your clients and keeping up with the industry?

• Marketing and Sales Plan: What is your plan for getting your company out there, expanding awareness of your products/services, and increasing your sales?

• Financials and Budget: What is your company’s budget and what financial information (like profit and loss statements) can you provide?

While your needs may vary, these sections can give you a sense of the basics you’ll likely want to cover.

Recommended: How Much Does It Cost to Start a Business?

Seven Steps to Creating a Five-Year Business Plan

The five-year business plan sections above are meant to give you an overview of what goes into many business plans. You might choose to modify one element or add another, depending on your business needs.

Now let’s walk through how to create a five-year business plan, illustrating what those sections are. We’ll also include five-year business plan examples using a fictitious tour company, Bella Tours.

1. Prepare Your Executive Summary

This is the first impression readers may get of your company, so you want it to be appealing and engaging. Your executive summary should be a high-level overview of your business plan. It might include just a little info on your mission statement, company history, what makes your company different, and your company goals.

Your executive summary might just be a page or two long. Remember: You’re going for high-level understanding, not nitty-gritty details. And even though we’re listing it first and it should come first in your finished business plan, you may want to consider actually writing this section last, because you might have achieved a better understanding of what needs to go into it at the end of the process.

Example of a Mission Statement

Bella Tours provides hands-on curated experiences for travelers in Calabria, Italy. Customers have the unique opportunity to meet locals and experience local culture on the tours, and Bella tours is the only company to provide this service in the region.

2. Consider Your Strategic Plan

In the sample five-year business plan we’re building for Bella Tours, we’ll next consider what we want to happen over the next five years. We also need to determine why we’ve chosen these goals and how we’ll meet them. Much of this information will go in your executive summary, though some may be relevant elsewhere, too.

Example of a Strategic Plan

Over the next five years, Bella Tours wants to expand its offerings. Our goal is to build partnerships with three to five homestay companies and add four new tour offerings per year. By partnering with homestay companies that offer excursions on their sites, we will expand our reach beyond that of our website. Additional tours will provide something new for repeat clients.

3. Describe Your Business

In your five-year plan for business strategy, you’ll also need to go more in-depth about what your business is and who’s involved. If you’re looking for investors, they will probably want to see that your team has deep experience in your industry.

This section (or an adjacent section) should also contain details on all products and services you offer.

Example of Management Team Description

Bella Tours is run by CEO Isabelle Rose, a published travel author who has lived in Calabria for 10 years. She brings a wealth of knowledge of the tourism industry to the company.

4. Analyze Your Market

Now it’s time to look at your client base. Who will buy your products or services? Where do they live? What kind of education or jobs do they have? How do they make decisions about what to buy? What other products or services do they buy?
Example of a Market Analysis Statement

Bella Tours customers are primarily solo travelers aged 30-40 or couples aged 60-75. They are college-educated and affluent. Many are retirees, and most travel in Italy for several weeks at a time. Our customers tend to be repeat consumers of our tours (58%), which is above the average return rate for similar tours in our state (25%).

5. Outline How You Will Handle Marketing

Now you’ll need to provide a marketing plan as part of your five-year business plan. This will address the channels you use for marketing as well as a budget for each.

These costs may include, for example, social media software subscriptions, a marketing employee’s salary, or a consulting fee to retain a marketing firm to manage social media, design fees, and advertising.

Example of a Marketing Plan

Bella Tours uses the following channels to reach our audience:

• Social media (Facebook, Instagram)

• Social media ads

• Content marketing

• Email marketing

• Pay-per-click ads

6. Budget Costs and Revenues

Now it’s time for dollars and cents. If you’re seeking financing or investment, the bank or investors will want to know that you know how to calculate cash flow, forecast sales, and account for expenses to grow your business.

You’ll want to include your income statement, balance sheet, and cash flow statement, as well as budgets for operations, overhead, sales and marketing, and other business expenses. You can also include sales forecasts here.

Example of a Marketing Budget

Bella Tours’ annual marketing budget consists of:

• Social media management (outside firm): $12,000

• Marketing software: $300

• Advertising: $5,000

Recommended: What Is a Business Liability?

7. Review Regularly

Now that you’ve created your five-year business plan, put it to good use. If you need to apply for funding, review it carefully before sharing with lenders or investors.

If you’ve created it for your own internal purposes, be sure to look at your business plan at least every quarter so you can ensure you’re tracking toward achieving your business goals.

Realize that your business plan may change over time. If company objectives change, be sure these changes are reflected in your plan.

Recommended: What to Know About Short-Term Business Loans

The Takeaway

Using these five-year business plan examples, you should be able to create a stellar business plan. Use that plan to continually push your business ahead.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

Why write a business plan?

