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How to Start a Finance Company

How to Start a Finance Company.

Finance companies provide loans to individual and commercial customers for a variety of reasons. Commercial customers can include retail stores, small businesses or large firms. Commercial loans can help established businesses construct a new office or retail space, or they can help new business get up and running. Personal loans for individual customers can include home equity loans, student loans and auto loans. Starting a finance company requires not only a thorough understanding of your target customer's needs and a comprehensive product line, but also a solid business plan that outlines how you will make your company successful. In addition,any new finance company must comply with strict state and federal regulations and meet initial funding requirements.

Part 1 Identifying the Finance Company Business Model

1. Select a finance company specialty. Finance companies tend to specialize in the types of loans they make as well as the customers they serve. The financial, marketing, and operational requirements vary from one specialty to another. Focusing on a single business model is critical to the successful creation and operation of a new company. Private finance companies range from the local mortgage broker who specializes in refinancing or making new loans to homeowners to the factoring companies (factors) that acquire or finance account receivables for small businesses. The decision to pursue a specific finance company specialty should be based upon your interest, your experiences, and the likelihood of success.

Many finance companies are founded by former employees of existing companies. For example, former loan officers, underwriters, and broker associates create new mortgage brokerage firms specializing in a specific type of loan (commercial or residential) or working with a single lender.

Consider the business specialty that attracted you initially. Why were you attracted to the business? Does the business require substantial start-up and operating capital?

Is there an opportunity to create the same business in a new area? Will you be competing with other similar, existing businesses?

2. Confirm the business opportunity. A new finance company must be able to attract clients and produce a profit. As a consequence, it is important to research the expected market space where the business will compete. How big is the market? Who presently serves potential clients? Are prices stable? Is the market limited to a specific geographic area? How do existing companies attract and serve their customers? How do competitors differ in their approach to marketing and service features?

Identify your target market, or the specific customers you intend to serve. Explain their needs and how you intend to meet them.}}

Describe your area of specialization. For example, if your market research indicates a growing number of small start-up companies needing loans, describe how the financial products and services you offer are strong enough to gain a significant share of that market.

Consider the companies already in the competitive space. Are they similar in size or dominated by a single company? Similar market shares may indicate a slow-growing market or the companies’ inability to distinguish themselves from their competitors.

Tip: Identifying your target market will require you to identify key demographics that are currently underserved and how you plan to draw these customers away from your competitors. You should list who these customers are and how your financial products will appeal to them. Include any advantages you have over competitors.

3. Identify the business requirements. What are the likely fixed costs to operate the business - office space, equipment, utilities, salaries and wages? What business processes are necessary for day-to-day operations - marketing, loan officers, underwriters, clerks and accountants? Will potential clients visit a physical office, communicate online, or both? Will you need a financial partner such as mortgage lender or a bank?

Mortgage brokers act as intermediaries between borrowers and lenders, sometimes with discretion up to a dollar limit. Factors typically leverage their own capital by borrowing from larger financial institutions.

4. Crunch the numbers. How much capital is required to open the business? What is the expected revenue per client or transaction? What is break-even sales volume? Before risking your own and other people’s capital, you need to ensure that profitability is possible and reasonable, if not likely.{{greenbox: Tip: Develop financial projections (pro formas) for the first three years of operation to understand how the business is likely to fare in the real world. The projections should include month to month Income Statements for the first year, and quarterly statements thereafter, as well as 'projected Balance Sheets and Cash Flow Statements.

Part 2 Making a Self Assessment.

1. Identify your skills. Before starting your new company and, possibly, a new career, it is important to objectively evaluate your skills and personality to determine what steps you need to take to successfully start and manage a finance company. Do you have special training in the finance specialty? Do you understand finance and accounting? Do you work well with people? Are you a leader, who inspires others to follow them, or a manager, who can assess a problem, discern its cause, direct resources to implement a solution? Are you a good salesperson? Do you have any special abilities specifically suited to the finance industry?

2. Assess your emotional strengths and interests. Do you work best alone or with others? Do you find it easy to compromise? Are you patient or demanding with others? Do you make quick, intuitive decisions or do you prefer detailed information and careful analysis before acting? How comfortable are you with risk? Are an optimist or a pessimist? When you make a mistake, do you beat yourself up or regard it as a learning opportunity and move on?

3. Consider your experience. Have you worked in the finance industry previously? Are you monetarily and professionally successful in your present position? Do you understand marketing, accounting, legal matters, or banking? Have you been responsible for creating new markets or leading sales teams?

4. Determine your financial capacity. Do you have sufficient capital to open the finance company you envision? Do you have assets that can cover your living expenses during a start-up phase? Will your family or friends contribute to the financing of your business? Do you have access to other financial sources - personal loans, venture capital, investment funds, or financial sponsors?

Part 3 Creating a Business Plan.

1. Set up your business plan. The Business Plan serves a number of functions. It is a blueprint for building your company in the future, a guide to ensure you remain focused in your efforts, and a detailed description of your company for potential lenders and investors. Begin writing your business plan by including all of the required sections and leaving room to fill them in. The steps in this part should serve as your sections, starting with the business description.

2. Write a business description. Your business plan will layout a blueprint for your company. The first part of your business, the description, is a summary of the organization and goals of your business. Begin by justifying the need for a new financial company in the industry or target location. You should briefly identify your target market, how you plan to reach them, descriptions of your products and services, and how your company will be organized.

Tip: You should also briefly explain how there is room in the current market for your company (how it will compete against competitors). You should already have this information from your initial market research.

3. Describe the organization and management of your company. Clarify who owns the company. Specify the qualifications of your management team. Create an organizational chart. A comprehensive, well-developed organizational structure can help a financial institution be more successful.

The Chief Executive Office leads the "executive suite" of other company officers.

