Entrepreneur loans for the start-up phase: what options are open to founders?

Many founders are at the very beginning of their careers. There are certainly already successful founders who have the necessary capital, but the majority have to look for ways to finance their start-up and the first period. Getting a loan is therefore often not easy. The self-employed are rarely among a bank’s favourite customers. But how do you actually obtain an entrepreneur loan in the start-up phase?

Figure 1: start-ups in Germany rely on various sources of finance. The focus is often on their own funds. But what if an additional cash injection becomes necessary? Image source: @ Smava.de

The situation of founders at a glance

Many founders are in the position of not yet having a sufficient financial cushion. There may well be savings, but in many cases these are already invested in their own business idea. The bottom line is that there is often little or no equity left.

For banks that means:

1. Hardly any dependable income

The founder’s income is not secure. There is a difference for part-time founders, since they can show income from their main job. Income from self-employment alone is always viewed by banks with a certain amount of doubt, because it is by no means guaranteed. Revenue fluctuates and, especially at the beginning, is by no means safe to calculate. On top of that, there is only rarely and only briefly an entitlement to unemployment benefit. If the venture fails, founders would have to fall back on Hartz 4 and could no longer meet their financial obligations.

2. Hardly any collateral

This too is usually thin on the ground. Of course there are founders who already own a fully paid-off home or high-value works of art, but that is rather the exception. Normally no collateral at all can be provided for the business loan.

In fact it is often difficult to convince a bank as a founder. For that reason, conventional business loans are not at the top of the list of financing options for start-ups either.

In many cases founders also get in their own way, because exaggerated expectations and calculations are ultimately a stumbling block. But none of that knowledge helps the founder, because in their situation they need an entrepreneur loan for:

• Building – whether office space, storage rooms, production halls or laboratories have to be built or extended is beside the point. The money for it is necessary.
• Equipment – this of course varies depending on the type of business founded. But almost every newly founded start-up needs certain plant or equipment.
• Legal costs – these should not be underestimated either. A founder is well advised to have specialist lawyers at their side. Hardly any founder manages to file a patent application correctly and comprehensively on their own.

Note: If a patent has already been successfully registered, this can have a positive effect on borrowing. The reason is quite simple: the product devised can no longer simply be brought to market by outside companies – so the prospects for sales, and therefore the income, increase.

What conditions do founders have to meet for bank loans?

Every company founder should prepare perfectly for the loan application. That means not only knowing about the possible funding programmes, but also being able to present themselves and their business in the best light. But what does that involve?

• Business plan – very few banks can assess a newly founded company, its products and its prospects. An outstanding – and professional – business plan is therefore the first foundation. Using the plan, borrowers can set out the company’s prospects and explain in precise detail how they intend to reach a specific goal. An essential part of the business plan is also a cash flow plan derived from it, showing how the bank loan will be repaid. Without a business plan, there is at best a chance of a small loan if the business is set up in the living room at home and there are hardly any start-up costs otherwise.
• Guarantors/second borrowers – it is also possible to use a guarantor for the entrepreneur loan. However, the guarantor in turn has to meet the bank’s requirements, and all parties must be clear that the guarantor is liable for the loan should the company fail. The same applies to a second borrower, whose liability sometimes goes even further.
• Equity – the more equity there is, the better the chances of getting a loan. Equity does not mean that the founders have to have saved the money themselves. Cash injections from family and friends can also count as equity. The same goes for land, provided it is unencumbered. As a rule it is advisable to be able to show at least 10-15% of the required sum as equity for a business loan.

In fact founders often have better chances if they can still show a salaried job. This serves as security for the bank. The important thing is simply to clarify exactly what the bank expects with regard to the employment relationship. Quite a few founders no doubt use employment to get a part-time venture underway safely and well, but plan to work full time in their own company from day X. It is conceivable that the lending bank will require the employment relationship to be maintained for a certain period.

What other ways can founders raise capital?