You might be required to submit a business plan when applying for a loan or seeking investors. Or you might create a business plan just to help you establish your strategy and goals.

What should you include in a five-year business plan?

A five-year business plan should include information about your company and its leadership, your target audience, your products and services, your company goals, and your budget and financial information.

How do I describe my business?

For your business plan, your business description should outline what your company does, what its mission statement is, and who your leaders are.

How do I write an executive summary?

An executive summary for your business plan should provide a high-level overview of what your company does and what its objectives are.

Photo credit: iStock/MicroStockHub

Jul

2024

Guide to Off-Balance-Sheet Financing

By Lauren Ward | SMB | Comments Off

Off-balance sheet financing is an accounting strategy that involves excluding certain liabilities from a business’s balance sheet. This can help keep a company’s ratios (like debt-to-equity) low and make it easier to attract an investor or get financing.

Is it legal? Yes, as long as you follow certain rules and regulations. If, on the other hand, you use off-balance-sheet financing to mislead investors, lenders, or regulators about your company’s financial picture, you can get into legal (as well as financial) hot water. Read on to learn how off-balance sheet financing works, as well as its benefits and risks.

What Is Off-Balance Sheet Financing?

Off-balance sheet financing is a way to keep certain debts and liabilities (and sometimes assets) off of a company’s balance sheet. This can lower a company’s debt-to-income and other ratios, and make it look more attractive to lenders and investors.

Another reason why a company might turn to off-balance sheet financing is to make sure their leverage ratios don’t breach agreements they already have with lenders (called covenants) regarding negative debt.

While it may seem potentially shady, off-balance sheet financing is a legal practice, provided you follow rules established by the generally accepted accounting principles (GAAP) and disclose off-balance sheet financing in the footnotes of your financial statements.

How Does Off-Balance-Sheet Financing Work?

Off-balance sheet financing involves financing an asset without adding liabilities to the balance sheet. To accomplish this, a company may move certain assets, liabilities, or transactions away from their balance sheet and onto other entities, such as a subsidiary, special purpose vehicle (SPV), or partner. Doing so can make the company appear more attractive to an investor or allow them to qualify for better rates and terms on a small business loan.

Off-Balance Sheet Item Examples

Here’s an off-balance-sheet financing example: Let’s say Company A is already heavily financed but wants to purchase high-dollar manufacturing equipment. By having one of its subsidiary companies (Company B) make the purchase, the debts and assets remain on Company B’s balance sheet. Even though Company A authorized the purchase and will be the one using the equipment, it will be Company B’s balance sheet and debt-to-income ratio that are affected.

Another way Company A could use off-balance sheet financing is to enter a long-term lease to obtain the equipment. This avoids financing the equipment and adding a new liability to its balance sheet.

Off-Balance Sheet Financing Methods

Here’s a look at some of the ways that companies use off-balance sheet financing.

• Operating lease: With this arrangement, a company rents or leases a piece of equipment instead of buying it outright. At the end of the lease period, the company then purchases that equipment at a low price. This strategy allows a business to only record lease payments as an operating expense on the income statement instead of listing the asset and liability on its balance sheet.

• Leaseback agreement: With a leaseback, a company can sell an asset to another company (usually one it has a financial connection to) and lease it back as needed. This allows them to use the asset yet keep it off its balance sheet.

• Accounts receivables: Companies that have unpaid invoices, can sell them to another company (called a factor company) at a discounted value. This allows the company to avoid recording a large (and possibly uncollectible) asset on its balance sheet. The factor company takes over the responsibility (and risk) of collecting payments from the customers. When the factor company receives payments, they give it to the original company, minus their fee.

• Partnerships: Creating a partnership is another way to improve a company’s balance sheet. By doing this, the business doesn’t have to show the partner company’s liabilities on its balance sheet, even if it has a controlling interest in the company.

• Special purpose vehicles (SPVs): Large companies may create a subsidiary, called an SPV, to reduce their financial risk. Because the SPV has its own balance sheet, the company can move assets or liabilities onto the SPV’s balance sheet. The SPV may also have a higher credit rating, allowing the company to get financing with better rates and terms.

Pros and Cons of Off-Balance Sheet Financing

Off-balance sheet financing can be appealing if your company wants to get different types of business loans that might otherwise be hard to qualify for. However, it also comes with some drawbacks.

Pros

Off-balance sheet financing is technically legal and permissible, so long as you follow all GAAP protocols. In addition, it can help a company get approved for credit when it otherwise would not be able to. If your business is already highly leveraged and wants to move forward with a large capital investment, off-balance sheet financing can make it happen. Likewise, it may help a company acquire additional investors.