The Chief Operating Officer manages the activities of the lending, servicing and insurance and investment units of the company.

The Chief Administrative Officer’s responsibilities include marketing, human resources, employee training, facilities, technology and the legal department.

The Chief Financial Officer ensures that the company operates within regulatory parameters. This person also monitors the company’s financial performance.

In smaller companies, executives may fill more than one of these roles simultaneously.

4. Describe your product line. Explain the types of financial products and loans you provide. Emphasize the benefits your products offer to your target customers. Specify the need your product fills in the market.

For example, if your target customers are small business owners, describe how the financial products and investments you offer to help them run their businesses.

5. Explain how your business is financed. Determine how much money you need to start your finance company. Specify how much equity you own. State what percentage other investors own in the company. Indicate how you plan to finance your company with leverage (loans),where these loans are coming from, and how the loans will be used in the business.

In most cases, equity in the company is used primarily for the company's operations, rather than the source of loans to customers. Secondary lenders provide funds to the finance company that is subsequently loaned to customers; the customers' loans collateralize the lenders' loans to the finance company. This is because profit is made in the spread, or the difference between your cost of acquiring capital and profit from lending it out.

Any funding request should indicate how much you need, how you intend to use the money, and the terms of the loan or investment.

6. Document your marketing and sales management strategies. Your marketing strategy should explain how you plan to attract and communicate with both customers and lenders/depositors. It should also show how you plan to grow your company. The sales strategy defines how you will sell your product.

Promotional strategies include advertising, public relations and printed materials.

Business growth opportunities not only include building your staff, but also acquiring new businesses or beginning to offer different kinds of products.

The sales strategy should include information about the size of your sales force, procedures for sales calls and sales goals.

7. Include financial statements in your business plan. Reviewing the pro forma financial statements you created during your business planning, be sure that your projections are reasonable and conservative. You may also want to cautiously estimate performance over the next two years after that. Include a ratio analysis to document your understanding of financial trends over time and predict future financial performance.

Prospective financial data should provide monthly statements for the first year and annual statements for the next two years.

Standard financial ratios include Gross profit margin, ROE, Current ratio, Debt to Equity.

Ratio and trend analysis data helps you document whether you will be able to continue to serve your customers over time, how well you utilize your assets and manage your liabilities, and whether you have enough cash to meet your obligations.

Tip: Add graphs to your analysis to illustrate positive trends.

Part 4 Determining Your Business Structure.

1. Consider forming a Limited Liability Company. A Limited Liability Company (LLC) is similar to a corporation in that it protects its owners from personal liability for debts or actions incurred by the business. However, they have the tax advantages of a sole proprietorship or partnership. A corporation typically files taxes separately from the shareholders.

Be aware that corporations pay double federal income tax, meaning taxes are assessed when profit is earned, and then again when it is distributed to shareholders.

You should seek legal advice to determine the best structure for your business.

2. Name and register your business. Choose a name that represents your brand and is unique enough to obtain a website address or URL. When choosing a name, check with the U.S. Patent and Trademark Office to make sure you are not infringing on any trademarks. Also, check with you state to see if the name is already in use by another corporation.

You will have to register with your state as a corporation. The exact registration process varies by state and type of corporation you decide to form.

Since your business name is one of your most important assets, protect it by applying for trademark protection with the U.S. Patent and Trademark Office.

3. Obtain a require operational licenses and permits. Financial institutions acquire these from the state in which they operate. Consult with your State Business License Office to identify the specific license and permit you need. Each state has different requirements for licensing financial institutions. You will need to specify exactly what type of financial institution you are opening, such as an investment company or a licensed lender. You will then furnish the requisite documents and pay any fees.

Due to the incredibly complex and constantly-evolving nature of the financial services industry, it is advised that finance companies hire and retain expert legal counsel to guide them through these regulations.

Note: You will also need to comply with any permit requirements surrounding your office space, like public and workplace safety regulations and operating permits.

4. Learn about regulations. The two categories of financial regulations in the United States are safety-and-soundness regulation and compliance. Safety-and-soundness regulations protect creditors from losses arising from the insolvency of financial institutions. Compliance regulations aim to protect individuals from unfair dealings or crime from the financial institutions. Financial regulations are carried out by both federal and state agencies.

Federal financial regulation agencies include the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Administration and the Securities and Exchange Commission (SEC).

State regulatory agencies may have additional requirements that are even more stringent than those set by the SEC.

With the help of your legal counsel, investigate reserve and initial funding requirements for your company. This will determine how much startup money you need.

5. Protect yourself from risk and liabilities with indemnity insurance. Indemnity insurance protects you and your employees should someone sue you. Financial institutions should purchase a specific kind of indemnity insurance called Errors and Omissions (E&O) insurance. This protects the financial company from claims made by clients for inadequate or negligent work. It is often required by government regulatory bodies. Remember, however, that staying in compliance with all regulatory requirements is still your responsibility.

Part 5 Setting Up Shop.

1. Obtain financing. You will need to finance your company according to your business plan, using a combination of equity and debt financing. Initial startup costs will be used for meeting reserve requirements and the building or rental of office spaces. From there, much of the company's operating capital will be lent out to customers.

Be aware of Federal and State laws regulating the private solicitation of investors. Adherence to securities laws regarding the information provided to potential investors and the qualifications of the investor will apply in most circumstances.

Sources of debt financing include loans from the government and commercial lending institutions. Money borrowed with debt financing must be paid back over a period of time, usually with interest.

The Small Business Administration (SBA) partners with banks to offer government loans to business owners. However, these loans can only be used for the purchase of equipment, not lent out to others. The SBA helps lending institutions make long-term loans by guaranteeing a portion of the loan should the business default.