Many founders face an enormous dilemma. They have a brilliant idea whose success they are genuinely convinced of. But putting that idea into practice on a larger scale takes money – and they do not get it because they cannot offer any financial security. There are good reasons why quite a few entrepreneurs do the rounds of special TV formats or look for investors elsewhere. But if conventional loans are difficult or impossible, it is time to look for alternatives. Because in principle there certainly are options for obtaining the capital needed:

• Funding products – at regional level there are often special funding programmes intended for start-ups from the region. Depending on where you live there are entire funding networks that can sometimes prove useful. If they cannot provide the funds themselves, they at least try to bring promising founders together with financially strong partners. There are also some funding programmes at EU level that at least
• KfW funding – through the KfW, founders can obtain the »StartGeld« and a further founder loan. While the capital loan for the start-up is intended to strengthen a company’s equity, the StartGeld is actually meant for the start-up itself, running costs and investments. The StartGeld is granted up to €125,000, the capital loan up to €500,000. The advantage of these subsidised loans is that the KfW takes on all or at least part of the credit risk and sets extremely reasonable repayment instalments. On top of that, depending on the programme, repayment-free years can be planned in initially, during which only interest is due. That gives the young company some time at first to place its investments successfully. It is also possible to take up the loans when the company was founded some time ago. The StartGeld can be applied for up to five years after the company was founded.
• KfW: SME subsidised loan – this is aimed at small and medium-sized companies, including newly started ones. Freelancers can apply for the loan as well. The sums run into the millions. This loan is more of interest to founders who have already managed the first step and now want to expand.
• Private loans – these are a good option provided there are sufficiently well-off people in the family or circle of acquaintances. With a private loan, however, a proper loan agreement is always necessary, setting out the amount, the repayment arrangements, the deadlines and the interest. Unfortunately the saying that friendship ends where money begins applies here, and without something in writing either side can claim that the loan was lower or higher, that a different interest rate was agreed and so on. In principle, by the way, a financing syndicate is not incompatible with a private loan. Friends and family can therefore also aim for private funding. Here too the rule is: every participant must have their terms written into the contract. Privately that can look like this: grandma €5,000, dad €1,000, brother €10,000 and so on. Everyone then has to agree jointly on the interest and the instalments.
• Crowdfunding – this method is also quite common, and there are clearly two options. The first, genuine crowdfunding, involves private individuals as backers who can contribute a sum to the venture. As a rule this works well if the company is going to sell innovative products – the backers normally do not get money back but the product. The other alternative is more specialised, because here real investors sometimes put money in – with large amounts, too. Much can certainly be arranged, but investors usually expect a share of the profits in return for their outlay. At the same time they take on a certain share of the company. Only the search via special platforms distinguishes them from ‘real’ investors. The second form is also referred to as crowdinvesting.
• Investors – to begin with: no investor gives money for a good cause, because of course they want to make money from the company. So once again the business plan is the measure of all things. Beyond that, though, the chemistry has to be right. So-called “business angels” like to come in right at the start in particular. But alongside a pure injection of capital they also want to help with their know-how. For that reason it is all the more important that there are no major personal differences.

Most start-ups are probably completed with a mix of different sources of finance. Even the equity is often made up of various funds, with further money coming from funding programmes, from family or from investors. What matters is being able to present a good business plan to all parties. Normally that is the only way to succeed with the pitch. An example: anyone who wants to found a specialist software company offering a special solution against hacking attacks should be able to present that solution clearly and understandably in a few sentences.

Figure 2: many roads lead to the desired cash injection. Founders should examine all the options carefully and, in the end, make an informed decision. Image source: @ Ibrahim Boran / Unsplash.com

Conclusion – several roads lead to the pot of money

Founders certainly do not have it easy. A good idea alone brings in no income, because only with implementation is there any potential for profit. Yet banks normally expect exactly that beforehand: financial security. That is what makes it so hard to gain access to appropriate sources of finance. Nevertheless there are certainly options and routes to obtaining suitable entrepreneur loans. The KfW’s founder loans and the start-up support offered by cities and federal states in particular can be helpful. Anyone who generates money from family, friends and perhaps crowdfunding at the same time has a good chance of actually pulling together the necessary capital.