Off-balance sheet financing can also happen naturally without any intention to cloud a company’s records. Leases, for example, are a valid strategy to keep a company’s overall debts down while enabling it to continue with its day-to-day operations.

Recommended: Types of Small Business Loan Fees

Cons

There are also a number of disadvantages and risks involved in off-balance sheet financing. For one, the practice is generally frowned upon by both investors and lenders. Even if the business follows every rule in the book, off-balance sheet-financing methods can suggest to outsiders that there is something to hide.

Using off-balance sheet financing can also put your company at risk. After all, things like debt-to-income ratios exist for a reason. When companies take on more debt than they can comfortably handle, they often have no choice but to default on their debts.

Pros of Off-Balance Sheet Financing	Cons of Off-Balance Sheet Financing
May help a company look more attractive to investors	Has contributed to financial collapses (such as Enron’s)
Can help a company get approved for financing with competitive rates and terms	Generally frowned upon by investors and lenders
Technically a legal practice and accepted by GAAP	Can falsely improve the appearance of a company’s financials

Reporting Requirements for Off-Balance Sheet Financing

The Securities and Exchange Commission (SEC) requires public companies to list off-balance sheet financing in the notes of all of their financial statements. This provides more transparency to investors.

It’s also important to note that in 2016 the Financial Accounting Standards Board (FASB) changed the rules around lease accounting. Companies are now required to list on their balance sheets any assets and liabilities that are a result of leases greater than 12 months. Businesses must record both finance and operating leases on their balance sheets.

Is Off-Balance Sheet Financing Legal?

Yes. While off-balance sheet financing is generally frowned upon, it is not illegal as long as a company makes proper notes and records. To police it to the degree that would be needed to stop off-balance sheet financing would make it difficult for businesses to engage in deals like leasing and partnerships.

Enron’s Notorious Off-Balance Sheet Financing Practices

Enron’s demise stands out as one of the most infamous examples of off-balance sheet financing. Enron essentially used SPVs to keep large amounts of debt and losses it had amassed hidden from lenders and investors. The SPVs were reported in the notes on Enron’s financial documents, but not many investors thought to look for them, and those that did failed to fully understand the precariousness of Enron’s situation.

When Enron’s stock started to go down, the value of the SPVs also went down. Because Enron was financially liable for the SPVs, the company became unable to repay its debts and ultimately ended up filing for bankruptcy.

Can You Tell if a Business Is Using Off-Balance Sheet Financing?

Generally, yes. Businesses are required to include information about any off-balance sheet financing in the footnotes of their financial statements. However, you have to know what to look for to fully understand a company’s liabilities.

As an investor, it’s a good idea to review all of a company’s financial statements thoroughly (including the footnotes) and to keep an eye out for keywords that may signal the use of off-balance sheet financing, such as “partnerships”, “rental,” or “lease expenses.” If you see any of those terms, it’s a good idea to investigate further to make sure that these expenses and deals are appropriate.

The Takeaway

Off-balance sheet financing is a way to make a company’s financial situation seem better than it really is. Nevertheless, it is legal. And certain methods of off-balance sheet financing, like leasing, are common and may be necessary.

The practice of keeping certain assets and liabilities off your balance sheet, however, can be risky. It’s important to know that even if you engage in GAAP-compliant methods of off–balance sheet financing, this strategy can make it harder to get a full and realistic picture of your company’s total financial commitments.

Get personalized small business financing quotes with SoFi's marketplace.

FAQ

Is off-balance sheet financing illegal?

No. As long as off-balance sheet financing is done in keeping with generally accepted accounting principles (GAAP) rules and is disclosed in the notes of your financial statements, it is legal.

What are considered off-balance sheet items?

Off-balance sheet items include:

• Leaseback agreements

• Operating leases

• Accounts receivables

How are balance sheet and off-balance sheet financing different?

A balance sheet lists a company’s assets, liabilities, and shareholder equity at a specific point in time. On-balance sheet financing is when a business accounts for an asset or liability on the balance sheet. Off-balance sheet financing is when a business leaves an asset or liability off the balance sheet and accounts for it somewhere else.

Photo credit: iStock/mediaphotos

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SOSB-Q224-1871711-V1

Jul

2024

Understanding Negative Working Capital

By Lauren Ward | SMB | Comments Off

Negative working capital is when a company’s current liabilities are greater than its current assets. Current liabilities are those that are due in less than 12 months. Current assets are those that can turn into cash in less than 12 months.

It’s easy to think that companies with negative net working capital would be at financial risk, but that’s not necessarily the case. There are many situations where having occasional and controlled negative working capital can actually work in a business’s favor.