Finance companies face the problem of having to raise large amounts of initial funding to be successful. They also often have to deal with a slew of other challenges before they become profitable. Without accounting properly for issues like fraud, it's very easy for a finance company to go out of business.

Note: Investors may want to provide financing in exchange for equity in the company. This is called equity financing, and it makes the investors shareholders in the company. You don’t have to repay these investors, but you do have to share profits with them.

2. Choose your location. A finance company should make a positive impression on customers. Customers looking for a loan will want to do business in a place that projects a trustworthy and sound image. Take into account the reputation of the neighborhood or of a particular building and how it will appear to customers. Also consider how customers will reach you and the proximity of your competitors. If your target customers are small local businesses, for example, they may not want to drive to a remote location or deal with heavy city traffic to meet with you.

If you are not sure, contact your local planning agency to find out if your desired location is zoned for commercial use, especially if you plan to operate out of your home.

Leasing commercial office space is expensive. Consider your finances, not only what you can afford, but also other expenses such as renovations and property taxes.

In today's connected world, it's also possible to run a finance company online, without a location for physical interaction with customers. While you'll likely still need an office for your employees, not having a retail location can save you some regulatory hassle expense.

3. Hire and retain employees. Write effective job descriptions so employees and applicants understand their role in the company and what your expectations of them are. Compile a compensation package, including required and optional fringe benefits. Compose an employee handbook that communicates company policies, compensation, schedules and standards of conduct.

Perform pre-employment background checks to make informed decisions about whom you hire. Financial planners and advisors require a specific educational background and are subject to rigorous certification requirements. Consider obtaining credit reports to show how financially responsible a candidate is.

4. Pay your taxes. Obtain an Employee Identification Number (EIN) from the IRS. This is also known as your Federal Tax Identification Number. Determine your federal and state tax obligations. State tax obligations include income taxes and employment taxes. All states also require payment of workers' compensation insurance and unemployment insurance taxes, and some also require payment of disability insurance.

5. Create loan packages for your clients. Decide if you are going to offer revolving or fixed-amount types of credit. Think about your target customers and what kinds of loans they would need. Homeowners and individuals may seek mortgages, auto loans, student loans or personal loans. Entrepreneurs may seek small business loans. Consolidated loans may help customers who are struggling to manage their finances.

Recognize that your loan offerings, rates, and terms will need to be constantly reworked with the changing loan market. Some of these items may also be subject to various regulations, so consult your legal counsel before finalizing your offerings.

6. Market your new finance company. Target your marketing efforts towards your chosen niche of clients. Marketing includes networking and advertising, but there are also other ways of letting potential customers know you have set up shop. Become a familiar face in your local business community by attending and speaking at events sponsored by the local chamber of commerce. Publish communications such as a newsletter or e-zine. Participate in social networking on sites like Facebook, LinkedIn and Twitter.

Note: In order to become successful, you'll have to attract both depositors and loan customers, so be sure to offer deals on both ends. Without attracting depositor, you will have no capital to lend out to customers.

December 03, 2019

how to start a finance company

How to Start a Finance Company.

December 01, 2019

Ten Ways to Create Shareholder Value (part 3).

by Alfred Rappaport.

Principle 8.

Reward middle managers and frontline employees for delivering superior performance on the key value drivers that they influence directly.
Although sales growth, operating margins, and capital expenditures are useful financial indicators for tracking operating-unit SVA, they are too broad to provide much day-to-day guidance for middle managers and frontline employees, who need to know what specific actions they should take to increase SVA. For more specific measures, companies can develop leading indicators of value, which are quantifiable, easily communicated current accomplishments that frontline employees can influence directly and that significantly affect the long-term value of the business in a positive way. Examples might include time to market for new product launches, employee turnover rate, customer retention rate, and the timely opening of new stores or manufacturing facilities.

My own experience suggests that most businesses can focus on three to five leading indicators and capture an important part of their long-term value-creation potential. The process of identifying leading indicators can be challenging, but improving leading-indicator performance is the foundation for achieving superior SVA, which in turn serves to increase long-term shareholder returns.

Principle 9.

Require senior executives to bear the risks of ownership just as shareholders do.
For the most part, option grants have not successfully aligned the long-term interests of senior executives and shareholders because the former routinely cash out vested options. The ability to sell shares early may in fact motivate them to focus on near-term earnings results rather than on long-term value in order to boost the current stock price.

To better align these interests, many companies have adopted stock ownership guidelines for senior management. Minimum ownership is usually expressed as a multiple of base salary, which is then converted to a specified number of shares. For example, eBay’s guidelines require the CEO to own stock in the company equivalent to five times annual base salary. For other executives, the corresponding number is three times salary. Top managers are further required to retain a percentage of shares resulting from the exercise of stock options until they amass the stipulated number of shares.
But in most cases, stock ownership plans fail to expose executives to the same levels of risk that shareholders bear. One reason is that some companies forgive stock purchase loans when shares underperform, claiming that the arrangement no longer provides an incentive for top management. Such companies, just as those that reprice options, risk institutionalizing a pay delivery system that subverts the spirit and objectives of the incentive compensation program. Another reason is that outright grants of restricted stock, which are essentially options with an exercise price of $0, typically count as shares toward satisfaction of minimum ownership levels. Stock grants motivate key executives to stay with the company until the restrictions lapse, typically within three or four years, and they can cash in their shares. These grants create a strong incentive for CEOs and other top managers to play it safe, protect existing value, and avoid getting fired. Not surprisingly, restricted stock plans are commonly referred to as “pay for pulse,” rather than pay for performance.

In an effort to deflect the criticism that restricted stock plans are a giveaway, many companies offer performance shares that require not only that the executive remain on the payroll but also that the company achieve predetermined performance goals tied to EPS growth, revenue targets, or return-on-capital-employed thresholds. While performance shares do demand performance, it’s generally not the right kind of performance for delivering long-term value because the metrics are usually not closely linked to value.

