It’s the question that everybody starting a small business asks. Do I need outside funding or can I bootstrap my business. If I do need funding, what kind do I need, and how to I get it?

Most businesses are actually financed by home equity or private savings. Attracting venture capital or angel investors is something that very few businesses will succeed at, though many will definitely try. And unlike investment money, borrowing will depend on collateral and guarantees over business ideas. So first and foremost, take a serious look at your financial situation and your business from a lender or investors  perspective. Be honest with yourself as you look at what sort of financing is feasible for your situation.

How do you know what the right funding is for your business type? In The Right funding for Your Business Type, Tim Berry discusses some funding options and their pros and cons. In a nutshell:

• Venture capital firms want repeat entrepreneurs and businesses with huge growth rates
• Angel investors are a lot like VCs but typically invest smaller amounts
• Commercial banks generally will loan money for working capital or expansion, but not usually to brand-new businesses
• SBA loans are available for various small business situations and populations, but still require collateral
• Friends and family financing can be a good fit, or fraught with problems
• Personal financing is great if you have the money and can put everything on the line.

For more details, read Tim’s full article. Or for another point of view, check out The Four Tiers of Small Business Financing.

Investment image from homepage courtesy of Shutterstock

It’s no secret that small businesses can have a hard time getting financing. So before you approach lenders, make sure you ask yourself: how can I maximize my chances of getting credit approval?

Here are five simple things you can do to up the odds of  getting your funding  approved.

1. Demonstrate that your business generates steady cash flow.
   Cash is still king and is also a key predictor of a business’ health and prospects for the future. By being able to demonstrate you have ample and/or steady cash flow, you are ensuring to potential financers that you have plenty of money to pay creditors, employees and others on time. Make sure to be clear and show your financer what predictable cash flow you have coming in. Demonstrate this by being ready to provide financials statements, tax returns, and bank statements. These documents provide the financer with a historical perspective of the performance and liquidity of the business. Anticipate questions about fluctuations in cash flow: if cash flow dipped because of the recession or the loss of a customer, provide an explanation in advance.
2. Maintain a manageable debt load.
   Debt load is the amount of debt that is carried on your balance sheet. You need to be able to demonstrate you can not only handle your current debt load but also the additional debt repayment your proposed financing will cause. If you want to incur the debt for expanding your business be prepared to demonstrate why this additional debt will be beneficial. For example, show how the added liquidity will be used, and forecast the additional revenue that will be derived as a result of the infusion of cash. The use of proceeds from the loan is a critical point of information for the financer.
3. Sustain a positive payment history.
   One of the most important factors for any financer to weigh is a business’ payment history. A financer needs to see that a business has a record of paying down debt, and on time. A financer may have obtained a third party credit report on your business, such as a Dun & Bradstreet report. Ask to see the report to verify that it is accurate. The report may not mention your significant trade partners and other lenders who would provide a good reference, and confirm your good payment history. You can demonstrate this by providing these references, and be sure to include the contact information for the person you deal with at your bank, trade supplier, etc.
4. Prove business judgment.
   Potential lenders want to be assured that you anticipate potential challenges and have a plan in place as to how to address these challenges. Furthermore, lenders are also interested to see that you have the management in place necessary to overcome any obstacles that might come your way. If possible, have a business plan that you can show financers. The business plan should contain a forecast for your business with at least two scenarios: how you expect your business to perform if you don’t get approved for financing, and how it will perform if you do.
5. Shop around for financing.
   Don’t assume your bank or the vendor will offer the best terms. Compare rates, lease terms, fees and options and use only established financing providers.

Since start-up funding and growth financing for small- and medium-sized businesses has been in such short supply these past couple years, I thought posting about this CNNMoney.com / Fortune Small Business article on finding novel local investment would be a welcome change.

The article, originally published earlier in September, is about owners of several types of small businesses which opened, recovered, or expanded during the current economic crunch because local patrons were willing to invest in their favorite local businesses. Several types of money raising programs are discussed, including VIP cards/treatment for shareholders, $600 store and restaurant certificates sold for $500 (20% is a pretty good ROI), as well as “shares”.

Businesses showcased include restaurants, bookstores, pub/bar, and a fair-trade retail gift store. The focus of these financing efforts is on encouraging customers to become patrons or shareholders. And shareholders are a loyal customer base. Local shareholders feel vested in the company and want you to succeed.

Look to your customer base and your community. Including them as participants in your business and fostering a buy-local awareness could bring you that shot-in-the-arm financial boost to success.

Read the entire Love a local business? Buy a share article.

Steve Lange
Palo Alto Software

On their Small Business page CNN.Money.com has published some interesting stories on small businesses in the U.S. who are feeling the credit crunch and how they are responding.

One page has a series of vignettes of small business efforts to cope. Business owners discuss many problems and solutions from moving their business locations, late accounts receivables, stunted growth, evaporating markets, to loss of lines-of-credit.