Indeed, many companies have and do use negative working capital to their advantage. Perhaps the most famous example is Walmart. As one of the first entrepreneurs to use this strategy, Walmart founder Sam Walton ordered large quantities of inventory and sold it at a profit weeks before he had to pay for it – freeing up cash to purchase more goods and to expand his business.

That said, this strategy doesn’t work for all companies. Read on for an in-depth look at what it means to have negative working capital, when it can happen, and whether it’s a good or bad thing for your small business.

What Is Negative Working Capital?

In order to understand what negative working capital is, it helps to have a clear understanding of working capital, also known as net working capital.

Simply defined, working capital is the difference between a business’s current assets and current liabilities.

Working Capital = Current Assets – Current Liabilities

A current asset is an asset that can be easily converted to cash within a year. Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, prepaid liabilities, and other liquid assets. A current liability is any debt that is expected to be repaid within a year. Current liabilities include obligations such as accounts payable and amounts due to suppliers, employee wages, and payroll tax withholding.

Ideally, current assets should be greater than current liabilities but for many businesses, that’s not always the case.

Negative working capital is when a company’s current liabilities are greater than its current assets as stated on the firm’s balance sheet. While that may sound like a risky proposition, some businesses are able to dip into periods of negative working capital without any ill effects.

Negative working capital commonly arises when a business generates cash very quickly because it can sell products to its customers before it has to pay the bills to its vendors for the original goods or raw materials. It then uses that cash to purchase more inventory or expedite growth in other ways. By doing this, the company is effectively using the vendor’s money as an interest-free loan. The firm still has an outstanding liability, however, which means it can end up with negative working capital.

Positive Working Capital

Positive working capital is when a company’s current assets exceed its current liabilities.. It’s the opposite of negative working capital and is usually a good position for a company to be in. Positive working capital means your business will be able to fulfill its financial obligations in the coming year and still have cash leftover to deal with any market disruptions (or other challenges) and/or invest in growth.

In order to be approved for a small business loan, businesses usually need to have a positive working capital, since many loans require assets as collateral. If the business is upside down on its debts vs. its assets, it may have trouble getting approved. However, working capital is one of many factors that lenders look at when approving loans.

Is it possible to have too much positive working capital? Yes. If assets are sitting somewhere and not helping the business grow and generate further revenue, then it’s possible they could be better used elsewhere to fuel the company’s next phase of development. To be competitive in today’s market, leveraging growth for healthy, steady business expansion is often essential.

Zero Working Capital

Zero working capital is when a company’s current assets are the same amount as its current liabilities. Having zero working capital can be a good sign, suggesting that the company is managing its resources effectively, maintaining just enough liquidity to cover its short-term obligations without tying up excess capital in non-productive assets.

However, having zero working capital can also signify that the company is operating on thin margins and doesn’t have much room for error. If unexpected expenses arise or if there’s a downturn in sales, the company could face liquidity problems.

Sometimes, a company might intentionally maintain zero working capital for a short period, perhaps to finance a specific project or investment. However, this is typically not a sustainable long-term strategy.

How Negative Working Capital Arises

While negative working capital might seem alarming, there are situations where it can be a strategic choice or a temporary condition. Here’s a look at some reasons why a company might have negative working capital.

• Industry norms: Some industries naturally operate with negative working capital due to their business models. For example, retail businesses often collect cash from customers before paying suppliers for inventory. This allows them to operate with negative working capital, using suppliers’ credit to finance their operations.

• Rapid growth: A company experiencing rapid growth might have negative working capital because it’s investing heavily in inventory and receivables to support increased sales. While this can strain short-term liquidity, it’s often seen as a sign of expansion and can be managed if the growth trajectory is sustainable.

• Seasonal variation: Businesses that experience seasonal fluctuations in sales may have negative working capital during slow periods when they build up inventory and receivables in anticipation of higher demand.

• Efficiency goals: In some cases, companies deliberately manage their working capital to optimize efficiency. They may prioritize cash flow by delaying payments to suppliers or accelerating the collection of receivables, even if it results in negative working capital on their balance sheet.

Pros and Cons of Negative Working Capital

Pros of Negative Working Capital	Cons of Negative Working Capital
Expedited growth	Difficulty meeting short-term obligations
Improved cash flow	Can strain relationships with suppliers
Lower financing costs	Limited financial cushion

When Is Negative Working Capital Good vs Bad?

As mentioned, negative working capital can either be good or bad. Let’s take a closer look at why.

Good Negative Working Capital

Negative working capital can be a good thing when companies are able to sell their inventory faster than their suppliers expect payment. This cash surplus allows the company to purchase more inventory or spur growth in other ways. In this scenario, the vendor is essentially financing part of the company’s operating and investment expenses — similar to a zero-interest loan.