Companies need to balance the benefits of requiring senior executives to hold continuing ownership stakes and the resulting restrictions on their liquidity and diversification.

Companies seeking to better align the interests of executives and shareholders need to find a proper balance between the benefits of requiring senior executives to have meaningful and continuing ownership stakes and the resulting restrictions on their liquidity and diversification. Without equity-based incentives, executives may become excessively risk averse to avoid failure and possible dismissal. If they own too much equity, however, they may also eschew risk to preserve the value of their largely undiversified portfolios. Extending the period before executives can unload shares from the exercise of options and not counting restricted stock grants as shares toward minimum ownership levels would certainly help equalize executives’ and shareholders’ risks.

Principle 10.

Provide investors with value-relevant information.
The final principle governs investor communications, such as a company’s financial reports. Better disclosure not only offers an antidote to short-term earnings obsession but also serves to lessen investor uncertainty and so potentially reduce the cost of capital and increase the share price.

One way to do this, as described in my article “The Economics of Short-Term Performance Obsession” in the May–June 2005 issue of Financial Analysts Journal, is to prepare a corporate performance statement. (See the exhibit “The Corporate Performance Statement” for a template.) This statement:

separates out cash flows and accruals, providing a historical baseline for estimating a company’s cash flow prospects and enabling analysts to evaluate how reasonable accrual estimates are;
classifies accruals with long cash-conversion cycles into medium and high levels of uncertainty;
provides a range and the most likely estimate for each accrual rather than traditional single-point estimates that ignore the wide variability of possible outcomes;
excludes arbitrary, value-irrelevant accruals, such as depreciation and amortization; and
details assumptions and risks for each line item while presenting key performance indicators that drive the company’s value.

Could such specific disclosure prove too costly? The reality is that executives in well-managed companies already use the type of information contained in a corporate performance statement. Indeed, the absence of such information should cause shareholders to question whether management has a comprehensive grasp of the business and whether the board is properly exercising its oversight responsibility. In the present unforgiving climate for accounting shenanigans, value-driven companies have an unprecedented opportunity to create value simply by improving the form and content of corporate reports.

The Rewards—and the Risks.
The crucial question, of course, is whether following these ten principles serves the long-term interests of shareholders. For most companies, the answer is a resounding yes. Just eliminating the practice of delaying or forgoing value-creating investments to meet quarterly earnings targets can make a significant difference. Further, exiting the earnings-management game of accelerating revenues into the current period and deferring expenses to future periods reduces the risk that, over time, a company will be unable to meet market expectations and trigger a meltdown in its stock. But the real payoff comes in the difference that a true shareholder-value orientation makes to a company’s long-term growth strategy.

For most organizations, value-creating growth is the strategic challenge, and to succeed, companies must be good at developing new, potentially disruptive businesses. Here’s why. The bulk of the typical company’s share price reflects expectations for the growth of current businesses. If companies meet those expectations, shareholders will earn only a normal return. But to deliver superior long-term returns—that is, to grow the share price faster than competitors’ share prices—management must either repeatedly exceed market expectations for its current businesses or develop new value-creating businesses. It’s almost impossible to repeatedly beat expectations for current businesses, because if you do, investors simply raise the bar. So the only reasonable way to deliver superior long-term returns is to focus on new business opportunities. (Of course, if a company’s stock price already reflects expectations with regard to new businesses—which it may do if management has a track record of delivering such value-creating growth—then the task of generating superior returns becomes daunting; it’s all managers can do to meet the expectations that exist.)

Value-creating growth is the strategic challenge, and to succeed, companies must be good at developing new, potentially disruptive businesses.

Companies focused on short-term performance measures are doomed to fail in delivering on a value-creating growth strategy because they are forced to concentrate on existing businesses rather than on developing new ones for the longer term. When managers spend too much time on core businesses, they end up with no new opportunities in the pipeline. And when they get into trouble—as they inevitably do—they have little choice but to try to pull a rabbit out of the hat. The dynamic of this failure has been very accurately described by Clay Christensen and Michael Raynor in their book The Innovator’s Solution: Creating and Sustaining Successful Growth (Harvard Business School Press, 2003). With a little adaptation, it plays out like this:

Despite a slowdown in growth and margin erosion in the company’s maturing core business, management continues to focus on developing it at the expense of launching new growth businesses.
Eventually, investments in the core can no longer produce the growth that investors expect, and the stock price takes a hit.
To revitalize the stock price, management announces a targeted growth rate that is well beyond what the core can deliver, thus introducing a larger growth gap.
Confronted with this gap, the company limits funding to projects that promise very large, very fast growth. Accordingly, the company refuses to fund new growth businesses that could ultimately fuel the company’s expansion but couldn’t get big enough fast enough.
Managers then respond with overly optimistic projections to gain funding for initiatives in large existing markets that are potentially capable of generating sufficient revenue quickly enough to satisfy investor expectations.
To meet the planned timetable for rollout, the company puts a sizable cost structure in place before realizing any revenues.
As revenue increases fall short and losses persist, the market again hammers the stock price and a new CEO is brought in to shore it up.
Seeing that the new growth business pipeline is virtually empty, the incoming CEO tries to quickly stem losses by approving only expenditures that bolster the mature core.
The company has now come full circle and has lost substantial shareholder value.
Companies that take shareholder value seriously avoid this self-reinforcing pattern of behavior. Because they do not dwell on the market’s near-term expectations, they don’t wait for the core to deteriorate before they invest in new growth opportunities. They are, therefore, more likely to become first movers in a market and erect formidable barriers to entry through scale or learning economies, positive network effects, or reputational advantages. Their management teams are forward-looking and sensitive to strategic opportunities. Over time, they get better than their competitors at seizing opportunities to achieve competitive advantage.
Although applying the ten principles will improve long-term prospects for many companies, a few will still experience problems if investors remain fixated on near-term earnings, because in certain situations a weak stock price can actually affect operating performance. The risk is particularly acute for companies such as high-tech start-ups, which depend heavily on a healthy stock price to finance growth and send positive signals to employees, customers, and suppliers. When share prices are depressed, selling new shares either prohibitively dilutes current shareholders’ stakes or, in some cases, makes the company unattractive to prospective investors. As a consequence, management may have to defer or scrap its value-creating growth plans. Then, as investors become aware of the situation, the stock price continues to slide, possibly leading to a takeover at a fire-sale price or to bankruptcy.