A longer article also discusses the problems businesses are facing in the current credit freeze. One family business was forced to close, another small business found local funding when big banks balked, and still another has had to turn away sales because no bank will fund their facilities expansion.

For many years home equity provided start-up and working capital for millions of U.S. businesses. In Hurdle: The Book on Business Planning, President and Founder of Palo Alto Software Tim Berry says:

Why do we say that banks are the most likely source of small-business financing? Because small-business owners borrow from banks. A great deal of small-business financing is accomplished through bank loans based on the business owner’s personal collateral, such as home ownership. Some would say that home equity is the greatest source of small-business financing.

However, this may no longer be the case as another article on CNN Money discusses how home equity as a source of small-business financing has recently changed.

All of this points out how absolutely necessary it is for business owners to focus on their planning processes every single month in managing their companies’ cash flow.

Steve Lange
Senior Editor
Palo Alto Software

Even in these tough times, as you look toward starting up, it’s still way too easy to focus on “getting financed” instead of focusing on getting financed right, getting financed well or, perhaps, getting no financing at all.

Amazing but true: Sometimes no financing at all is better than the wrong financing.

I was at the Forbes.com headquarters in New York last week, as a judge at the Forbes.com Boost Your Business contest, which includes a $100,000 prize. By the way, if you’re interested, you get to vote on this one, so click here for details on that.

On the Forbes.com site, I discovered The Right And Wrong Ways To Raise Money, written last month by Dileep Rao. He tells a story that illustrates my point:

Take it from Consumer Products Company. (I have disguised the real name to save the owner the embarrassment.) CPC was started by a young entrepreneur with a new product. He obtained his funding from a rich investor to whom he sold a controlling stake.

When the product started to take off, the majority investor took control and threw the entrepreneur out on his ear. The poor guy sued, recovering a little over $100,000 (after substantial legal fees); meanwhile, the investor unloaded the company a few years later for over $100 million.

Seems unfair, I suppose. But, just my opinion here, there are two sides to some of these stories. That $100,000 investment is a lot of money. Would you invest that much without control? If you had the money? Maybe. With the right team, the right product, the right plan . . . but maybe not. These issues aren’t all that simple.

For another view, try Choose Investors Carefully, or Not at All, on my other blog.

Dileep Rao goes on to add some additional good advice on watching this carefully:

Then there was Healthcare Company, a contract home-care provider. HC had raised nearly $400,000 of working capital from a bank and was also planning to lease $70,000 worth of computers. About a year after the original financing, my phone rang. The frantic entrepreneur explained that while he was tracking his sales targets, he needed another $70,000 to cover working capital.

When I looked at his financial statements, I found that he had used $70,000 of that original $400,000 to buy computers because Dell (nasdaq: DELL – news – people ) was not willing to lease them. I asked him if he had looked into other leasing companies–he hadn’t. HC never recovered, and the bank foreclosed on the business.

Moral: Startup capital is precious. Do not deplete your working-capital reserves until the venture is kicking off positive cash flow–chances are you will regret it.

And I want to add my own conclusion, from a more recent post on my other blog. This is a quote from William Sahlman, whose 1997 article on business plans is one of the most-often downloaded articles on the Harvard Business Review site. He was asked how his views have changed in 10 years. One of my favorite pieces of his answer was:

The best money comes from customers, not external investors.

Good, solid, well-thought-through cash-flow planning just became all the more important. The New York Times reported in a 28 July 2008 article, Worried Banks Sharply Reduce Business Loans, how banks nationwide have clamped down on loans and lines of credit to businesses.

“Financial industry executives say tighter credit from major banks represents a swing back to a realistic assessment of risk, after years of handing out money with abandon,” says the NYT. This new aversion to lending to businesses is putting a damper on the expansion and growth of business and industry alike.

Here’s where realistic cash-flow planning proves its worth. With it, businesses can moderate their yearly goals, adjust their accounts receivable and payables, keep tighter inventory control (such as just-in-time ordering), and weather the current financial storm without having to borrow money.

With a history of well-documented planning, correct accounting, and plan vs. actual analysis, coupled with well-considered course adjustments, a business which does need to borrow can overcome the reticence of newly risk-averse banks.

Without realistic cash-flow planning, you can be a profitable, successful business and still be bankrupt.

Business Plan Pro, published by Palo Alto Software, is the tool for planning and managing your business’ cash-flow. Use it to sail the stormy waters of this tempestuous economy. And if your planning process shows you will need to borrow money, Business Plan Pro can produce the plan and report documents you need to successfully navigate the reefs and shoals of bank financing. Show them that this is a planned part of the voyage, not just a desperate cash-dash to any port in the storm.

Steve Lange
Senior Editor
Palo Alto Software