Negative working capital can also provide a company with greater flexibility and agility to respond to changing market conditions or unexpected expenses, while also allowing it to take advantage of growth opportunities as they arise.

Bad Negative Working Capital

As soon as a company is unable to pay its operational costs or suppliers on time, negative working capital can shift from good to bad. Even if a company may have utilized negative working capital in the past without issues, a hiccup in sales can hurt operations fast. Negative working capital leaves a company with minimal cushion to absorb the unexpected.

If a business must constantly delay payments to vendors and suppliers in order to maintain negative working capital, it could strain relationships with those partners. Over time, suppliers may become reluctant to extend credit or offer favorable terms, which could affect a company’s ability to secure necessary goods and services.

Which Industries Typically Have Higher Negative Capital?

Companies with rapid turnover of inventory or services and make their money through cash often have negative working capital. This includes: large food stores, retailers, fast food restaurants, service-oriented business, E-commerce companies and software companies.

Recommended: Asset Turnover Ratio Formula and Definition

Strategies for Dealing With Negative Working Capital

To stay on top of negative working capital, business owners may want to:

1. Fully understand the flow of cash within your company. Using a business balance sheet to track income and expenses can help you pinpoint money issues that could contribute to negative working capital.

2. Keep track of account receivables.

3. Analyze how long it takes to completely sell through inventory batches.

4. Optimize billing cycles to space out expenses to match estimated sales.

Negative Working Capital Example Calculation

Here’s a negative working capital example:

A gaming retailer buys $1.5 million worth of the latest console directly from the manufacturer. It sells every console within the first day, but doesn’t have to pay its bill for the next 45 days. So it uses this influx of cash to buy more consoles and further increase revenues. In this case, negative working capital works because sales are growing. As a result, this retailer should not have trouble meeting its short-term financial obligations as they become due.

Recommended: How Much Does it Cost to Start a Business?

The Takeaway

Negative working capital is a state in which a company’s current liabilities exceed its current assets. Negative net working capital is fine as long as a company is able to pay its operational expenses and suppliers on time. If it is unable to do so, however, its long-term financial health may be in jeopardy.

While negative working capital can offer certain advantages in terms of cash flow management and flexibility, it’s essential for companies to carefully monitor and manage their working capital levels to avoid potential pitfalls and maintain financial stability.

Get personalized small business financing quotes with SoFi's marketplace.

FAQ

What does negative working capital indicate?

It depends on the business. It can indicate a business has a high inventory turnover, meaning it’s able to sell off inventory before any amount is owed to the supplier. On the other hand, it can simply mean that the business is having difficulty receiving on-time payments from its customers.

Is negative working capital typically a bad thing to have?

Not necessarily. Businesses in retail or fast-moving consumer goods often operate with negative working capital because they receive payment from customers before paying their suppliers. However, negative working capital can also signify liquidity issues, financial distress, or strained supplier relationships if the company is unable to meet its short-term obligations.

Can working capital being too high be a problem?

Yes. High working capital often means that a significant portion of the company’s assets is tied up in short-term assets like cash, accounts receivable, and inventory. If these assets are not being efficiently utilized, it can lead to lower returns on investment and reduced profitability.

Photo credit: iStock/designer491

SOSB-Q224-1869739-V1

Jul

2024

Guide to Buying Out a Business Partner

By Susan Guillory | SMB | Comments Off

Maybe your partner is ready to retire, but you want to keep running the business. Or, perhaps you have different views about how to run the business and have decided to part ways. Whatever the reason, buying out your partner’s ownership of the business might be the best step forward.

Partner buyouts can be expensive. And, depending on how your business is doing, you may not have enough cash on hand to pay for it out of pocket. The good news is that there are a variety of small business loans you can use to cover these costs.

Business partner buyout loans work a little differently than other kinds of business loans. Below, we walk you through the process of financing a buyout and offer tips for making the separation process as seamless as possible.

What Is a Buyout?

A buyout is a way to end a business partnership that involves one business partner buying another partner’s ownership interest in the business.

If there are only two partners in the business and you buy out your partner’s equity (whether it’s 50 percent or a different percentage), you would then own 100% of the business. If that’s the case, the buyout would also mean that the business is no longer a partnership and you would need to change the legal status of the company.

4 Steps to Setting Up a Buyout

If you’re interested in buying out your partner from partial ownership of the business, consider the following steps to help make the process as seamless as possible.

1. Review Operating Agreements

Your partnership agreement (or articles of incorporation) may have been written to include a buy-sell agreement that outlines how buyouts are to be handled.