Severely capital-constrained companies can also be vulnerable, especially if labor markets are tight, customers are few, or suppliers are particularly powerful. A low share price means that these organizations cannot offer credible prospects of large stock-option or restricted-stock gains, which makes it difficult to attract and retain the talent whose knowledge, ideas, and skills have increasingly become a dominant source of value. From the perspective of customers, a low valuation raises doubts about the company’s competitive and financial strength as well as its ability to continue producing high-quality, leading-edge products and reliable postsale support. Suppliers and distributors may also react by offering less favorable contractual terms, or, if they sense an unacceptable probability of financial distress, they may simply refuse to do business with the company. In all cases, the company’s woes are compounded when lenders consider the performance risks arising from a weak stock price and demand higher interest rates and more restrictive loan terms.

Clearly, if a company is vulnerable in these respects, then responsible managers cannot afford to ignore market pressures for short-term performance, and adoption of the ten principles needs to be somewhat tempered. But the reality is that these extreme conditions do not apply to most established, publicly traded companies. Few rely on equity issues to finance growth. Most generate enough cash to pay their top employees well without resorting to equity incentives. Most also have a large universe of customers and suppliers to deal with, and there are plenty of banks after their business.

It’s time, therefore, for boards and CEOs to step up and seize the moment. The sooner you make your firm a level 10 company, the more you and your shareholders stand to gain. And what better moment than now for institutional investors to act on behalf of the shareholders and beneficiaries they represent and insist that long-term shareholder value become the governing principle for all the companies in their portfolios?

July 25, 2020

How did Warren Buffett get started in business?

By BRENT RADCLIFFE.
Warren Buffett may have been born with business in his blood. He purchased his first stock when he was 11 years old and worked in his family’s grocery store in Omaha.
His father, Howard Buffett, owned a small brokerage, and Warren would spend his days watching what investors were doing and listening to what they said. As a teenager, he took odd jobs, from washing cars to delivering newspapers, using his savings to purchase several pinball machines that he placed in local businesses.

His entrepreneurial successes as a youth did not immediately translate into a desire to attend college. His father pressed him to continue his education, with Buffett reluctantly agreeing to attend the University of Pennsylvania. He then transferred to the University of Nebraska, where he graduated with a degree in business in three years.

After being rejected by the Harvard Business School, he enrolled in graduate studies at Columbia Business School. While there, he studied under Benjamin Graham – who became a lifelong friend – and David Dodd, both well-known securities analysts. It was through Graham's class in securities analysis that Buffett learned the fundamentals of value investing. He once stated in an interview that Graham's book, The Intelligent Investor, had changed his life and set him on the path of professional analysis to the investment markets. Along with Security Analysis, co-written by Graham and Dodd it provided him the proper intellectual framework and a road map for investing.

Benjamin Graham and The Intelligent Investor.
Graham is often called the "Dean of Wall Street" and the father of value investing, as one of the most important early proponents of financial security analysis. He championed the idea that the investor should look at the market as though it were an actual entity and potential business partner – Graham called this entity "Mr. Market" – that sometimes asks for too much or too little money to be bought out.

It would be difficult to summarize all of Graham's theories in full. At its core, value investing is about identifying stocks that have been undervalued by the majority of stock market participants. He believed that stock prices were frequently wrong due to irrational and excessive price fluctuations (both upside and downside). Intelligent investors, said Graham, need to be firm in their principles and not follow the crowd.
Graham wrote The Intelligent Investor in 1949 as a guide for the common investor. The book championed the idea of buying low-risk securities in a highly diversified, mathematical way. Graham favored fundamental analysis, capitalizing on the difference between a stock's purchase price and its intrinsic value.

Entering the Investment Field.
Before working for Benjamin Graham, Warren had been an investment salesman – a job that he liked doing, except when the stocks he suggested dropped in value and lost money for his clients. To minimize the potential of having irate clients, Warren started a partnership with his close friends and family. The partnership had unique restrictions attached to it. Warren himself would invest only $100 and, through re-invested management fees, would grow his stake in the partnership. Warren would take half of the partnership’s gains over 4% and would repay the partnership a quarter of any loss incurred. Furthermore, money could only be added or withdrawn from the partnership on December 31st, and partners would have no input about the investments in the partnership.

By 1959, Warren had opened a total of seven partnerships and had a 9.5% stake in more than a million dollars of partnership assets. Three years later by the time he was 30, Warren was a millionaire and merged all of his partnerships into a single entity.
It was at this point that Buffett’s sights turned to directly investing in businesses. He made a $1 million investment in a windmill manufacturing company, and the next year in a bottling company. Buffett used the value-investing techniques he learned in school, as well as his knack for understanding the general business environment, to find bargains on the stock market.

Buying Berkshire Hathaway.
In 1962, Warren saw an opportunity to invest in a New England textile company called Berkshire Hathaway and bought some of its stock. Warren began to aggressively buy shares after a dispute with its management convinced him that the company needed a change in leadership.. Ironically, the purchase of Berkshire Hathaway is one of Warren’s major regrets.
Understanding the beauty of owning insurance companies – clients pay premiums today to possibly receive payments decades later – Warren used Berkshire Hathaway as a holding company to buy National Indemnity Company (the first of many insurance companies he would buy) and used its substantial cash flow to finance further acquisitions.

As a value investor, Warren is a sort of jack-of-all-trades when it comes to industry knowledge. Berkshire Hathaway is a great example. Buffett saw a company that was cheap and bought it, regardless of the fact that he wasn’t an expert in textile manufacturing. Gradually, Buffett shifted Berkshire’s focus away from its traditional endeavors, instead using it as a holding company to invest in other businesses. Over the decades, Warren has bought, held and sold companies in a variety of different industries.

Some of Berkshire Hathaway’s most well-known subsidiaries include, but are not limited to, GEICO (yes, that little Gecko belongs to Warren Buffett), Dairy Queen, NetJets, Benjamin Moore & Co., and Fruit of the Loom. Again, these are only a handful of companies of which Berkshire Hathaway has a majority share.
The company also has interests in many other companies, including American Express Co. (AXP), Costco Wholesale Corp. (COST), DirectTV (DTV), General Electric Co. (GE), General Motors Co. (GM), Coca-Cola Co. (KO), International Business Machines Corp. (IBM), Wal-Mart Stores Inc. (WMT), Proctor & Gamble Co. (PG) and Wells Fargo & Co. (WFC).

Berkshire Woes and Rewards.
Business for Buffett hasn’t always been rosy, though. In 1975, Buffett and his business partner, Charlie Munger, were investigated by the Securities and Exchange Commission (SEC) for fraud. The two maintained that they had done nothing wrong and that the purchase of Wesco Financial Corporation only looked suspicious because of their complex system of businesses.
Further trouble came with a large investment in Salomon Inc. In 1991, news broke of a trader breaking Treasury bidding rules on multiple occasions, and only through intense negotiations with the Treasury did Buffett manage to stave off a ban on buying Treasury notes and subsequent bankruptcy for the firm.
In more recent years, Buffett has acted as a financier and facilitator of major transactions. During the Great Recession, Warren invested and lent money to companies that were facing financial disaster. Roughly 10 years later, the effects of these transactions are surfacing and they’re enormous.

A loan to Mars Inc. resulted in a $680 million profit.
Wells Fargo & Co. (WFC), of which Berkshire Hathaway bought almost 120 million shares during the Great Recession, is up more than 7 times from its 2009.
American Express Co. (AXP) is up about five times since Warren’s investment in 200813
Bank of America Corp. (BAC) pays $300 million a year and Berkshire Hathaway has the option to buy additional shares at around $7 each – less than half of what it trades at today.
Goldman Sachs Group Inc. (GS) paid out $500 million in dividends a year and a $500 million redemption bonus when they repurchased the shares.

Most recently, Warren has partnered up with 3G Capital to merge J.H. Heinz Company and Kraft Foods to create the Kraft Heinz Food Company (KHC). The new company is the third largest food and beverage company in North America and fifth largest in the world, and boasts annual revenues of $28 billion. In 2017, he bought up a significant stake in Pilot Travel Centers, the owners of the Pilot Flying J chain of truck stops. He will become a majority owner over a six-year period.
Modesty and quiet living meant that it took Forbes some time to notice Warren and add him to the list of richest Americans, but when they finally did in 1985, he was already a billionaire. Early investors in Berkshire Hathaway could have bought in as low as $275 a share and by 2014 the stock price had reached $200,000, and was trading just under $300,000 earlier this year.

Comparing Buffett to Graham.
Buffett has referred to himself as "85% Graham." Like his mentor, he has focused on company fundamentals and a "stay the course" approach – an approach that enabled both men to build huge personal nest eggs. Seeking a seeks a strong return on investment (ROI), Buffett typically looks for stocks that are valued accurately and offer robust returns for investors.
However, Buffett invests using a more qualitative and concentrated approach than Graham did. Graham preferred to find undervalued, average companies and diversify his holdings among them; Buffett favors quality businesses that already have reasonable valuations (though their stock should still be worth something more) and the ability for large growth.

Other differences lie in how to set intrinsic value, when to take a chance and how deeply to dive into a company that has potential. Graham relied on quantitative methods to a far greater extent than Buffett, who spends his time actually visiting companies, talking with management and understanding the corporate's particular business model. As a result, Graham was more able to and more comfortable investing in lots of smaller companies than Buffett. Consider a baseball analogy: Graham was concerned about swinging at good pitches and getting on base; Buffett prefers to wait for pitches that allow him to score a home run. Many have credited Buffett with having a natural gift for timing that cannot be replicated, whereas Graham's method is friendlier to the average investor.

Buffett Fun Facts.
Buffett only began making large-scale charitable donations at age 75.
Buffett has made some interesting observations about income taxes. Specifically, he's questioned why his effective capital gains tax rate of around 20% is a lower income tax rate than that of his secretary – or for that matter, than that paid by most middle-class hourly or salaried workers. As one of the two or three richest men in the world, having long ago established a mass of wealth that virtually no amount of future taxation can seriously dent, Mr. Buffett offers his opinion from a state of relative financial security that is pretty much without parallel. Even if, for example, every future dollar Warren Buffett earns is taxed at the rate of 99%, it is doubtful that it would affect his standard of living.