Buy-sell agreements typically outline how ownership of the company is to be handled if one partner leaves, as well as how the value of a partner’s shares should be assessed. Before you begin the buyout process, it can be a good idea to review your partnership agreement to determine whether any buy-sell agreements factor into your buyout process.

2. Create a Buyout Agreement

If you don’t have a buy-sell agreement, you’ll need to create one. This should include the transfer of ownership, the purchase price of the buyout, the terms and conditions, and any restrictions that may come up in the future.

It can also be a good idea to consult with a lawyer with expertise in mergers and acquisitions. They can help structure the buyout deal so that it’s mutually beneficial for both partners, as well as help you set up a financing agreement, non-compete agreement, and a partnership release agreement.

3. Determine Fair Value

The next step is to determine the value of your business. For this, you may want to bring in an outside consultant that you both agree on. A professional valuation considers factors such as your company’s income, the market value of similar companies, and the fair market value of your company’s assets after liabilities are factored in.

4. Find Financing

Once you’ve come to an agreement, you’ll need to secure financing. Options include using your own cash to buy out your partner, using a small business loan, or coming to an agreement on your own with your former business partner, such as making monthly payments to them. The last option can save you money on interest, but may not be something your partner is willing to agree on.

Financing a Buyout

Once you and your business partner have agreed to part ways and you know the value of your business, you’ll need to find the funds to cover your partner’s share of the business. Whether you choose to pay a lump sum or buy your partner out over time, you may need to explore partner buyout financing to get the capital you need for the transaction.

While some banks offer traditional term loans to pay for the cost of a business buyout, these can be hard to come by. Businesses often take a financial hit after a buyout, and many traditional banks don’t want to take on that risk. Fortunately, there are some other options for financing a buyout.

Recommended: A Guide to Silent Partner Agreements

SBA Loans

If your business has a solid operating history, has increased profits in the last six months, and you have excellent personal credit, a loan backed by the U.S. Small Business Administration (SBA) can be a good way to finance a buyout. Because these loans are partly guaranteed by the government, it offsets some of the risk for the lender and makes you a more attractive borrower.

SBA loans come with low interest rates and long repayment terms. However, in addition to solid financials, you’ll likely need to present a strong application that includes a plan for how you’ll run the business effectively on your own.

Pros of SBA Loans

• SBA lenders may be more likely to finance a partnership buyout than banks.

• These are among the most affordable small business loans, offering long repayment periods and low interest rates.

Cons of SBA Loans

• If you don’t have great credit or haven’t been in business for at least two years, you may not qualify for an SBA loan for a buyout.

• Applying for an SBA loan is a lengthy process, and it can take many months before you receive the funding.

Alternative Business Loans

If you don’t qualify for an SBA loan or want to move quickly on a buyout, you might consider applying for a small business loan through an online or alternative lender.

Alternative lenders tend to look at a broad range of criteria to approve a buyout loan, which means they can be easier to qualify for than loans from banks or SBA lenders. The approval process also tends to move much more quickly. However, these loans typically cost more than SBA and bank loans.

Pros of Alternative Business Loans

• Even if you don’t qualify for a bank or SBA loan, you may be able to get buyout financing from an alternative lender.

• The application and approval process is typically quick — you may be able to get buyout financing within a few days or weeks.

Cons of Alternative Business Loans

• Alternative lenders typically charge higher interest rates and fees than banks or SBA lenders.

• Typically, loan amounts are smaller, and repayment terms are shorter than they are with bank and SBA loans.

Recommended: Typical Small Business Loan Fees

Pros and Cons of Partner Buyouts

If you’re researching how to buy out a business partner, you’ve likely already made your decision. Still, there are some benefits and drawbacks to partner buyouts you should be aware of before you move forward.

Pros of Buying Out a Business Partner

• It ends the partnership quickly. If your partnership is no longer working, a quick exit can be ideal. Buying your partner out allows you to get back to focusing on your business and gives you full control over how to move the company forward.

• It allows you to keep the business going. If you buy out your partner, rather than dissolve the business, you can keep your business running and won’t have to start all over again from scratch.

Cons of Buying Out a Business Partner

• It can be costly. Buyouts can be expensive, and you will likely also need to take out financing, which means paying interest and fees.

• It could have a negative impact on the business. If your business partner provides value to your business through expertise or connections, buying out your partner means giving up those assets.

Alternatives to Partner Buyouts

If you want to separate from your partner but don’t want to get a buyout loan, there are some other alternatives to a full, upfront buyout that you may want to consider.

• Buy your partner out over time. If your partner is open to it, you could agree to a payment plan over time. Each month, you would pay your partner part of the buyout over an agreed-upon period.