Buffett has described The Intelligent Investor as the best book on investing that he has ever read, with Security Analysis a close second. Other favorite reading matter includes:
Common Stocks and Uncommon Profits by Philip A. Fisher, which advises potential investors to not only examine a company's financial statements but to evaluate its management. Fisher focuses on investing in innovative companies, and Buffett has long held him in high regard.
The Outsiders by William N. Thorndike profiles eight CEOs and their blueprints for success. Among the profiled is Thomas Murphy, friend to Warren Buffett and director for Berkshire Hathaway. Buffett has praised Murphy, calling him "overall the best business manager I've ever met."
Stress Test by former Secretary of the Treasury, Timothy F. Geithner, chronicles the financial crisis of 2008-9 from a gritty, first-person perspective. Buffett has called it a must-read for managers, a textbook for how to stay level under unimaginable pressure.
Business Adventures: Twelve Classic Tales from the World of Wall Street by John Brooks is a collection of articles published in The New Yorker in the 1960s. Each tackles famous failures in the business world, depicting them as cautionary tales. Buffett lent his copy of it to Bill Gates, who reportedly has yet to return it.

The Bottom Line.
Warren Buffett’s investments haven't always been successful, but they were well-thought-out and followed value principles. By keeping an eye out for new opportunities and sticking to a consistent strategy, Buffett and the textile company he acquired long ago are considered by many to be one of the most successful investing stories of all time. But you don't have to be a genius "to invest successfully over a lifetime," the man himself claims. "What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."

August 04, 2020

How to Choose Business Financing.

Every business needs funding for a variety of reasons, including startup, operations, equipment and project completion. Finance for business is a complex subject that must be approached from a variety of angles. There are many business financing options, some of which may or may not be right for your particular needs. In order to evaluate your situation and determine which finance avenues to pursue, there is a variety of factors to consider. Follow these guidelines to choose business financing.

Method 1 Arranging for a Loan.

1. Compare loans with other types of financing. Loans are a type of debt financing. This means that you have to pay the money back, plus interest. Loans are typically offered by banks, credit unions or other financial institutions. Businesses that typically qualify for loans have a strong business plan, favorable business credit rating and a fair amount of equity capital.

Equity capital is the current market value of everything the company owns less any liabilities owed by the company.

Lenders are sometimes hesitant to give loans to companies without a lot of equity capital. Without equity capital, businesses don't have much collateral to put up for a loan. Also, revenues earned by the business will go toward repaying the debt instead of growing the business.

2. Get a line of credit from a bank. A line of credit is different from a typical loan in that it doesn't give you a lump sum of cash. Rather, like a credit card, you withdraw from the available credit any time you need it. You only withdraw as much as you need. This gives you control over the amount of interest expense you will have to pay. A line of credit can help you control your cash flow as your expenses or income ebb and flow.

To qualify for a line of credit, be prepared to submit financial statements, personal tax returns, business tax returns, bank account information and business registration documents.

Annual reviews are required to maintain your line of credit.

3. Obtain a business loan from a bank. A business loan is like any other kind of term loan. Business loans come with fixed interest rates. You make monthly payments over a period of years until the loan is paid off. Unlike a line of credit, a term loan gives you a lump sum of cash up front. Businesses who are expanding their space or funding other large investments can benefit from a term business loan.

Before making a loan, lenders want to know what the loan is for and how you will spend the money. Be prepared to demonstrate that the loan is for a sound financial purpose.

Different lenders require different documents. In general, be prepared to produce: your personal and business credit history; personal and business financial statements for existing and startup businesses; projected financial statements; a strong, detailed business plan; cash flow projections for at least a year; and personal guaranties from all principal owners of the business.

Large banks tend to avoid working with small businesses. They don't want to do all of the work to underwrite a small loan that won't make a large profit for them.

Local banks with whom you already have done business or credit unions may be more willing to work with small businesses.

4. Apply for a commercial loan. A commercial loan is similar to a home equity loan. It is for businesses that own commercial real estate. You borrow against the equity you have in the commercial real estate you own. The amount you can borrow depends on the value of your property and how much equity you have.

Commercial loans are not backed by government entities like Fannie Mae, so lenders see these loans as risky. Therefore, they tend to charge higher interest rates for them. Also lenders scrutinize the business more closely as well as the real estate that will serve as collateral for the loan.

5. Request a Small Business Association (SBA) loan. These loans are given by participating banks and are guaranteed by the SBA. They are for businesses that might have trouble getting a traditional bank loan. The SBA guarantees a portion of your loan to repay if you default on your payments. Find a bank that works with SBA loans by visiting www.sba.gov/lenders-top-100. Use the application checklist (www.sba.gov/content/sba-loan-application-checklist) to make sure you have all of the necessary documentation.

SBA loans for starting and expanding a business include the Basic 7(a) Loan Program, the Certified Development Company (CDC) 504 Loan Program and the Microloan Program.

SBA also offers disaster assistance loans for businesses in a declared disaster area and economic injury loans for businesses that have suffered a physical or agricultural production disaster.

Export assistance loans help exporters obtain financing to support exporting activities or to compete if they have been adversely affected by competition from imports.

Veteran and military community loans help businesses meet expenses when an essential employee has been called up on active duty.

Other special purpose loans include CAPlines, which help businesses purchase capital equipment, pollution control loans for pollution control facilities, and the U.S. Community Adjustment And Investment Program (CAIP), for businesses that have been adversely affected by the North American Free Trade Agreement (NAFTA).

6. Work with state and local economic development agencies. Economic development agencies exist in every state and in some local municipalities. They provide low-interest loans to businesses that might not qualify for traditional bank loans. In addition to financial services, these agencies provide startup advice, training, business location selection assistance and employee recruitment and training assistance. You can find the economic development agency in your state by visiting www.sba.gov/content/economic-development-agencies. You can also contact your city or county government office to find out about their economic development programs.

Each agency has its own application process. However many require the same basic documentation. Gather the following information.

A loan application form that details why you are applying for the loan and how you will use the money.