• Change the weighting of the partnership. If you want to continue with the current business, but your partner has lost interest, you might consider changing the weighting in the partnership agreement. This would allow you to retain primary control of the company’s decisions and finances without the upfront cost of buying out your partner completely.

• Find a different partner (or partners). If your current partnership no longer works but you like having a partner, you might look into finding another partner who can buy out your current partner’s equity. Or, you could use equity financing to buy out your partner, which involves selling their ownership shares to multiple investors.

• Dissolve the partnership. This would allow you to go your separate ways without any one person needing to buy out the other person.

The Takeaway

The best way to finance a buyout will depend on where your business is right now and what you envision for the future. If you’re breaking ties with your partner because you want full ownership, then getting a buyout loan may be a good option.

Before deciding on a type of financing, you’ll want to compare business loans to see which works best for your business.

If your company is well-established, you might want to pursue a low-cost SBA loan to buy out your partner. If your business is on the newer side — or you’re looking to make the break sooner than later — alternative business loans might be the way to go.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

Can you buy out a business partner?

Yes, you can buy out a business partner in order to be the sole owner of the business. To do this, you can buy them out with cash on hand or secure a small business loan.

Can you get a loan to buy out a business partner?

Yes, you can use a business loan to buy out a business partner. Types of business loans include short-term loans, long-term loans, and SBA 7(a) loans, which are backed by the Small Business Administration. These loans typically come with better rates than other types of small business financing.

Does a partner have to agree to be bought out?

If you have a buy-sell agreement in place and the terms were violated, you can force your partner to be bought out. However, if no agreement was in place, you’d have to come to terms with your business partner in order to fully take over the business.

How do you negotiate a business partner buyout?

To negotiate a business partner buyout, you’ll need to review your buy-sell agreement, assuming you created one when you formed your business. This agreement will detail how to handle buying out your business partner. You can also turn to a business attorney or accountant to reach an agreement. Clear, concise communication must be used between both you and your business partner.

Is buying out a partner a business expense?

Yes, typically buying out a partner is tax deductible for the business owner. The funds received by the former business owner (the person being bought out) are classified as income and will be taxed accordingly.

Photo credit: iStock/PeopleImages

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Jul

2024

How to Use Crowdfunding Loans for Your Business

By Lauren Ward | SMB | Comments Off

Loan crowdfunding, also known as debt crowdfunding or peer-to-peer lending, is a source of capital for small businesses where a number of investors (a.k.a. the “crowd”) lend money to early-stage businesses or individuals through a regulated platform.

In some cases, crowdfunded loans can be easier to get and offer better terms and interest rates than traditional bank loans. Read on to learn more about how debt crowdfunding works, plus how it compares to other startup funding options for small businesses.

What Is Loan Crowdfunding?

Loan crowdfunding is used to raise capital by taking loans from several investors (lenders) who expect to be repaid for their loan with added interest over the period that the loan was used. The entire process takes place through a crowdfunding platform.

In removing many of the middlemen that would be involved if the transaction happened through a bank, debt crowdfunding can keep the costs down for borrowers while potentially giving the lenders improved rates of return.

Loan crowdfunding differs from other forms of crowdfunding. Equity crowdfunding, for example, gives investors partial ownership of a company if they invest in the equity crowdfunding campaign.

With reward crowdfunding, on the other hand, a business provides investors with a reward, such as early access to the new product, but doesn’t offer any repayment in the future.

What Are the Different Types of Loan Crowdfunding?

There are three main types of loan crowdfunding:

P2P Lending: Peer-to-peer lending is when potential investors are matched with borrowers in search of raising capital. Depending on the loan amount, a borrower may receive funds from a single investor or a group of investors. While borrowers are able to gain access to needed capital without having to meet a lender’s credit requirements, credit scores may be taken into account when calculating interest.

Microloans: Microloans involve individuals issuing loans directly to borrowers, but in smaller amounts. According to the U.S. Small Business Association (SBA), a microloan is anything under $50,000. However, many microloan platforms typically provide much smaller loans.

Invoice Financing: Invoice financing allows a business to borrow against unpaid invoices owed by clients. Instead of harassing customers for money, a company that takes advantage of invoice financing can remain on good terms with all of its clients. However, the investors keep a percentage of the invoice once it’s paid.

How Do You Find Investors?

To raise the money you need to start a business or grow an existing business using this lending model, you’ll first need to register on a crowdfunding or peer-to-peer lending platform. Some debt-based crowdfunding platforms you may want to check out include:

• Funding Circle

• Honeycomb Credit

• Lending Club

• Kiva

• Mainvest

• Prosper

• SMBX

• Worthy Bonds

Once you register with a platform, you will likely need to draft a pitch with the details of the loan your are looking for, such as how much you are looking to raise, the type of investors you’re looking for, how many investors you’re looking for, what your business plan is, and what the funds will be used for.

Typically, the platform will then conduct a background check of your company and its principals to prove your credibility. If your offering is accepted, the platform will offer you a rate of return and applicable fees that correlate with the type of business you have and overall risk involved in the business being successful.

You may also need to provide some form of security, such as personal guarantee or a business asset.

Once this is complete, the platform can then promote your venture to investors through its online channels.

What Are the Benefits of Loan Crowdfunding?

Debt crowdfunding often comes with better terms than traditional loans. For many borrowers, the loans are greenlit faster than they would be with a bank or online lender. Standard SBA loans can take a few months to process, but loan crowdfunding can often take place in just a matter of days. The interest rates are often lower, too.

As with other forms of crowdfunding for small businesses, the process of applying for debt crowdfunding gets your name out there, can help to create some buzz around your business, and builds a community that supports your business.

Unlike other crowdfunding models, however, you don’t have to share equity of your company with the investors. This means that they have less of a say in how you run your day-to-day business. As long as you repay the interest on time and there is no fear that the principal of the loan runs any risk, you are generally able to run your business as you see fit.

Recommended: A Guide to Reward-Based Crowdfunding

Loan Crowdfunding vs Traditional Small Business Loans

It can be easier to qualify for loan crowdfunding than it is for traditional small business loans. For example, many traditional lenders want to see a strong credit score, financial statements, and tax returns that illustrate multiple years of positive cash flow. To get an SBA loan through a bank can take anywhere from 30 to 90 days. A P2P loan, on the other hand, often only takes a few days.

While crowdfunding loans also have requirements, those requirements differ with each platform. If one is too stringent, borrowers can simply try another knowing that the application process will be different with each company. Bank requirements, on the other hand, tend to be the same no matter what institution you’re working with.

Similar to a loan from a bank, your debt interest paid to investors can likely be deducted as a business expense under your company’s tax return.

Recommended: Fees for Small Business Loans

What Risks Are Involved With Loan Crowdfunding?

Like any loan, you have to repay the crowdfunded loan with the agreed-upon interest and within the agreed-upon time — regardless of how your business is performing.

If your business can’t repay the debts, you may be forced to sell off your assets and close your business. If you provided a personal guarantee for the loan, you might also be held accountable for all or some of the debts that your business has amassed. Your assets could be in jeopardy and your personal credit score could drop.

What Are Some Alternatives to Crowdfunding Loans?

Many peer-to-peer lending platforms have maximum loan amounts of only $40,000, so debt crowdfunding loans may not be high enough to meet the demands of many small business owners’ needs. In addition, loan crowdfunding may not be ideal for startups, since investors often prefer investing in businesses that already have a good track record.

Fortunately, crowdfunding loans are just one of the many types of financing options small businesses have. Other options include:

SBA Loans. SBA loans are backed by the U.S. Small Business Administration (SBA) to provide loans to startups and small businesses. Instead of directly lending to the businesses, the SBA guarantees a portion of the loan, which lets startup businesses access loans with more competitive rates and repayment terms.

Personal Loans. Personal loans are typically unsecured and based on your personal credit history (not business credit). This can be a versatile financing option, but keep in mind that some personal lenders do not allow funds to be used for business purposes.

Online Business Loans. Some online lenders offer similar loan options as a traditional bank, but typically have a faster approval process and may offer more options (though usually at higher interest rates) for people with lower credit scores.

Business Line of Credit. A business line of credit is a short-term financing option that can be revolving or non-revolving in which you pay interest on unpaid balances.

Merchant Cash Advance. A merchant cash advance offers cash up front in return for a portion of a business’s future sales. Since they aren’t loans, MCAs do not require collateral and merchant cash advance companies typically won’t look at your credit scores to determine approval.

Grants. Small business grants are awards given by a government agency, foundation, nonprofit, or other entity that typically don’t have to be repaid. Grants may be sector- or demographic-specific in their focus. For federal grant opportunities, Grants.gov and Challenge.gov are good places to begin searching.

The Takeaway

Crowdfunding loans provide an alternative avenue to traditional bank loans for small businesses. Offered by many peer-to-peer lending platforms, you are responsible for paying back the money from investors that funded your campaign, typically with interest.

Loan crowdfunding may have more favorable terms, lower interest rates, and quicker approval times than traditional loans, but the amount you can borrow may be limited, and qualification requirements vary from one platform to the next.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

Photo credit: iStock/Drazen_

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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