Your resume gives lenders information about your expertise in the field.

All lenders will require a sound business plan. For help with writing your business plan, visit www.sba.gov/writing-business-plan.

Your business credit report gives lenders information about your credit worthiness.

Be prepared to submit your business and personal tax returns for the past three years.

Prepare historical financial statements, including your balance sheet, income statement, cash flow statement and bank statements. You may also be asked to submit projected financial statements.

Be able to demonstrate your business' current financial position with accounts receivable and accounts payable information.

You may need to put up collateral, especially if you cannot provide strong financial statements.

Gather important legal documents, including your business license, articles of incorporation, third party contracts, franchise agreements and commercial leases.

7. Consider online lending. Online lending services include Kabbage and OnDeck. These loans are for businesses who want small, short-term loans. Businesses turn to these lenders to handle short-term cash flow shortfalls. The application process is quick, and most applicants can complete the application in an hour. If approved, you get the money within days.

Be aware that you will pay for the convenience of the fast processing time. These loans are expensive. A typical loan from an online source costs about the same as taking a cash advance from your credit card. The average interest rate on one of these loans can be as much as twice that of a traditional bank loan.

Method 2 Applying for Grants.

1. Compare grants with debt financing. Like a loan, a grant is typically a one-time infusion of cash. Unlike a loan, however, you do not have to pay back the money. You can think of a grant as free money. But it can be trickier to qualify for a grant than for a loan. Typically, grants are awarded to businesses that meet special criteria. For example, non-profits, minority- or women-owned businesses and those that perform highly-technical research and development activities often qualify for grant money.

2. Find out if you qualify for federal grant money. The federal government does not give grants for starting or growing a small business. Some businesses do receive federal grant money if they are involved in something related to a policy initiative. For example, the Small Business Administration (SBA) can sometimes make grants to non-profits for education and training. Also, federal grants sometimes fund medical research, science, education and highly-technical research and development activities.

SBA grants for non-profits are announced on grants.gov.

Businesses qualifying for specific initiative grants authorized by Congress will be notified.

U.S. government's Small Business Innovation Research (SBIR) program and its Small Business Technology Transfer (STTR) programs offer grants for high-tech research and development. You can find out about these grants at SBIR.gov.

3. Find state and local grants. State and local governments sometimes offer grants to specific kinds of businesses. For example, some states offer grants for expanding child care facilities. Other initiatives for which you may find state grants include developing energy-efficient technology and creating marketing for tourism. You usually are required to match funds if you receive one of these grants. Also, the grants are typically small, so you may have to seek other forms of financing, such as a loan.

4. Apply for grants for women- or minority-owned businesses. Most states offer grants for women- or minority-owned businesses. Also, federal agencies assist women and minorities to find funding to start or expand their businesses. Finally, private funding sources are available for women- and minority-owned businesses.

Go to the business section of your state's website to find available grants. Here you will also find information about any incentives or programs your state has available for your business.

Visit the Minority Business Development Agency (MBDA) at mbda.gov. This agency is run by the U.S. Department of Commerce, and it helps minorities and women to establish and expand their businesses. Here you can research grants and find links to state funding for your business.

Private companies that fund grants for women-owned businesses include Huggies, Chase Google, InnovateHER, Fedex, Idea Cafe, the Woman Veteran Entrepreneur Corp (WVEC), Walmart and Zion's Bank.

Private companies that offer grants for minority-owned businesses include Fedex, the National Association for the Self Employed (NASE), Miller Lite and Huggies.[15]

Method 3 Finding Investors.

1. Compare investments with other types of financing. Investments are similar to grants in that they do not have to be paid back. However, they are different from grants in that the investor contributes to the company in exchange for shares, or partial ownership, of the company. This is called equity financing. Companies who choose to find investors are typically young companies that cannot qualify for other types of financing.

2. Find venture capital investments. Venture capital is perfect for businesses that cannot qualify for traditional financing either because of their small size, early stage of development or lack of equity capital. Venture capital funds invest cash in exchange for shares in your business and an active role in running the business. These investors target young, high-growth companies. This is typically a long-term commitment that gives young companies time to grow into profitable businesses.

Find venture capital funds through the Small Business Investment Program (SBIC). This program is administered by the SBA. It licenses private funds as SBICs and links them to businesses seeking equity financing. You can find the list of licensed funds by state at www.sba.gov/content/sbic-directory.

Each venture fund is a private company with its own application process. In general, the fund begins by reviewing your business plan. Then it does due diligence on your business to evaluate the worth of the investment. If the fund decides to invest, it will take an active role in running the business with you. As your company meets milestones, more financing may be available. Venture funds typically exit the investment after four to six years via mergers, acquisitions or Initial Public Offerings (IPOs).

3. Seek an angel investor. Angel investors are high-net-worth individuals who seek lucrative investments in young, high-growth businesses. These investors may be doctors, lawyers or former entrepreneurs. The Securities and Exchange Commission (SEC) has established specific criteria for accrediting angel investors.

According to the SEC, angel investors must have a net worth of at least $1 million and make $200,000 a year (or $300,000 a year jointly with a spouse).

Angel investors give you money in exchange for shares in your company. This exchange must be registered with the SEC.

Find angel investors through networking with your local Chamber of Commerce or Small Business Development Center. Also, a trusted lawyer or accountant may be able to link you to an angel investor.

Find angel investors online at the Angel Capital Association (ACA), AngelList and MicroVentures.

4. Ask friends and family. You may have friends or family members who are willing to invest in your business. Be very careful about making this choice. Unless they are already wealthy, sophisticated investors, they may not understand the risk involved. If your business fails, you cannot easily shut it down and walk away if friends and family are partial owners. Before accepting their money, make sure they understand how easily it can be lost.

December 19, 2019